Tag Archives: portfolio-strategy

Generating 15% Returns Using The Growth Rating System

Summary How the Growth Score is created. What Growth related ratios I focus on from a value viewpoint. Types of stocks produced from the Growth Score. The Growth Score Introduction The backtests for this Growth Score show that it’s another winner at 15.3%. Previously I showed the Quality Score generating 16.8% and the Value Score achieving 16.7% . Creating the Growth rating was harder than I thought as I don’t have much of a typical “growth” mindset. My interpretation and focus on growth has to do with the qualitative side. “Growth” questions I ask myself are things like; what other industries or creative ways is the company executing to grow? is the industry large enough to accommodate more growth by the company? is the industry also growing or shrinking? (sample questions you can add to your own checklist) I look for stocks that are solid fundamentally and in a position to grow. I don’t search for stocks based on how much revenue, earnings or other numbers have grown over the past years. Relative strength and other technical indicators are beyond me also. That’s the approach I took here as well. Rather than search for high flyers, what the Growth Rating really represents are stocks with positive growth who are growing by utilizing their assets well. I’m going to share the full details with you. Just don’t focus too much on the 15.3% returns. The 15.3% returns from the backtest is just theoretical proof that this works on paper. In other words, the strategy itself is a winner. But what I really want to show is how and why this works. Analyzing the Results First the numbers on a yearly basis. As I pointed out in the quality score, I focused on reducing drawdown as much as possible. Drawdowns are a huge problem with mechanical strategies and since you end up buying stocks you don’t know, it’s easy to give up. And since I create tests and strategies based on 1 year holding periods, the drawdowns are larger than trading systems where you buy and sell about 20 stocks a day. As much as I don’t like drawdowns, I also don’t believe in frequent trading as it eats away your portfolio with fees as you end up playing the same game as the traders. They will out trade you with their eyes closed. Now, there are really 3 bad years here where the Growth Rating seriously underperformed. 2007, 2008 and 2014 where 2008 was horrific with a -44% decline. That’s close to half of a portfolio being wiped out. 2009 more than made up for it, but 2008 is enough to make anyone puke. However, when coupled with Q and V, the final combined Action Score performed marvelously well in 2008. That’s the power of combining Q, V and G all together. But I’ll be talking about the Action Score in another post. How I Created the Growth Score I kept the max number of criteria to 4. The more filters a stock has to pass, the bigger the drop in performance. Just because stocks can pass a 8 point checklist, it doesn’t mean it’s a buy. It could be the total opposite where you are too strict and end up only allowing mediocre upside stocks to pass through. Here’s what I narrowed the Growth criteria to: TTM sales percentage change: greater than zero 5 year sales CAGR: greater than zero Gross Profit to Asset Ratio (GPA): greater than 1 Piotroski F Score: higher the better Here’s the initial backtest I performed that proved I was onto something. This is a 20 stock portfolio backtest. Growth Score Backtest – Full Universe Woah. Deep breath. Just theoretical returns. After eliminating OTC stocks, financials, energy, mining and utilities, the results continue the outperformance. Growth Score Backtest w/ no OTC, Financials, Energy, Mining or Utilities Based on this data, I’m really excited because the combination of metrics I’m using is validated and it’s not a borderline combination. The ugly spike in the first backtest is gone. Most likely from an OTC stock that exploded temporarily and crashed back down. Rationale for Each Criteria TTM Sales Percentage Change > 0 The goal here is to look for stocks that actually grew. I’m not interested in high flyers and wall street darlings. I’m really looking for growth stocks with a strong value flavor. 5 Year Sales CAGR > 0 Same thing as above. I don’t want companies that are perennial losers for 5 years or more. Gross Profit to Asset Ratio (GPA) This ratio deserves an article of its own. In this case though, it has the biggest positive effect on the results. Comparing gross profit to assets tells you whether or not the assets are profitable. In other words, GPA measures the growth of profitability. When I look for stocks with a GPA above 1, I’m saying that I want stocks that are generating more than a dollar for every $1 of asset. A GPA of 0.5 means the company is generating profits of $0.50 for every dollar of assets. You can see how this is also a great way to compare competitors within the same industry. Piotroski F Score I include the F score for quality and value. Best way to filter out horrific stocks so that it doesn’t cloud the results. A Rating System is NOT a Screener I have to repeat this because I get this question about the results often. Since my goal is building a rating system where every stock is scored and ranked, it’s very different to a screener. A screener is to simply get stocks that pass specific numbers. A rating system may have stocks at the top of the list that fail certain criteria. That’s why each variable is weighted in the final formula. Stocks outside of the ideal ranges are penalized. You’ll see what I mean in the list of 2015 stocks below. Top 20 Growth Stocks from 2015 If you look at the GPA column, only 4 stocks meet the criteria of being 1 or above. That’s what I meant by a rating system being different to a screener. If you bought these 20 stocks at the beginning of the year, you’d be looking at a price return of 1%. Sure I’d love to have shown you the growth stocks exploding and defying the struggles of 2015, but the final Action Score is so much better and you’ll be amazed at the results. Watch out the for the final part of how the OSV Ratings have been created. Disclosure: Long GILD

