What we are looking for
A U.S. small-cap name set to outperform based on a quant model with a proven track record.
The London Stock Exchange Group’s StarMine Intrinsic Valuation Model is a quantitative model that measures how attractively valued a stock is relative to it’s true, or “intrinsic” value. That model in turn is based on future earnings projections that adjust for systematic biases in analyst forecasts.
Over the past 12 months, the model has a decile spread of 23 per cent for all U.S. stocks. This means that the top 10 per cent as a group has outperformed the bottom 10 per cent by 23 per cent.
However, when we look at just U.S. small-cap stocks, this spread increases to 41 per cent. Put another way, if an investor simply bought the top 10 per cent of small-cap stocks, and shorted the bottom 10 per cent, he or she would have earned a 41-per-cent one-year return (before transaction costs and the interest on short positions).
More about London Stock Exchange Group
LSEG is one of the world’s leading providers of financial markets infrastructure and delivers financial data, analytics, news and index products to more than 40,000 customers in 190 countries. Since 1698, we have been helping customers seize opportunities and create value.
The screen
We start with a universe of stocks comprising the Russell 2000 index, the main benchmark for U.S. small-caps.
- Replicating the top/bottom 10 per cent strategy would involve more than 400 companies so, for simplification, we screen for the top 1 per cent, relative to the model’s coverage of more than 21,000 stocks across the world.
- For reference we include the model’s calculated intrinsic value of the stock, and the implied return if the stock were to price rally to that price.
What we found
Only five companies in the index score in the 100th percentile globally. Interestingly, two of these companies are in the homebuilding industry, one building single and the other multifamily homes. The United States faces a major housing shortage after decades of underconstruction. There is a wide array of estimates of the exact shortage, owing to different methodologies – a recent Deutsche Bank report cited a range of estimates from 1.5 to 6.5 million houses – but whichever method is used, this is a huge opportunity for the homebuilding industry.
In addition to the massive structural supply-demand imbalance, there are political tailwinds. Housing availability is a key priority of the Biden administration and should continue to be a priority for whichever party wins the White House for the next four years.
These tailwinds are especially relevant to United Homes Group, which builds and sells homes in North Carolina, South Carolina and Georgia. South Carolina and North Carolina were tied for fourth in the nation for percentage growth of the housing stock over the past three years, at 6 per cent, while Georgia was also in the top 10 at 5 per cent. In terms of absolute growth Georgia and North Carolina also ranked in the top five and both are key swing states in the coming election.
The intrinsic value calculated by the model is a statistical output, rather than a prediction by a human analyst on the basis of fundamental research. However, if the if the stock were to rally to this level, an investor who bought at last week’s closing price would earn a return greater than 1,700 per cent.
Hugh Smith, CFA, MBA, is director of analytics at London Stock Exchange Group.
