10 value shares that are moving higher

Research has shown the power of buying cheap shares just as their prices are beginning to strengthen. Using this methodology, Stockopedia's Ben Hobson picks UK shares that fit the bill.

Buying undervalued shares in the belief that they'll rise in price is the stock-in-trade of value investors. It's also one of the most successful and vigorously tested strategies in investing. But while value strategies are shown to work over the long-term, it's also true that they endure spells of painful underperformance.

So it's no surprise that researchers have looked for ways of getting smoother returns from value strategies. One of the most compelling findings is that you can reduce wild volatility by looking for stocks that already have momentum behind them.

The pain of value investing

Back in the 1990s, a well-known British fund manager called Tony Dye raised eyebrows when he warned that the market was overpriced. With the FTSE 100 at around 4,000 points, Dye slashed his clients' exposure to equities. But as the dotcom bubble inflated, some started complaining that he was being far too pessimistic. 

While many others raced to buy speculative and increasingly pricey technology and telecoms stocks, Dye's fund performance slumped. He was ridiculed in the City and ended up getting fired by his firm, Phillips & Drew. 

Within months of course, Dye's predictions proved correct as the market collapsed. Phillips & Drew hadn't even had time to reverse his strategy. Lucky for them too, because the firm was catapulted from the bottom to the top of the pension fund performance league table as the tech crash unfolded.

This was a classic illustration of one of John Maynard Keynes' famous quotes: "Markets can remain irrational longer than you can remain solvent." Although in Dye's case, the market remained irrational longer than he could stay employed. 

Dealing with volatility

Over the past 30 years researchers studying the forces of stockmarket returns have formed a consensus around the power of mixing value with momentum to manage this volatility. Academic-turned-fund manager Josef Lakonishok was one of the main players in this movement. His research showed the power of buying cheap shares just as their prices were beginning to strengthen.

More recent studies by influential investors like Cliff Asness of AQR Capital and Wes Gray of Alpha Architect, have reinforced the view that a combination of value and price momentum can improve returns and smooth volatility over time.

One of the strategies that we track at Stockopedia seeks out companies that show the signs of having both value and momentum. It looks for firms that are well priced against their growth rates (using the price/earnings-to-growth, or PEG ratio) and seeing their share prices begin to reach new highs. Although the strategy has come under pressure recently, it's long-run performance has been strong. 

Source: Stockopedia       Past performance is not a guide to future performance

Here are some of the companies that currently qualify for the strategy rules, sorted by their PEG ratios. 

Source: Stockopedia       Past performance is not a guide to future performance

This value and momentum approach tends to gravitate towards smaller-cap stocks, although the education group Pearson and the logistics and travel operator Dart Group both pass these strategy rules. 

Elsewhere, the list is led by the bathroom and kitchen products supplier Norcros, communications agency Mission Marketing, recruitment firm Staffline and building services business T Clarke.

Smoother returns

In the current market conditions, there are questions about whether the momentum trade, which has been so powerful in recent years, is breaking down. In glamorous, fast growing shares those question might have merit. But with smaller, relatively cheap stocks that are beginning to catch attention, momentum can be a useful indicator.

A combination of appealing valuation and positive price strength are hallmarks of some of the world's most successful investors. In tandem, these two factors can point to stocks with classic turnaround profiles - where the shares are bouncing back from a period in the wilderness.

Most investors shun them, and there is no doubt that careful research is needed. Yet cheap stocks on the move may well offer a smoother way of capitalising on two of the strongest drivers of returns in the stock market.

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