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Playing Pure Value for a +14.5% Pure Profit

Posted
3/15/2010 3:53:00 PM
By: Melvin Pasternak
Referenced Stocks:PRF;RPV;RSI;SHLD;TSO;VLO;VTV

Many traders have asked me the same question during my 40 years of trading. What is the key to being successful?

Over the years, I have seen a lot of changes in the market, but one strategy has stood the test of time: seeking out attractively valued stocks with strong charts. I especially like established companies with low price-to-earnings (P/E) ratios in strong uptrends.

This is one reason the Rydex S&P 500 Pure Value ETF ( RPV ) interests me. RPV is an exchange-traded fund that seeks to replicate the S&P, and is currently comprised of 98 of the most attractively valued stocks in the S&P 500. The average holding of the ETF has a P/E ratio of 13.5. In contrast, the current P/E of the S&P 500 is 16.7.

RPV's one-year performance ranks in the top 1% of its large-cap value category. For 2009, RPV returned +53.4%. In comparison, the S&P 500 returned +23.4% for the year.

RPV stands out because it is a "pure play." Stocks included in this ETF are pure large-cap value plays only. The fund does not include small- or mid-cap value stocks.

RPV's holdings include 11 different sectors, from financial services to healthcare to consumer goods. Financial services account for the largest piece of the pie, about one-quarter. Utilities and Energy follow at 14.0% and 13.6%, respectively.

Tesoro Corporation ( TSO ) , a petroleum refiner and retailer, is the top holding. Other well-known companies among its top 10 holdings include Sears (Nasdaq: SHLD) and Valero Energy Corporation ( VLO ) -- a pick I described in last week's Double-Digit Trading .

RPV typically reflects the movement of the S&P 500. However, since the S&P bottomed in March 2009, the ETF far outperformed the index . The S&P hit a low in March 2009 at 666.79 and has risen by +71%. In contrast, RPV hit a low of $8.46 and has increased +194% during the same period --nearly three times the increase of the S&P.

Technically RPV has broken out of a bullish ascending triangle formation. The triangle was formed by the uptrend line and resistance, which was at roughly $24.



Two weeks ago RPV climbed back above its rising 10-week moving average, showing bullish momentum.

If the S&P continues to rally, RPV is likely to move higher. In this case, it will probably not encounter resistance until around $29. If the S&P corrects, RPV will likely find trendline and lateral support around $23.20.

The indicators are also bullish. MACD is about to cross over its trigger line, giving a buy signal. The relative-strength index ( RSI ) has been trending upward for nearly a year and is well above its current trendline, a bullish sign. Stochastics has reached overbought levels; however, strong securities can stay overbought for prolonged periods of time. So far, stochastics has not given a sell signal.

Fundamentally, RPV is attractively valued. On many metrics it boasts the best valuation of its peer group.

The ETF has a trailing P/E ratio of 13.5. The S&P's trailing P/E ratio is 16.5.

The price to sales (P/S) ratio of its portfolio holdings is 0.23. This is lowest P/S ratio out of all 32 large-value ETFs. In comparison, PowerShares FTSE RAFI US 1000 ( PRF ) has the second lowest P/S ratio at 0.49, more than double RPV's. The Vanguard Value ( VTV ) ETF has the third lowest P/S ratio. At 0.84, RPV also has the lowest price-to-book value ratio of its holdings compared with its large cap value peers. The next lowest price-to-book value is PRF at 1.25.

Given RPV's solid fundamentals, attractive valuation, and technically bullish chart pattern, it could be a worthwhile addition.


Editor
Double-Digit Trading

P.S. What's the best of the best? I did technical analysis on all 98 stocks in the Rydex S&P 500 Pure Value ETF and then fundamentally analyzed ten of the companies with the most attractive charts. I selected the best of these ten companies and I reveal the name of this stock in this week's issue of my newsletter, Double-Digit Trading.

Disclosure: Melvin Pasternak does not own shares of any security mentioned in this article.