Quant System Drives Stock Outperformance Through Disciplined Metrics

Key Quotes

"We use a Z-score for all the financial metrics, whether it's PE or revenue growth or EPS growth or EBITDA growth. What goes into a Z-score is you're taking the absolute data point for that metric versus the average or a median data point for the sector, and you create a ratio out of it, and that becomes the Z-score."

Steven Cress explains that a Z-score is a ratio comparing a specific financial metric's data point to the sector's average or median. This metric is used across various financial indicators within their quantitative analysis.

"So when you look at that grade, it shows you, it gives you an instant characterization of how that metric compares to the rest of the sector. So it could be an A, it could be a B, it could be a C, or it could be an F, and that tells you if that particular metric is strong or weak."

Steven Cress clarifies that the Z-score is translated into an academic letter grade (A-F) to provide an immediate understanding of a metric's performance relative to its sector peers. This grading system offers a quick assessment of whether a metric is strong or weak.

"The difference we see though is momentum for Merck is a B minus where Pfizer is a C, and the EPS revisions are both B. So it's basically winning by a nose. They're very close, but Merck just beats it slightly on the momentum basis."

Steven Cress highlights that Merck slightly outperforms Pfizer in their quantitative analysis, specifically on the momentum factor, which is rated B- for Merck compared to C for Pfizer. While both stocks have strong overall quant grades, Merck's edge in momentum is a key differentiator.

"Even though the growth is really strong and the profitability is strong, the stock is very expensive. If you look at it on a PE forward basis, the trailing PE is 42 times versus the sector at 21 times. The forward PE is 38 times versus the sector at 20 times."

Steven Cress explains that Comfort Systems receives a "hold" rating despite strong growth and profitability due to its significantly high valuation metrics. He provides specific PE ratios for Comfort Systems, showing them to be roughly double those of the sector average.

"So we're looking for stocks that are collectively strong on value, growth, profitability, momentum, and EPS revisions. Those are the factors that are important to our quant system."

Steven Cress outlines the core factors his quantitative system prioritizes when assessing stocks. These key areas include value, growth, profitability, momentum, and earnings per share (EPS) revisions, which collectively inform their stock selection process.

"But a diverse portfolio helps to minimize your risk and maximize your returns, and it's important to do it on a consistent basis."

Steven Cress emphasizes the importance of diversification in portfolio management for both risk reduction and return maximization. He advises that consistent application of investment discipline, such as regular investing, is crucial regardless of market conditions.