Stock Picks for Quant Strategies

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There's an increasing amount of buzz on the street about the folks behind the curtain who build complex algorithms and mathematical models intended to detect (and exploit) market inefficiencies. As hedge funds continue to lose clients disenchanted with lagging performance, quant investment strategies are becoming more and more appealing to both fund managers and investors alike. According to the Financial Times, the flow of investor funds into the "quant" sector has more than doubled since 2009 (from $408 billion to nearly $880 billion). Several large hedge funds are increasing investments in quant strategies "as they search for new-and potentially more reliable-ways to produce returns." Tony James, chief operating officer of Blackstone, was quoted as saying, "Frankly, we expect to see assets move from human managers to machine managers."

Last year, Paul Tudor Jones of Tudor Investment Corp., one of the biggest names in the industry, tried to motivate his team for the new era of quant investing by declaring, "No man is better than a machine, and no machine is better than a man with a machine." Tudor's assets have fallen from $14 billion in 2014 to approximately $11 billion, and the firm has reduced staff and turned its attention toward elaborate data-crunching in an effort to shore up performance. In May of this year, billionaire Steven Cohen invested upwards of $250 million in Quantopian, a free online platform that gives its 85,000 members the infrastructure to build quant strategies. Perhaps the most successful hedge fund launch in recent years, PDT Partners, is a firm run by quant wunderkind Pete Muller (formerly of Morgan Stanley).

There's nothing magical about quant strategies. If anything, they're the opposite of magic. Models are built, numbers are crunched, and the outcomes trigger buy/sell decisions. Granted, that's an oversimplification, but suffice to say this is definitely a safety in numbers approach, with the added bonus that it removes any emotional response that a human might inject into the process. But the models are only as good as the humans who build them, so a strong quant team will keep its models flexible to avoid derailment when abnormal market events inevitably occur.

At Validea, all of our guru-based strategies are built using fundamental analysis of how an underlying business is performing as indicated through earnings, sales, debt, cash flows and related metrics. Of the investment legends we reference in our models, the three that focus strictly on quantitative measures are James O'Shaughnessy, Joel Greenblatt and Joseph Piotroski. Using these guru-based models, I have identified the follow six high-scoring picks:

Thor Industries, Inc. ( THO ) manufactures and sells various recreational vehicles (RV) throughout the U.S. and Canada. Our O'Shaughnessy-based model favors this company's persistent growth in earnings per share over the past five years as well as its price-sales ratio (based on trailing 12-month sales) of 0.99, below the maximum allowed of 1.5. THO also earns a high score under our Peter Lynch-based screen for the favorable relationship between the stock's price-earnings ratio and average earnings-per-share growth (based on 3, 4 and 5-year historical earnings-per-share), or the P/E/G ratio. At 0.85, THO meets the requirement for a P/E/G of below 1.0. Our Joel Greenblatt-based model favors the company's earnings yield (8.38%) and return-on-total capital of 62.05%.

Huntington Ingalls Industries Inc. ( HII ) designs, builds, and repairs ships for the United States Navy and the United States Coast Guard. Our O'Shaughnessy-based stock screening model favors the company due to its size (market cap of $7.24 billion) and consistent growth in earnings-per-share over the past five years, as well as the price-sales ratio of 1.01 (1.5 is the max allowed). This company also scores well under our Peter Lynch-based investment model due to the P/E/G ratio of 0.51 (anything under 1.0 passes this screen).

Five Prime Therapeutics Inc. ( FPRX ) is a clinical-stage biotechnology company focused on discovering and developing protein therapeutics. The company earns a perfect score under our Greenblatt-based stock screen given its earnings yield of 28.19% (calculated including all the company's debt as part of enterprise value) which ranks it sixth among the stocks in our database. The score is further supported by the company's return-on-total capital (59.14%).

HP Inc. ( HPQ ) is a provider of personal computing and other access devices, imaging and printing products, and related technologies, solutions and services. The company earns a perfect score under our Joel Greenblatt-based model based on its earnings yield (earnings before interest and taxes divided by enterprise value) of 15.10% and return-on-total capital of 111.34%. Our James O'Shaughnessy-based screen likes the company's size (market cap of $26.33 billion) and cash flow per share of $2.88 (versus the market mean of $1.40). HPQ also gets high marks under this screen based on sales (trailing 12-month) that exceed the market mean by at least 1.5 times. Our Kenneth Fisher-based model also gives HPQ a nod for its price-sales ratio of 0.55, well under the maximum of 0.75.

Unum Group ( UNM ) is a provider of disability insurance products in the U.S. and the U.K. The company is favored by our Peter Lynch-based investment strategy due to its attractive P/E/G ratio, an earmark of this model. At 0.67, UNM passes this screen. Our John Neff-based model, which requires sales growth to be greater than 7%, likes UNM's sales growth of 15.1%. Our Joseph Piotroski-based screen favors UNM's low leverage (long term debt-to-assets of 0.04, unchanged from the prior year) and operating cash flow of $1.29 billion which exceeds net income of $843.22 million (a requirement under this model).

Trinity Industries Inc. (TRN) is a diversified industrial company that owns a range of businesses providing products and services to the energy, transportation, chemical and construction sectors. Our Piotroski-based model, which focuses on companies with high book-market ratios (the inverse of price-book ratio) finds the company's positive return-on-assets (8.73%, up from the prior year) and positive operating cash flow indicators of fundamental strength. This model also likes the company's expanding profitability (gross margin of 27%, an increase over the prior year).

At the time of publication, John Reese and his clients were long THO, HII, FPRX, HPQ, UNM and TRN.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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