StyleBox classification

In the previous article, we introduced our StyleBox classification methodology for stocks and saw that we have 10 StyleBoxes.

The first 4 boxes (Super stock, Under the radar, Market angel and Potential turnaround) are “attractive” styles – stocks in these boxes are potentially attractive investment opportunities. These are styles that have high scores on 2 or more factors.

Then we have 5 “should-be-avoided” styles (Value trap, Momentum trap, Out of favour, Fallen angel, Don't touch). Stocks in these boxes should be avoided. These are styles that have high scores on only 1 or no factors.

In this article, we will discuss each StyleBox in detail.

Super stocks

These are stocks that score high on all there factors – quality, value and momentum. Coined by Robert A Haugen in his book The Inefficient Stock Market, Haugen argued that good quality (Q) and cheap stocks (V) that have shown recent uptrend in price (M) tend to outperform the broader market. Therefore, we classify those stocks that score high on all the 3 factors as super stock.

Under the radar

The name is self-explanatory. These are stocks that have high quality and value, but low to medium momentum score. These are good quality cheap stocks that have not done well in recent times reflecting either lack of investor interest and/or lack of discovery. These stocks qualify for the classic value investing style of Graham and Dodd and, to some extent, Warren Buffet.

Market angels

These are stocks that the markets love. These stocks have high quality and momentum, but low to medium value score. These stocks are not cheap, but investors still prefer them. These are stocks that have delivered great returns in the past for investors and continue to deliver sustained growth. For a decade, FMCG and Pharma stocks were market angels in India.

Potential turnaround

These are stocks that are cheap and have shown recent uptick in prices after being beaten down for a while (and hence cheap). These stocks have high value and momentum, but low to medium quality score. Remember, value and momentum are 2 of the most effective factors and these set of stocks have both in their favor. Stocks in this style closely resembles James O'Shaughnessy’s “trending value” strategy.

Value trap

These are stocks that have high value score but low scores on both momentum and quality. These stocks have been beaten down and show no signs of revival. Picking such stocks solely based on valuation can be dangerous (a trap) because there could be something fundamentally wrong – failing business, potential bankruptcy, secular decline in the sector or operating environment etc.

Momentum trap

These are stocks that have high momentum score but low scores on both value and quality. These can be hot trending stocks or meme stocks that have gained recent attention. But their underlying fundamentals are bad, and they are not cheap. Investors should be careful while picking such stocks because as soon as the trend reverses, the downside could be much more violent than the upside.

Out of favour

These are stocks that have high quality score, but low scores on value and momentum. These were once market angels (expensive high-quality stocks loved by the market), but the tide has suddenly turned, and these stocks have been underperforming in recent times. However, the prices have not corrected to the extent that valuations have become cheap (to justify them as “Under the radar” stocks)

Fallen angel

These are stocks that have high quality score, medium score on value and low score on momentum. These were once market angels (expensive high-quality stocks loved by the market) and went out of favour. The prices have corrected (low momentum) and valuations have become reasonable but not cheap (medium value). Investors could wait till the stocks correct more and move into the “Under the radar” StyleBox.

Don't touch

These stocks have low scores on all 3 factors – quality, value, and momentum. Investors should just stay away from these stocks (hence the name!). If you are thinking of buying such stocks, just ask yourself this – why would you want to own a junk company that has not been performing and is not cheap?

Neutral

For stocks in our universe that cannot be classified in any of the boxes, we have a neutral classification. An intuitive way to understand why many stocks will be classified as “Neutral” is to identify the total number of calcification possible. Since we have 3 factors and for each factor, we have 3 levels of score (high, medium, and low), theoretically we could build 27 StyleBoxes. But that would just end up confusing everyone (including us). Since we limit ourselves to 9 classifications (excluding neutral), a lot of stocks do end up being classified as neutral.