Trading In Style with Zacks Style Score and VGM Score
Academic research has proven that stocks with the best value, growth and momentum characteristics outperform the market.
This is good to know because most investors tend to categorize themselves into one of these three fundamental styles of trading.
And that is why we have created our Zacks Style Scores which assigns and individual style score of A, B, C, D, or F to each stock for each style. We also produce the VGM Score ('V' for Value, 'G' for Growth and 'M' for Momentum), which takes the weighted average of each of the three individual Style Scores and combines them into one score. This is perfectly suited for those who want their stocks to have the best scores across the board.
As you likely remember from your school days, an A is better than a B; a B is better than a C; and so on. That means the better the score, the better the expected performance.
And while the best stocks from any one of these styles is likely to beat the market, it's still important to know what kind of a trader you are (or want to be) and which style fits you the best.
Why is this important? Because if you find yourself getting into stocks or trading a strategy that's not in alignment with who you are or want to be as a trader, you're going to drop that strategy (no matter how good it's proven to work), the moment it hits a rough patch. So it's important to be in the stocks and the style that are right for you.
Defining the Basic Trading Styles
Each style has a unique set of characteristics that sets it apart from the others.
To make it easier to identify what kind of trader you are, let's define the three main fundamental trading styles.
Value investors and traders favor good stocks at great prices over great stocks at good prices. This does not mean they have to be cheap in price, though. The key is the belief that they're undervalued. That they are, for some reason, trading under what their true value or potential really is. And the value investor hopes to get in before the market "discovers" this and moves higher.
Of course, some stocks are cheap for a reason. Or, they may appear undervalued on one metric, but not on another. Too many so called value stocks have low valuations because they don't have compelling enough earnings or growth rates to speak of. (Why pay up for a company if there's nothing to pay up for?)
The value investor is trying to find stocks that are trading at a discount. And it's this deviation from its 'fair value' that creates upside opportunity.
Those interested in value will typically look at valuations like P/E ratios, PEG ratios, Price to Book ratios and more. But it's not enough to just look for the stocks with the lowest valuations. They might be low for a reason. Or worse, they might be damaged in some other way. These types of stocks are not value stocks. And they are definitely no bargain.
The Zacks Value Style Score helps separate the wheat from the chaff by identifying the stocks most likely to outperform by doing a deep dive on their valuation measures.
Stocks with a Style Score of A or B rate the best on these metrics and help identify the truly discounted names. These types of value stocks have a long history of showing superior returns.
Growth traders (aka Aggressive Growth traders), are primarily focused on stocks with aggressive earnings growth or revenue growth (or at least the potential for aggressive growth), which should propel their stock price higher in the future.
You'll often find smaller-cap stocks in this category because these are typically newer companies in the early part of their growth cycle. But you'll also find plenty of mid-caps and large-caps with stellar growth rates too.
However, there's much more to picking growth stocks than simply looking for those with the highest growth rates. In fact, companies with the highest growth rates have been known to perform almost as poorly as those with the lowest growth rates.
How can this be? It's because sky-high growth rates are unsustainable. And they can be priced for perfection. For example, a company earning 1 cent a share that is now expected to earn 6 cents, has a 500% growth rate. But, if it receives a downward revision to 5 cents, that's a significant drop. Even though it still has a 400% growth rate, the estimates were just reduced by -16.7% and the price is likely to follow.
If you've ever wondered how a stock with a triple-digit growth rate could possibly go down -- that's how.
Strong growth, of course, is important. And so are earnings estimate revisions. But quality is important too. The Zacks Growth Style Score evaluates companies based on their corporate financial statements, which includes the Income Statement, Statement of Cash Flows and the Balance Sheet.
Stocks with a Score of A or B are deemed the best and are expected to yield the highest returns over the next 1-3 months. Of course, they are not without their volatility. But these types of stocks can be some of the most exciting and can be very rewarding.
Momentum traders look to take advantage of upward trends (or downward trends) in a stock's price or earnings. We've all heard the old adage, "the trend is your friend." And who doesn't like riding a trend? Momentum style traders believe that these stocks will continue to head in the same direction because of the momentum that is already behind them.
These are the kinds of stocks a momentum trader is after - stocks exhibiting strong upwards momentum. And this, of course, also includes stocks making new 52-week highs.
I point this out specifically because some people hate getting into stocks making new highs. If you are one of them, you shouldn't be. Most people will cheer a stock they're already in if it makes a new high, but feel dread at getting into one making a new high if they haven't already done so. This is usually because of fear that since the stock has already gone up it has more room to fall. However, studies have shown that stocks making new highs have a tendency of making even higher highs.
However, if you're uncomfortable buying stocks making new highs, that's okay. But the Momentum Style is probably not for you. This style will also carry with it a higher degree of volatility, which is the rate at which a stock moves up or down. Although the Momentum trader expects the gains made because of this to make it all worthwhile.
Momentum is about cause and effect. The cause of the move is typically positive earnings estimates revisions. This upward shift in earnings estimates prompts more and more investors to take an interest in the company with the effect being that shares go on a bull run.
