Cheap stocks flash a buy signal!

Predictive model shows cheap stocks on a price to earnings (P/E) ratio basis should outperform a year from now

Source: Bloomberg, BMI
The Nigerian Stock Exchange All Share Index is down 9.8 percent so far this quarter, underperforming every emerging -market equity benchmark along the way.

Using Bloomberg’s back testing model building tool to determine how price earnings (PE) ratios might predict the performance of stocks, we can see the performance of the different P/E ratio quintiles historically.

The table shows that stocks with the lowest P/E ratios (Quintile 1) had better annualized returns (2010 to Q3 2016) than those with the highest ratios (Quintile 5) which had the worst.

The Nigerian Stock Exchange All Share Index’s annualized return is also displayed.

The Q Spread, the difference between the lowest and highest quintiles’ returns, shows how lower P/E stocks outperform through time.

The Average Information Coefficient (‘Average IC’) values indicate which factors have better predictive ability. Factors with an average coefficient of 0.05 to 0.07 are considered to have excellent predictive capacity.

The P/E factor has an IC of 0.045.

The data suggest that stocks that currently sport low P.Es can be bought and should outperform in coming quarters.

Some stocks now sporting really low PEs include UBA, Dangote Flour and Lafarge Africa, among others.

 

PATRICK ATUANYA