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Signs of Revival in Unpopular Stock Picks

In this article, I delve into the methodology employed by Josef Lakonishok, shedding light on a roster of stocks that currently align with his strategy. Departing from Benjamin Graham’s principles, Lakonishok’s focus lies in acquiring undervalued companies that exhibit early signs of resurgence. The Lakonishok screening model has exhibited remarkable long-term performance, boasting an average annual gain of 12.3% since 1998, surpassing the S&P 500 index’s 6.2% over the same timeframe.

Decoding the Lakonishok Screening Model

The crux of this approach involves procuring underappreciated or overlooked stocks at favorable prices. Value investors, in particular, seek stocks that are attractively priced relative to their intrinsic value. This entails scouting for stocks trading at temporarily reduced multiples of price concerning book value, cash flow, earnings, or sales. The underlying premise is that although these stocks may currently be undervalued, the market will eventually recognize their worth, leading to price appreciation.

While historically, value investing has outperformed more glamorous strategies, it can also experience periods of disfavor. Nonetheless, the enduring appeal lies in its consistent outperformance compared to the broader market in the long run.

The foundational principles of value investing trace back to Graham and David Dodd’s seminal work [ppp1], initially published in 1934. Graham further refined his value investing philosophy in [ppp2], advocating for meticulous company and industry analysis to unearth robust, growing businesses trading at a significant discount.

Over time, several proponents have championed the cause of value investing. In [ppp3], Jonathan Burton converses with another luminary in the realm of value investing, Lakonishok, who transitioned from academia to the investment management sphere, leaving an indelible mark.

As one of the founding figures at LSV Asset Management, Lakonishok spearheads a team managing approximately $96 billion in assets as of the close of 2023. The firm specializes in value equity management, catering primarily to institutional investors.

The Virtue of Patience

Value investing eschews the allure of current stock market favorites. While others may seek quick profits, value investors must be prepared for potentially extended periods of lackluster performance before the market acknowledges the appeal of a particular company or industry. Patience, according to Lakonishok, is the cornerstone of successful value investing. It necessitates a contrarian mindset and a willingness to swim against the tide. If instant gratification is the goal, value investing may not be the ideal path.

Moreover, before committing to any “value” company, conducting thorough research is imperative to comprehend why the market is undervaluing it.

Understanding Investor Behavior

Lakonishok made significant contributions to the finance domain through his research in behavioral finance. He challenges the notion of a perfectly efficient market, asserting that inefficiencies exist which savvy investors can leverage to outperform the market.

Central to his thesis is the impact of investor behavior on market inefficiencies. Investors often rely excessively on past performance to predict future outcomes. Lakonishok contends that optimism prevails in assessments of growth stocks, while pessimism clouds judgments on value stocks.

According to Lakonishok, value stocks outshine growth stocks because of subdued expectations. When a value stock surpasses expectations, investors respond positively by driving up its price. In contrast, unrealistic expectations often plague growth stocks, leading to harsh market reactions when these expectations are unmet.

Key Value Metrics

Lakonishok employs fundamental value metrics like the [ppp4], [ppp5], and [ppp6].

Price-to-Book Ratio

This metric gauges a company’s book value, representing the net worth of its assets (shareholder’s equity). Value investors like Graham sought companies where the book value exceeded the share price, indicating a potential bargain.

Price-to-Free-Cash-Flow Ratio

While sales and earnings are crucial performance indicators, sustainable cash flow is vital for a company’s survival. Companies with robust cash generation can navigate economic fluctuations effectively.

Price-Earnings Ratio

A widely used metric, the price-earnings ratio signifies investor confidence in a company’s future prospects. A high ratio reflects optimism, while a low ratio signals uncertainty or subdued growth expectations.

Price-to-Sales Ratio

This metric is useful for evaluating companies with erratic earnings or no earnings. It indicates how much investors are willing to pay for a company’s revenue.

Lakonishok initiates the screening process by identifying companies with a market capitalization of $500 million or more. Additional screens are applied to ensure the quality and integrity of the selected companies, such as excluding those traded over-the-counter and those represented as American depositary receipts.

Identifying Value Opportunities

Lakonishok identifies potentially undervalued companies by comparing their key metrics against industry benchmarks. Companies exhibiting favorable ratios relative to their industry peers are considered potential value plays.

To avoid investing in stagnant or failing companies, Lakonishok looks for signs of momentum, such as price movements or improving analyst sentiments. Relative strength against the S&P 500 and positive analyst earnings revisions are key indicators of a company’s potential resurgence.

In Conclusion

While value investing has historically yielded favorable results, success isn’t guaranteed by solely relying on a single value metric. Lakonishok’s approach emphasizes identifying undervalued companies with sustained or improving performance metrics and positive analyst sentiment.

It’s crucial to remember that the stocks meeting Lakonishok’s criteria aren’t recommendations for purchase. Thorough due diligence is essential before making any investment decisions.