As estimate revisions rise, prices race to keep up, as future estimate revisions are anticipated, potentially driving the stock price up even more.
The Zacks Momentum Style Score analyzes the stock's price momentum and earnings momentum, indicating when the timing is favorable to enter a stock with the highest probability of success.
Momentum Scores of A and B are the best at identifying when the timing is right to get in and stay in for even bigger gains.
The Zacks VGM Style Score is perfectly suited for those who want the best Style Scores across the board.
Whether you're a Growth Trader, Value Investor, or interested in Momentum, you can further increase your odds of success by having the best characteristics of all the styles together.
That's what the VGM Score gives you -- a weighted average of the individual Style Scores.
And you can get them quickly and easily without having to pour though stacks of research or turn yourself into an analyst.
A VGM Score of A or B will produce the top-rated stocks and the best results.
How to Use the Style Scores and VGM Score
The Zacks Style Scores were created as a complimentary set of indicators to use alongside the Zacks Rank.
As you probably already know, the Zacks Rank is one of the most successful stock rating systems out there, with the Zacks Rank #1 Strong Buys producing a 26% average annual return since 1988. That's nearly triple the S&P 500.
But, on any given day, there are over 200 stocks with a Zacks Rank #1 Strong Buy. Plus another 600 stocks with a Zacks Rank #2 Buy. All in all, that's over 800 top-rated stocks to choose from.
It's a spectacular list of potential outperformers. But a list so large can pose a challenge when trying to decide which ones are exactly right for you.
Now, with the Zacks Style Scores, picking the best Zacks Rank stocks just got easier and even more profitable.
And since the Zacks Rank helps predict which stocks will outperform over the next 1-3 months, the Zacks Style Scores were optimized to excel over this same time frame.
To maximize your returns, you want to buy stocks with the highest probability of success.
So that means buying stocks with a Zacks Rank #1 or #2, which also has a Style Score of A or a B .
There are times when it's perfectly alright to hang onto stocks with a Zacks Rank #3 Hold. But when you do, the same grade hierarchy applies; As are better than Bs, etc.
But under no circumstance should you buy a stock with a Zacks Rank #4 or #5, even if it has a Style Score of A or B .
Remember, the individual Style Scores were created as a complement to the Zacks Rank. Regardless of how a stock might score based on its valuation metrics or growth attributes, etc., a poor Zacks Rank still means the company's earnings estimate revisions are going down, which means a much greater likelihood that the stock will go down too.
Earnings estimate revisions remain the most important factor impacting stock prices which makes the Zacks Rank the very first step in any stock-selection process. Then adding a favorable Style Score to the top Zacks Ranked stocks enhances your odds of success even more.
As you can see by the chart below, stocks with a Zacks Rank #1 or #2 and a VGM Style Score of A or B can take your returns to even greater heights.
But note, as the performance results show, a weak Style Score robs the stock of much of its upside potential over the next 30 days. So if a stock you're in slips to Style Score of D or F, it's better to sell that stock and switch into a new one with an A or B.
Any stock in your portfolio that doesn't fit these sell rules can continue to be held with confidence. But obviously the more stocks you hold with a Zacks Rank #1 or #2 and a Style Score of A or B the better.
Where to Find the Zacks Style Scores and VGM Score
We wanted to make sure this information was prominently displayed for your convenience. That is why you will find the Zacks Rank and Style Score ratings featured at the top of all Zacks.com quote and research pages.
As you can see, it quickly summarizes the attractiveness of any stock. Again, only consider buying a stock if the Zacks Rank is a #1 or #2 and the Style Score that matters to you is A or B.
Want to Dig Deeper?
That is exactly what the Zacks Scorecard page was designed for. From any stock quote or research page, just click the Style Scores link on the left-hand navigation.
Once there you will find a detailed table, specific to each Style: Value, Growth and Momentum. Beyond your stock's Style Score and VGM Score, you will find the ratings for its three closest peers.
Plus, we have added 10 items of importance that are vital to that trading style, and how the stock stacks up to its industry and competitors.
You can also get a complete list of all of the Zacks #1 Ranked stocks and their corresponding Style Scores by going to the Stocks tab on Zacks.com and selecting Zacks #1 Rank.
Finding stocks in the right trading or investing style that is best suited for you is one of the keys for consistently making money in the market.
In addition to that, you'll likely find yourself with less stress, and having more fun while doing so. Plus, finding the right stocks to buy will suddenly become much easier.
Remember, the Zacks Rank remains the first step in your stock-selection success, while the Zacks Style Scores are the next and final step to lock in your biggest winners.
Focus in on stocks with a Zacks Rank #1 or #2. Then key in on those with a Zacks Style Score of A or B for your preferred trading style. Even better, find those with a VGM Score of A or B and increase your chances of success even more.
It truly has never been easier and more profitable to find the best Zacks Rank stocks than now.
To see the individual Style Scores and VGM Score for the stocks you're interested in-plus, gain access to the Zacks Rank for your stocks, mutual funds and ETFs; Premium Screens; Equity Research Reports; Focus List portfolio of 50-longer-term stocks and more- start your 30-day free trial to Zacks Premium .
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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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