11 value shares bouncing back in volatile conditions

Amid the chaos there are opportunities to buy great companies on the cheap. Stockopedia's Ben Hobson names the shares that are recovering and beginning to outperform the market.

As we approach the end of 2018, the near-term political and economic outlook in the UK could hardly be less certain. For investors, it's a volatile end to the year in the stockmarket. Falling prices in recent weeks might have improved valuations in some parts, but predicting where the market will go next is impossible.

Deciding when to trade in or out of shares is a very personal decision. But in times of stress - certainly when prices are falling - it's worth considering the rules behind some of the most influential and time-tested strategies.

Back in the early 1990's, a hugely successful investment manager called Seth Klarman wrote a book called Margin of Safety. In it, he explained why investing in shares priced at a deep discount to their underlying value has a stellar track record of producing excellent results. Indeed, Klarman became a billionaire by running his firm Baupost using the exact same principles. 

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Deep value investing is very much a contrarian approach to the stockmarket. It means finding shares that other investors hate the look of. Klarman summed it up by explaining:

"Value investing by its very nature is contrarian. Out-of-favor securities may be undervalued; popular securities almost never are. If value is not likely to exist in what the herd is buying, where may it exist? In what they are selling, unaware of, or ignoring. When the herd is selling a security, the market price will fall well beyond reason. Ignored, obscure, or newly created securities may similarly be or become undervalued." 

Value with a momentum twist

The same value approach has been adopted and executed with great success by other investors, too. One of them is Josef Lakonishok, another US-based fund manager. His academic work found that investors generally rely too much on the past to make predictions about the future, and frequently pay too high a price for the shares that they buy.

But while Lakonishok is committed to the rules of value investing, he gave his strategy a twist by looking for shares that were beginning to rise in price. So he combined conventional measures of cheapness with signs of positive momentum. He looked at valuation ratios like price-to-book, price-to-earnings, price-to-cash flow and price-to-sales, together with positive price momentum and earnings surprises. The aim of the strategy is to find out-of-favour shares that are on the move. 

At Stockopedia we track an investment strategy based on Lakonishok's rules and it has generated an annualised return of 13.8% over the past six years. 

Here are some of the companies that are currently passing those rules.

Source: Stockopedia       Past performance is not guide to future performance

While the recent market declines have dragged on some of these shares in recent weeks, they all show a positive momentum trend over the past six months. Some of the larger groups here include BT, which has been recovering from turmoil in early 2018, and Smith & Nephew, which has seen its share price soar in recent weeks.

Based on six-month relative price strength, the big movers include the communications firm Mission Marketing, data analysis company D4t4 Solutions and the aircraft leasing business Avation. Using Stockopedia's own Value-Momentum Rank, some of the other top achievers are firms like Ocean Wilsons and T Clarke. 

Overall, these stocks display the signs of value and momentum that are the classic hallmarks of contrarian investment strategies. But remember that further research and investigation is essential - especially when markets have been falling.

In periods of uncertainty it can be hard to know how to position a portfolio and when to trade. From a value perspective, it does look like the valuations of some stocks are more attractive after recent price falls. But those prices could fall further. 

For those investors looking for opportunities now or in the future, the combination of value and momentum could be a useful tactic. Cheap stocks that are recovering and beginning to outperform the market have a history of impressive returns. Value strategies can be hard to stomach. But in the case of investors like Josef Lakonishok, blending value with signs of recovery and positive momentum has proved successful.

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