Combining Sentiment and Fundamentals: How Quant Models Uncover Opportunities

Combining Sentiment and Fundamentals: How Quant Models Uncover Opportunities

By Justin Carbonneau (@jjcarbonneau) —

In my previous article, “Unlocking the Market’s Mood,” we explored various methods of gauging investor sentiment in stocks. In this article, we’ll delve into how different investing models on Validea employ some of these sentiment indicators to find their way into the fundamental models we run, including analyst earnings revisions, buy and sell recommendations, insider buying, stock buybacks, and momentum.

The Earnings Revision Model – Capturing Wall Street’s Mood

Our Earnings Revision model on Validea is based on a research paper by Wayne Thorp, “How to Profit from Revisions in Analysts’ Earnings Estimates.” The model focuses on companies with upward revisions in analyst earnings estimates, often coupled with analyst buy/sell ratings. The Earnings Revisions model considers the following criteria to determine if a company has earnings revision strength and is viewed positively by analysts:

  1. Sufficient Analyst Coverage: The stock must have at least four analysts covering it.
  2. Current Year Estimate Revisions: The current year EPS estimate must be greater than it was one month ago.
  3. Next Year Estimate Revisions: The EPS estimate for the next fiscal year must be greater than it was one month ago.
  4. Current Year Up and Down Revisions: The company must have more than one positive current year estimate revision in the past thirty days and no negative revisions.
  5. Next Year Up and Down Revisions: The company must have more than one positive estimate revision for the next fiscal year in the past thirty days and no negative revisions.

Companies with upward revisions in earnings are viewed more favorably by Wall Street, indicating positive investor sentiment among analysts. The table below uses our Guru Stock Screener to highlight some of the top scoring stocks in the Earnings Revisions model as of today.

TickerNameEarnings Revision ScorePriceMkt Cap (mil)P/ELT EPS GrowthDividendRel. Str.
URIUNITED RENTALS, INC.100372.832586912.532.0%1.6%76
TOLTOLL BROTHERS INC10058.4964775.126.8%1.4%90
PARRPAR PACIFIC HOLDINGS INC10028.5417334.759.2%98
TGLSTECNOGLASS INC10038.66184311.890.3%0.9%95
KNSLKINSALE CAPITAL GROUP INC100293.5677942.746.4%0.2%92
MTARCELORMITTAL SA (ADR)10028.41247212.99.0%0.8%54
ASCARDMORE SHIPPING CORP10015.146214.53.0%99

Shareholder Yield Model – Importance of Stock Buybacks

Stock buybacks have become more common over the past two decades. Companies that buy back their shares indicate to the market that management has confidence in the company’s financial stability and future prospects. They believe that using cash to buy back stock will increase long-term shareholder value.

There are a few models on Validea where stock buybacks are important. The Shareholder Yield model we run is taken from Meb Faber’s book, “Shareholder Yield: A Better Approach to Dividend Investing.” Shareholder yield measures all the ways a company returns cash to shareholders, including dividends, buybacks, and debt reduction. In addition to the Shareholder Yield model, our Patient Investor model, based on Warren Buffett’s approach in “Buffettology,” also rewards buybacks. The model looks for a declining number of shares outstanding over the last five years.

The table below combines the Shareholder Yield model with the Patient Investor model (Buffett screen) to find stocks that score highly based on both models.

TickerNamePatient InvestorShareholder Yield InvestorPriceMkt Cap (mil)P/ELT EPS GrowthDividend
URIUNITED RENTALS, INC.7980372.832586912.532%2%
WSMWILLIAMS-SONOMA, INC.10085118.8778737.341%3%
DKSDICK’S SPORTING GOODS INC86851351155812.841%3%
LCIILCI INDUSTRIES9680105.2326506.819%4%
MEDMEDIFAST INC1008599.110757.829%7%
SEICSEI INVESTMENTS CO798055.47744816.14%2%
CHRWCH ROBINSON WORLDWIDE INC938096.461123613.210%3%

The Motley Fool Model – When Insider Buying Counts

Another direct sentiment indicator of management bullishness is a high degree of insider ownership or aggressive insider buying. When executives are personally buying stock, they are putting their own money into the shares and have an even bigger incentive to drive strong business results and potentially higher stock prices. Our Small-Cap Growth model, based on The Motley Fool Investment Guide, rewards stocks with at least 10% insider ownership. Our growth strategy based on Martin Zweig’s book, “Winning on Wall Street,” wants to see the number of recent insider buys to be at least three with no insider sells.

The table below combines the Growth Investor approach (Zweig) and The Motley Fool quant screen to find stocks that are favored by both. I added an additional filter of at least 10% insider ownership to further refine the list.

TickerNameGrowth InvestorSmall Cap GrowthPriceMkt Cap (mil)P/ELT EPS GrowthDividend
CALMCAL-MAINE FOODS INC857255.2724395.723%6%
CCBGCAPITAL CITY BANK GROUP, INC.858330.2551512.822%2%
BSVNBANK7 CORP858324.852277.725%3%
VOCVOC ENERGY TRUST85768.251406.519%15%
PBBKPB BANKSHARES INC897214.124031.330%

Quantitative Momentum Model – Investors Voting With their Dollars

The Quantitative Momentum model is a pure momentum-based model used to identify stocks with strong and consistent momentum. The model rewards stocks with strong price momentum, which may be the ultimate investor sentiment indicator, as strong momentum indicates that investors of all types are buying the shares and bidding up the price.

The Quantitative Momentum model is based on the book “Quantitative Momentum: A Practitioner’s Guide to Building a Momentum-Based Stock Selection System”, written by Wes Gray and Jack Vogel. The model identifies stocks that have strong price momentum over the past 12 months and rewards consistent momentum over stocks that have produced a more volatile ride.

The table below highlights the top-scoring stocks through the lens of the Quantitative Momentum model.

TickerNameQuant Momentum InvestorPriceMkt Cap (Mil)P/ELT EPS GrowthDividendRel. Str.
RSRELIANCE STEEL & ALUMINUM CO94256.18151098.634.1%1.6%93
ZEUSOLYMPIC STEEL, INC.10051.345716.564.3%1.0%94
XOMEXXON MOBIL CORP94105.8430710836.6%3.4%91
WIREENCORE WIRE CORP94175.7331574.881.6%0.1%95
ABGASBURY AUTOMOTIVE GROUP, INC.94198.5443064.547.8%88
PARRPAR PACIFIC HOLDINGS INC10028.5417334.759.2%98
MPCMARATHON PETROLEUM CORP94128.91569304.569.1%2.3%96
GWWWW GRAINGER INC100671.663375922.225.2%1.0%93
ASCARDMORE SHIPPING CORP10015.146214.53.0%99

In conclusion, by considering both sentiment and fundamental factors, investors can make more informed decisions and potentially uncover new opportunities in the market. Sentiment indicators are just another tool that investors have at their disposal for stock analysis and investment idea generation. Whether using quantitative models like Validea’s, fundamental analysis, or a combination of both, investors should always approach the market with a disciplined, long-term mindset.

Justin J. Carbonneau is VP at Validea & Partner at Validea Capital Management.
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