Trending Value: cheap stocks that are already moving up

Cheap stocks can stay cheap for a long time, sometimes for good reason. Rising prices (momentum) show that other investors have started to agree a stock is worth more. James O'Shaughnessy tested many strategies in What Works on Wall Street and reported that combining value with momentum worked well in his historical tests. His Trending Value approach screens for the cheapest stocks, then picks those with the strongest recent price performance.

Stock Meadow follows that two-step shape with the data it has.

1. Build a value composite. Each stock is ranked 0–100 on P/E, price / sales, EV / EBITDA, price / free cash flow and price / book (lower is cheaper), and the scores are averaged with equal weights. A stock with no price / book figure is averaged on the other four. A loss, negative free cash flow, negative EBITDA or negative book value ranks below every positive figure on that measure.
2. Keep the cheapest 10%. The stocks with the best composite go through (at least one). Everything else is listed as unranked.
3. Rank the survivors by momentum. They are scored 0–100 by six-month relative strength (six-month return minus the S&P 500's return) against each other. That score is the stock's score. The value composite only decides who gets ranked, so it adds no points.

Assume 500 fictional stocks pass your filters and have complete data. The value composite keeps the cheapest 10%, which is 50 stocks. Company A is one of them. The figures are made up for illustration and do not describe any listed company.

With a composite of 90.0, Company A is among the 50 cheapest. Those 50 are now ranked by six-month relative strength. If A beat the S&P 500 by 15 percentage points and that is the tenth best of the 50, its score is (50 − 10) ÷ 49 × 100 = 81.6 out of 100.

Note that the score reflects only momentum within the cheap group. It is not a forecast of the stock's return.

1. Choose Trending Value (O'Shaughnessy) in the scoring-model picker.
2. Keep filters light. Only a tenth of the stocks are ranked, so it works best on a large screen with few filters.
3. Open a stock's breakdown to see its value-composite position and its relative-strength score.

The model uses a fixed recipe, so metric Score switches and custom weights don't change it, although filters still apply. A stock needs P/E, price / sales, EV / EBITDA, price / free cash flow and six-month relative strength; price / book is optional. That leaves out banks and insurers, which have no EV / EBITDA, and recent listings without enough price history. At least ten eligible stocks are needed. The sector comparison does not apply. See the full methodology.

• Only the cheapest 10% are ranked. A good stock just outside the cheapest group gets no score.
• Momentum is short-term. Six months of relative strength can reverse quickly.
• It is not an exact copy. O'Shaughnessy's version also uses shareholder yield, which Stock Meadow doesn't have.
• Cheap on ratios is not always cheap. Depressed earnings and one-off items distort multiples.
• Quality is not checked. The model does not look at debt or profitability.

Stock Meadow's scores are research tools based on reported financial data. They do not predict returns or recommend buying a particular stock.

James P. O'Shaughnessy, What Works on Wall Street. This guide describes Stock Meadow's implementation; Stock Meadow is independent of that publication. For a value strategy based on quality instead of momentum, read the Magic Formula guide.

Each measure has its own page with a formula, how to read it and common pitfalls.

• P/E Ratio (Price-to-Earnings): what you pay for each dollar of profit.
• Price-to-Sales Ratio (P/S): what you pay for each dollar of sales.
• EV/EBITDA: whole-company price vs. operating cash earnings.
• Price-to-Free-Cash-Flow (P/FCF): what you pay for each dollar of spare cash.
• Price-to-Book Ratio (P/B): what you pay for each dollar of net worth on the books.
• Six-Month Relative Strength: six-month return compared with the S&P 500.

What is the Trending Value strategy?

It is James O'Shaughnessy's approach of buying the cheapest stocks, as measured by a composite of several valuation ratios, but only those whose prices have already begun to rise. It avoids stocks that stay cheap because the market is giving up on them.

Why does Stock Meadow keep only the cheapest 10% of stocks?

The value step is a screen: the 10% of stocks with the best value composite are kept, and only they are ranked by momentum. The rest are listed as unranked with the reason.

How is momentum measured in Trending Value?

As six-month relative strength: the stock's six-month return minus the S&P 500's return over matching trading dates. The kept stocks are ranked by it against each other.

Is Stock Meadow's Trending Value identical to O'Shaughnessy's?

No. It is a close cousin. O'Shaughnessy's version also uses shareholder yield, which Stock Meadow doesn't have, and measures momentum differently.