Valuation Dashboard: Energy And Materials – Update

Summary 4 key fundamental factors are reported across industries in Energy and Basic Materials. They give valuation status of an industry relative to its historical average. They give a reference for picking stocks in each industry. This is part of a monthly series of articles giving a valuation dashboard in sectors and industries. The idea is to follow up a certain number of fundamental factors for every sector, to compare them to historical averages. This article covers Energy and Basic Materials. The choice of the fundamental ratios used in this study has been justified here and here . You can find in this article numbers that may be useful in a top-down approach. There is no analysis of individual stocks. You can refine your research reading articles by industry experts here . A link to a list of stocks to consider is provided in the conclusion. Methodology Four industry factors calculated by portfolio123 are extracted from the database: Price/Earnings (P/E), Price to sales (P/S), Price to free cash flow (P/FCF), Return on Equity (ROE). They are compared with their own historical averages “Avg”. The difference is measured in percentage for valuation ratios and in absolute for ROE, and named “D-xxx” if xxx is the factor’s name. For example, D-P/E = (AvgP/E – P/E)/AvgP/E. It can be interpreted as a percentage in under-pricing relative to a historical baseline: the higher, the better. It points to over-pricing when negative. ROE is already a percentage. A relative variation makes little sense. That’s why we take the simple difference: D-ROE = ROE – AvgROE. The industry factors are proprietary data from the platform. The calculation aims at eliminating extreme values and limiting the influence of the largest companies. These factors are not representative of capital-weighted indices. They are useful as reference values for picking stocks in an industry, not for ETF investors. Industry valuation table on 12/21/2015 The next table reports the 4 industry factors. For each factor, the next “Avg” column gives its average between January 1999 and October 2015, taken as an arbitrary reference of fair valuation. The next “D-xxx” column is the difference between the historical average and the current value, in percentage. So there are 3 columns relative to P/E, and also 3 for each ratio. P/E Avg D- P/E P/S Avg D- P/S P/FCF Avg D- P/FCF ROE Avg D-ROE Energy Equipment&Services 20 24.2 17.36% 0.72 1.73 58.38% 8.65 35.34 75.52% -10.91 7.34 -18.25 Oil/Gas/Fuel 14.93 18.53 19.43% 1.65 3.35 50.75% 15.48 29.03 46.68% -15.55 4.47 -20.02 Chemicals 18.3 18.48 0.97% 1.31 1.21 -8.26% 35.82 25.37 -41.19% 8.71 6.74 1.97 Construction Materials 51.27 21.44 -139.13% 1.36 1.16 -17.24% 58.56 40.5 -44.59% 9.34 5.77 3.57 Packaging 21.58 17.96 -20.16% 0.91 0.61 -49.18% 23.15 20.09 -15.23% 18.23 8.34 9.89 Metals&Mining 19 19.83 4.19% 1.2 2.65 54.72% 13.94 25.53 45.40% -19.39 -8.6 -10.79 Paper&Wood 30.98 21.27 -45.65% 0.92 0.72 -27.78% 21.8 22.81 4.43% 8.35 4.99 3.36 The following charts give an idea of the current valuation status of Energy and Materials industries relative to their historical average. In all cases, the higher the better. Price/Earnings : Price/Sales : Price/Free Cash Flow : Quality (ROE) Relative Momentum The next chart compares the price action of the SPDR Select Sector ETF in Materials (NYSEARCA: XLB ) and energy (NYSEARCA: XLE ) with SPY (chart from freestockcharts.com). (click to enlarge) Conclusion In one month, XLE has fallen by 11.3% and XLB by 6.3%, both underperforming SPY by a wide margin. The reason is obvious looking at WTI oil price: it hit last week a level not seen since the second half of 2003. In this meltdown, the five more resilient S&P 500 stocks in Energy and Materials on a 3-month period are Airgas Inc (NYSE: ARG ), Chevron Corp (NYSE: CVX ), E. I. du Pont de Nemours (NYSE: DD ), Tesoro Corp (NYSE: TSO ), Valero Energy Corp (NYSE: VLO ). The two latter are refiners. Oil price is not a major driver of their profitability, and concerns about a possible end of the crude oil export ban seem to disappear. The improvement in valuation ratios for all industries of these sectors since my last update is just a consequence of lower stock prices. The harder the fall, the better the “improvement”. It is not a signal that things are really improving for oil and gas companies. It is even the opposite: the quality measured by the ROE industry factor went down. As a group, energy and metal/mining are looking like a nest of value traps: the 3 valuation ratios point to underpricing, whereas the quality factor (D-ROE) is deep in the red and worsening. This is not true for all the oil industry: we have seen that refiners are doing quite well and several of them have hit an all-time high in November. Some of them are also in the very best of the S&P 500 in my value and quality-based screens. No industry in these two sectors looks globally very attractive. However, comparing individual fundamental factors to the industry factors provided in the table may help find quality stocks at a reasonable price. The next table shows a list of stocks in the Energy and Basics Materials sectors. They are all cheaper than their respective industry for 3 valuation factors simultaneously: Price/Earnings, Price/Sales, Price/Free Cash Flow. Then they are selected for their higher Return on Equity. This screen updated and rebalanced monthly has an annualized return about 17% and a drawdown about -65% for a 17-year backtest. The corresponding sector ETFs XLE and XLB have an annualized return of respectively 8.32% and 6.79% on the same period. Past performance, real or simulated, is not a guarantee of future return. This list may be considered an entry point for further due diligence, or as a portfolio after adding a few trading rules and market timing. This is not investment advice. Do your own research before buying. ATW Atwood Oceanics Inc. ENERGYEQUIP DOW Dow Chemical Co (The) CHEM EMN Eastman Chemical Co CHEM IOSP Innospec Inc CHEM KS KapStone Paper & Packaging Corp FORESTRY LYB LyondellBasell Industries NV CHEM REX Rex American Resources Corp OILGASFUEL TSO Tesoro Corp OILGASFUEL VLO Valero Energy Corp OILGASFUEL WNR Western Refining Inc OILGASFUEL If you want to stay informed of my updates on this topic and other articles, click the “Follow” tab at the top of this article.

