RealMoney

Before I move on from reviewing 2016, I want to take a look at which models performed best during the year and how those top performers look as 2017 begins. The top performing model last year was made of stocks trading below book value that had high F-scores and high Altman Z-scores. Although this approach netted a little over 30% last year, I don't expect too much from it this year.

Just a handful of companies make the list for 2017 and they are tiny, with an average market cap below $20 million. Last year at this time you had 25 stocks on the list, and 15 of those were over $50 million in market cap, so you could get some money to work in these fundamentally sound cigar butt stocks. After another up year in the stock market, that is simply not the case in 2017.

The basic model I have used with lots of success also had a healthy 2016. Picking stocks that trade below tangible book value and also have high F and Z-scores had a solid year, with a total return of over 30%. However, this model has the same problem as the liquidation model, in that there are very few stocks on the list right now. Just one, Kelly Services (KELYA) has anywhere near the liquidity needed to mention it in public. Kelly shares trade at just 85% of book value, so it is cheap right now. The company earns an F-score of 6 and a Z-score of 4.42; there is a margin of safety in the financial statements.

The value momentum model worked very well in 2016, also returning a hair over 30% for the year. This approach looks for stocks that trade below book value and are showing dual momentum, with a two-month return that is positive and outperforming the S&P 500. I then select the 50 stocks on the list trading at the lower price to tangible book ratios and rebalance every three months.

The more frequent rebalancing keeps us from running into too much company-specific risk, as once a stock starts underperforming it is sold. The valuation criteria help us deal with market risk: when markets are extended, you cannot find enough stocks with positive 12-month performance to get fully invested. During 2008, for example, using this approach you would have never been more than 30% invested in value momentum stocks. The ones you did own got crushed along with everything else, but most of your portfolio would have been 70% in cash.

Insurance companies are a large allocation in this year's portfolio, with nine insurance companies making the cut as value momentum stocks. The portfolio includes some of my long-time favorites, like American National (ANAT) , National Western (NWLI) and Kansas City Life (KCLI) . Several of the mega-cap insurance companies like Met Life (MET) , Prudential (PRU) and Voya Financial (VOYA) are in the current portfolio.

The largest industry is energy; 14 of the companies in the 50-stock portfolio are in the energy sector, giving the value momentum portfolio a 28% energy weighting. If oil keeps going up, that will be a huge positive. If we see a reversal in energy prices, we will have to rely on the rebalancing policy to get us out without too much damage.

There are several small REITs on the list this quarter. Preferred Apartments (APTS) , Transcontinental Realty Investors (TRI) , BRT Realty (BRT) and Anworth Mortgage Asset Corporation (ANH) are all in the value momentum portfolio as we start the year.

The model appears to be anticipating a stronger economic recovery and perhaps some infrastructure spending in 2017. Metals-related companies like Century Aluminum (CENX) , Northwest Pipe (NWPX) and Universal Stainless and Alloy Products (USAP) are on the 50-stock list right now. These stocks have been pretty much dead money for several years, so it will be interesting to see if the price momentum continues over the next year.

The word momentum scares some investors off, as it implies richly valued popular companies. The stocks in the value momentum portfolio are outperforming the market, but they have a long way to go to be richly valued. The average price to book value in the portfolio is just 68%, so these stocks are still bargains that have a long way to go to be even fairly less overvalued.

The value momentum approach is not for everyone. The stocks in the mix are not as exciting as most momentum types like owning and the turnover is a lot higher than most traditional value investors will find acceptable. However, for those willing to take a more flexible, hybrid approach, the model has survived the test of time and consistently delivered market-beating returns.