Capture an Undervalued Market with This Active ETF | ETF Trends

The recently launched actively managed exchange traded fund, ValueShares U.S. Quantitative Value ETF (BATS: QVAL), tries to exploit behavioral biases in the market by tapping into undervalued stocks.

Drexel University finance professor Wesley Gray, the co-author behind Quantitative Value, crafted QVAL based on five factors, including identifying target stocks, forensic accounting screens, valuation screens, quality screens and investment preferences.

Specifically, Morningstar strategist Samuel Lee points out that the ETF starts out with a universe of large- and mid-cap stocks and excludes stocks with market caps below the 4th percentile of the NYSE; takes out mortgage REITs, royalty trusts, ETFs, ETNs, CEFs, ADRs, and SPACs; and sets aside financials.

Then, ValueShares tries to eliminate any companies with dubious finances or accounting schemes, along with stocks with operating cash flows that persistently fall behind net income, volatile financial statement ratios, high leverage and rapid sales growth.

The remaining picks are sorted by earnings before interest and taxes, or EBIT, over total enterprise value, or TEV. TEV is equal to market cap plus debt, minus excess cash, preferreds and minority interests. Stocks are selected on low enterprise values relative to operating earnings. Lee argues that in back-tested data, the strategy’s value comes from its EBIT/TEV, providing a more discriminatory take on value than traditional ratios like price-to-earnings and price-to-book.

Moreover, component stocks are picked for quality. For instance, companies with strong finances and economic moats are selected.