Playing Momentum-Stock Meltdown With John Neff’s Formula

If you pick stocks so well that you beat the Standard & Poor’s 500 Index by an average of 3 percentage points a year for three decades, it means people will still be talking about your ideas 20 years after you retire.

That’s the case with John Neff, who returned an average 13 percent a year at the helm of Vanguard’s Windsor Fund starting in the “Mad Men” era all the way through the Madonna era.

One of Neff’s favored formulas was dusted off today by Chris Montagu, London-based quantitative research analyst at Citigroup Inc., and his colleagues. The equation, known as GYP, goes like this: Add a company’s forecast earnings growth rate to its projected dividend yield and divide by its price-to-earnings ratio. The higher the result, the more attractive the stock.

While Neff focused on value stocks, or those with low P/E ratios, Montagu focused on the formerly high-flying momentum stocks that have sold off heavily in the last two months.

Consider the $250 million iShares MSCI USA Momentum Factor ETF as a proxy to get a sense of the carnage. The exchange-traded fund, whose biggest holding is Facebook Inc., fell more than 9 percent from its peak on March 5 through April 11. It’s still down about 6.3 percent from that record. Meanwhile the Russell 1000 Value Index rose almost 10 percent from its low for the year on Feb. 3 through April 30.

Exaggerated Shift

The Citigroup quants make the case that the shift from momentum to value over the last two months has gone a bit too far in some cases and created opportunities for short-term profits to be made in momentum stocks.

Montagu’s screen found a dozen momentum stocks in the U.S. and 15 in Europe. Among them, he highlighted those already on lists of recommendations from Citigroup. That boils it down to Las Vegas Sands Corp. and Visa Inc. in the U.S. and Continental AG, ING Groep NV and Societe Generale SA in Europe.

Others that showed up in the screen, which are rated buy at Citigroup though not on lists of top recommendations, include Royal Caribbean Cruises Ltd., Applied Materials Inc. and Raytheon Co. in the U.S. In Europe, the highest GYP ratios include Osram Licht AG, KBC Groep NV and 3i Group Plc.

Just like good comedy, timing is the key to buying and selling momentum stocks. Only time will tell if Montagu got the punch line right.

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