Lazard Explains Benefits Of Multi-Factor Smart Beta

Smart-beta strategies attempt to provide better risk-adjusted returns by using measures other than market capitalization to weight portfolio holdings. Historically, these alternative weightings have produced higher Sharpe ratios, a measure of return per unit of risk, and this is why they’ve earned the “smart” moniker in the view of their advocates. Smart-beta strategies can be considered as occupying the middle-ground between active and passive investing, with rules-based methodologies (like passive investing) that nevertheless deviate from broad market benchmarks (like active investing). Distinct smart-beta strategies and funds can either be “single factor” or “multi-factor,” as explained in Lazard’s December 2015 Letter from the Manager: A Better Kind of Beta , which reviews five such “factors” before going on to make the case for multi-factor investing in general, and Lazard’s own multi-factor strategies in particular. Style Factors A “factor” is any consistent characteristic that academic research has shown explains the risk or return characteristics of stocks. Common style factors include: Value – Value-investing is championed by the most successful investor of all time: Warren Buffett. But “value” can be defined in a number of ways, and not all measures are as likely to produce superior results. In Lazard’s view, a combination of “cyclical” (such as price-to-book) and “defensive” (such as cash flow) measures provides the most consistent exposure. Momentum – Stocks going up tend to continue going up – and vice-versa. At the same time, what goes up must come down – the question is “when?” Lazard recommends using measures other than simply price momentum to judge market sentiment – including macroeconomic data releases. Low Volatility – Low volatility stocks have added appeal in the wake of the financial crisis, but Lazard thinks this factor can best be exploited not by allocating specifically to low-volatility stocks, but by targeting low volatility in portfolio construction. Lazard’s process identifies low-volatility companies with attractive fundamentals. Quality – Lazard’s take on “quality” compares a company’s (paper) earnings and (actual) cash flow. Accounting rules and the market’s short-term focus may put undue emphasis on the former, whereas an analysis of a company’s cash flow may provide a more accurate estimate of its earnings strength. Growth – While “momentum” is a growth measure determined by share price, the “growth” factor considers a company’s financial statements. Lazard’s approach is designed to identify stocks that are well-positioned to experience above average growth in the future. Multi-Factor Advantages Multi-factor investing offers the advantages of diversification and flexibility. Although individual factor indexes have outperformed since 1988, returns are cyclical and different factors outperform at different times. Diversified multi-factor investing thus works to mitigate volatility, which can limit account drawdowns. Multi-factor investing also promises the benefit of flexibility, wherein outperforming factors can be emphasized. Single-factor and passive cap-weighted investing has no such flexibility. Lazard boasts of its own “multi-factor pedigree,” with “a set of balanced style criteria” that have been researched and refined over the past two decades. The firm has been implementing multi-factor approaches in live portfolios over the entire in period, in a variety of global-, regional-, and country-specific scenarios. In fact, Lazard was doing smart beta before smart beta was even known as smart beta – Lazard used to call it “quantitative” or “systematic” investing. “Not all smart-beta strategies are created equal,” according to Lazard, and in the firm’s opinion, exposure to several factors provides far greater consistency of performance over both the long- and short-term. Lazard’s own multi-factor strategies have “the benefit of the skill and long-standing experience” of the firm’s multi-factor selection, combination and diversification, as well as ongoing research and risk monitoring. For more information, download a pdf copy of the letter .