Quality and value are two of the most important drivers of stock market returns - yet many investors fail to take them seriously. At a time of deep economic uncertainty, using these two powerful factors to find stocks could help you navigate market volatility.
The Jersey Electricity share price has moved by 7.55% over the past three months and it’s currently trading at 470. But what's interesting about this share is its strong exposure to those all-important profit drivers of high quality and a relatively cheap valuation.
This matter because at a time when many investors are on the lookout for cheap shares, it's essential to know the difference between a genuine bargain and a value trap. The secret is that it's often the quality of the stock that makes all the difference.
Here's where that difference shows up:
Quality you can depend on
Good quality stocks are loved by the market because they're more likely to be solid, dependable businesses. Profitability is important, but so is the firm's financial strength. A track record of improving finances is essential.
One of the stand out quality metrics for Jersey Electricity is that it passes 6 of the 9 financial tests in the Piotroski F-Score. The F-Score is a world-class accounting-based checklist for finding stocks with an improving financial health trend. A good F-Score suggests that the company has strong signs of quality.
Buying at a fair price
While quality is important, no-one wants to overpay for a stock, so an appealing valuation is vital too. With a weaker economy, earnings forecasts are unclear right across the market. But there are some valuation measures that can help, and one of them is the Earnings Yield.
Earnings Yield compares a company's profit with its market valuation (worked out by dividing its operating profit by its enterprise value). It gives you a total value of the stock (including its cash and debt), which makes it easier to compare different stocks. As a percentage, the higher the Earnings Yield, the better value the share.
A rule of thumb for a reasonable Earnings Yield might be 5%, and the Earnings Yield for Jersey Electricity is currently 11.3%.
In summary, good quality and relatively cheap valuations are pointers to those stocks that are some of the most appealing to contrarian value investors. It's among these shares that genuine mispricing can be found. Once the market recognises that these quality firms are on sale, those prices often rebound.
Find the strongest shares in the stock market
Finding good quality stocks at attractive prices is a strategy used by some of the world's most successful investors. If you want to find more shares that meet these rules, you can see a comprehensive list on Stockopedia's StockRanks page.