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Do Tesco shares offer an interesting Value & Momentum opportunity?

16th Jul by Keelan Cooper

Decades of academic research by quants, fund managers and institutional investors alike have found that a combination of Value & Momentum factors in stocks typically lead to market-beating returns.

Investment Guru and US Fund Manager, James O’Shaughnessy has been a strong advocate of ‘Trending Value’. In his book What Works on Wall Street, he explains that using several valuation ratios and combining them with improving price strength forms the basis for what has been one of the most effective stock market strategies.

But what is it that makes Value & Momentum such a successful stock market strategy and how does this apply to Tesco (LON:TSCO)?

GET MORE DATA-DRIVEN INSIGHTS INTO LON:TSCO »

The value component…

Cheap stocks have been shown to outperform expensive stocks over long-time frames. Therefore, finding stocks with a high Earnings Yield and low Price to Sales can be a good place to start in identifying attractively priced stocks.

The Earnings Yield takes a company’s profits and compares it to its current market valuation (enterprise value). Using the enterprise value takes into account cash and debt and the calculation gives us a good idea of the total value of the stock. Expressed as a percentage, a high Earnings Yield is a good sign of value. A good rule of thumb can be to look for an Earnings Yield above 5%Tesco beats this comfortably, with an Earnings Yield of 7.53%.

The Price to Sales ratio tells us how cheap/expensive a company is relative to its current sales. The calculation is quite straightforward, taking the current share price and dividing this by its sales per share. A Price to Sales ratio of less than 1 is said to offer good value. Tesco is well below this level, with a Price to Sales ratio of 0.32.

However, exposure to value as the only factor can increase the risk of finding value traps, which are cheap for a reason and often fail to recover.

… and the momentum driver

Although momentum inherently goes against investor psychology, it has proven to be one of the greatest tools investors can use when combined with other factors such as quality and value.

Trend following and momentum investing are often very effective strategies, although when momentum turns losses can mount quite quickly. Whilst value can take time to be realised momentum works very well during bullish, trending periods. To assess price momentum we can use Relative Strength, which compares the share price change to the underlying market index over a specified period of time.

Outperformance and strong momentum is a good indicator that a share might continue its upward trend. Tesco’s Relative Strength over the past 6 months stands at an impressive 7.15%.

What does this mean for potential investors?

Finding good quality stocks at cheap prices is a strategy used by some of the world's most successful investors. But be warned: these factors don't guarantee future returns and we've identified some areas of concern with Tesco that you can find out about here.

Alternatively, if you'd like to find more shares that are showing signs of having strong quality and momentum, just come and take a look at this Value & Momentum screen.

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