Outperform without the risk

Mr O'Shaughnessy's approach to constructing screens is not based on fitting fundamentals to a pre-existing investment narrative. Instead, he simply back-tested various bits of data for their effectiveness at predicting share price movements and came up with what his book describes as "unbiased and unexpected findings". Last week, we looked at his growth, which did much to popularise the use of the price-to-sales ratio as a shrewd way of identifying value. This week, we're revisiting his value screen, which he found produced annual returns of 15 per cent between 1954 and 1996.

It is fair to say that, in the two years in which we have run the screen, the results have been less than stunning, but they have also been far from disastrous. Our first screen, covering the period from 15 February 2011, when the article was published, to the update on 22 February 2012 came up with a portfolio that produced a negative total return (share price movements plus dividends) of -6.5 per cent compared with -2.1 per cent from the FTSE 350. The 22 February 2012 screen did better, producing a total return of 12.7 per cent from publication date to 11 February 2013, compared with 11.1 per cent from the FTSE 350.

While these results may not be as spectacular as some of the screens we've recently updated, performance records from strategies such as those laid out by Mr O'Shaughnessy are built up over many years rather than on a single-year basis. What's more, in the long term, Mr O'Shaughnessy found that his value screen produced more consistent, although lower, returns than the growth screen. Indeed, Mr O'Shaughnessy asserted that "history shows that a portfolio of market-leading stocks that possess attractive value ratios - particularly those with high dividend yields - consistently beats the market with similar levels of risk". It should be noted that Mr O'Shaughnessy's findings were based on a screen of US stocks and the risks associated with an S&P 500 tracker as opposed to our Anglicised version of the screen.

Mr O'Shaughnessy's research was based on buying the 50 highest-yielding market-leading stocks. However, we're constrained by the number of results we actually got from our screen. Therefore, what we present below are the 25 stocks we identified that yield more than the median average (2.75 per cent) of all of the dividend-paying shares we looked at. The fact that we have fewer stocks in our portfolio can be expected to increase the low risks cited by Mr O'Shaughnessy. The Cornerstone Value screen also bans utilities on the basis that they would otherwise dominate the results. We've stayed faithful to this, although the only stocks we've had to knock off our list are SSE and National Grid. Admittedly, some may quibble at the continued inclusion of Vodafone and BT on this basis. We've provided a write-up of the five highest-yielding shares as a taster, with the rest presented in the accompanying table.

THE FIVE HIGHEST-YIELD CORNERSTONE VALUE SHARES

Resolution

Income is undoubtedly the key attraction for investors in life assurer Resolution. The company was established to acquire, integrate and squeeze costs out of UK life firms, and that is just what it has been doing. The cost savings target for last year was £235m and the full synergies from combining three big life acquisitions are expected to be felt this year. The business has started to generate a good amount of cash, which should support the aim of raising the final dividend payment for the recently completed 2012 financial year by 5 per cent and pursuing a progressive dividend policy thereafter. So, while the company's shares may not offer the most enticing prospects for capital growth, the outlook for income is good (Last IC view: Buy, 266p, 16 Aug 2012).

Source: S&P CapitalIQ

Aviva

While Aviva offers similar attractions to fellow life assurer Resolution on the income front, there is arguably more upside potential from the shares, although this comes with added risk. The company is in the process of slimming down in order to bolster its balance sheet and focus on more profitable operations. Good progress is being made and recent news of the sale of the US life annuity business - albeit accompanied by a £2.3bn writedown - marked a major step forward. The group's solvency ratio should now be on a par with that of rivals, too. Any improvement in consumer and business confidence in Europe could also help sales and evidence of any performance boost from the restructuring could result in a re-rating of the shares (last IC view: Buy, 10 Jan 2013, 383p).

Evraz

Russian steel giant Evraz will be glad to have seen the back of 2012. The group was hit by falling demand and price weakness during the year. Improvements are expected in 2013, helped by the reconstruction of two rail mills, which hit sales volumes last year, and the modernisation of production facilities, which is nearing completion. And, despite the issues the group faced in 2012, the interim dividend was hiked by 64 per cent to 11¢ (last IC view: Sell, 231p, 31 Aug 2012).

BAE Systems

Defence company BAE Systems starts 2013 with cries of outrage still ringing in management's ears over its aborted merger with EADS. There's another spectre from 2012, too, which is the possibility of sequestration (automatic budget cuts) being triggered in the US, which is a very significant market for BAE. Along with the uncertainty this has caused, investors have little to be excited about regarding the outlook for overall growth. However, BAE does continue to generate cash and the bumper yield looks safe enough for now. Meanwhile, the company is looking for growth from areas such as cyber security and more promising regions of the world, such as the Middle East, at the same time as cutting costs. Final results are due to be released between the time of writing and publication of this magazine (last IC view: Hold, 327p, 15 Oct 2012).

AstraZeneca

For a long time there has been talk of the "patent cliff" faced by big pharmaceutical companies, and AstraZeneca now looks as though it's taking a tumble down it. Last year's revenues were off 17 per cent as key drug patents expired and management predicts a mid-to-high single-digit decline this year. Meanwhile, analysts predict that core EPS could drop by as much as a quarter. The company has been trying to deal with the pressures by restructuring and laying off staff. Still, the cash returns that Astra is famed for have suffered. The group's share buyback programme has been suspended and the 2 per cent full-year dividend increase in 2012 was the lowest in a decade. So, while the dividend yield is attractive, Astra needs to come up with a convincing way to salvage its fortunes in the market's eyes (last IC view: Sell, 2,989p, 31 Jan 2013).

20 more Cornerstone Value shares