Does the JSE Top 40 affect the excess returns of value stocks using the Piotroski score methodology between 2000 and 2022?

As of December 2022, the market has shown signs of a bear environment with a recession on the horizon. While the Federal Reserve (Fed) remains the primary focus for many investors, we can assume that a pivot can only be expected from late 2023 into 2024, and the likelihood of a pause in the interest rate hike cycle is far greater. The South African rand weakened significantly due to the stronger dollar, but in recent days, it has clawed back some losses in the hopes that the Fed will reduce the size of its rate hike. While the economy continues to be plagued by political uncertainty, a volatile domestic currency, and increased blackouts caused by Eskom, the equity market has been sheltered to a degree from offshore volatility.

Thus, this article aims to identify if excess returns of the JSE Top 40 influence excess returns on value stocks identified with the Piotroski Score Formula.?

The Backdrop

Considering all major indices in Table 1, the South African Top 40 has remained resilient among its peers. As the base effect of the pandemic and lockdown measures make their way out, most major indices are down due to economic hardship and tightening monetary policies. As many central banks continue their rate hiking cycle, inflation remains persistent due to supply-side issues and tight labour markets. The Hang Seng remains the biggest loser due to Chinese strict zero Covid policies, Evergrande contagion and tighter policies on tech companies over the last three years.??

Table 1: Global Indices Performance as of 6 December 2022

A recession can be identified by two consecutive periods of negative growth (something we have seen in 2022); however, a bear market and recession are often tossed around together but are not the same; the former relates to investor sentiment and a decline in the stock market while the latter is a slowdown in economic activity. Hence, growth stocks fall away, and investors position themselves for value to weather the storm. Morningstar ratings mention that the best-value sectors produce or service the consumer needs, e.g., utilities, financials, healthcare and consumer staples. In Table 2, 14 stocks with a Piotroski score above seven have been identified, with only eight being identified as value stocks highlighted in green.

Table 2: Piotroski Score?

Methodology

Piotroski Score

The formula was founded by Professor Joseph Petroski, who identified scoring criteria of 1 being the worst and nine being the best, focusing on the financial statement ratios for companies. The formula aims to identify value stocks without considering fundamental aspects such as management and other stakeholder environments. The formula uses historical price data, a significant limitation that distorts the picks identified. For example, some companies rank higher in 2020, while others may differ in 2022.?

Excess Return Model

The regression equation takes the form.

Where Rstock ?Is the return on Piotroski stocks, rf?Is the return on the risk-free proxy (5-year South African government bond), Rm?Is the return on the market proxy (JSE Top 40), ?Ut Is the error term; and (alpha) and (beta), ?are the parameters to be estimated.?

Model Specifications

The model utilises Eviews to estimate variables under a Least Squares (NLS and ARMA ) method of stock prices between 1 January 2000 and 30 November 2022, with only six companies (CLS, FBR, KAP, APN, HCI, SAP) listed on the JSE before that date. The remaining eight companies (ARL, EXX, RES, KST, BID, MTH, SSU, TGA) were listed from 2001 to 2021.?

Model Output

The data collected was adjusted to simulate the period of a recession between 2008 to 2013 in South Africa. Of the stocks listed during that time, nine out of fourteen were listed on the JSE, and four were classified as value sector stocks.

Table 3 represents the analysis results, indicating that eight of the nine stocks’ excess return on the market proxy has significant explanatory power for their variability on excess returns. In contrast, Resilient REIT Limited (RES) expressed the opposite by which the market proxy had no significant explanatory power of variability of excess returns of the stock.?

Table 3: Recessionary Output

Inception to date

The model accounted for the beginning of the testing period and later listings. Table 4 indicates that from January 2000 or from inception on, the JSE stocks, whether value or not, have displayed excess returns on the market proxy and have significant explanatory power for the variability of the excess return of stocks analysed.?

Table 4: Overall Stock Movement from 2000 to 2022

Stock Breakdown

Graph 1: Price to Book value uncertainty analysis

Analyst reviews are graded on a scale of 1 to 3, with 1 being a low uncertainty level and 3 being a high uncertainty level for price forecasts. Clicks (CSL) is the standout P/B factor. This stock has grown over the last decade and remains a crucial player in the retail staple industry.?

Graph 2: P/E to Dividend yield?

Significant stocks to consider are Motus and Astral food, with high dividend yields. Both stocks have a favourable valuation and specialise in their respective food and speciality retailing sectors. The macro-environment will play in their favour, while Motus management has been buying back shares.

Conclusion

While the Piotroski Score makes it easier to identify potential stocks in the market, value and growth stocks are subject to macro conditions. Resilient REIT Limited remained a promising value stock in a recession, with data depicting excess returns that were not influenced by JSE Top 40 from 2008 to 2013. This can be due to a low correlation between the property sector and the stock market.

Considering a value investor, the Piotroski pick of Motus and Astral may require further analysis of their business environment, dividend and long-term outlook.

This article is for research purposes only and does not constitute financial advice.