Stockopedia | Stock Market Research Network

5 stocks on the move after broker upgrades

Ben Hobson — Mon, 20 May 2013 10:05:06 +0100

While the opinions of brokers often attract legitimate scepticism among investors, there’s little doubt that anyone keeping an eye on our analyst upgrade screen recently would have been impressed. Of all the investing strategies we track here at Stockopedia, the Earnings Upgrade Momentum screen has wiped the floor with most of the others and, unlike some of the other best-performing screens, it comes with decent levels of diversification to boot. Over six months it has returned a startling 55.6% against a healthy gain of 17.8% in the FTSE 100, which ties in with the performance of a similar AAII screen which has trounced the index for over a decade. So what’s causing these impressive screen returns?

Who cares what brokers say?

A glance over the decades of research into the impact that broker research can have on stock prices reveals that investors need to tread carefully, particularly if you are thinking of trading on ‘buy’ and ‘sell’ recommendations. Despite the way you see broker recommendations bandied around by bulls on bulletin boards, the research shows that the price impact of new ‘buys’ and ‘sells’ is sudden and short-lived – and because of the bias inherent in much broker research, sometimes analyst buy recommendations are best used as a contrarian indicator!

However, a strategy based on trading on changes in broker estimates, rather than recommendations, is supported by much more promising research. This is likely to do with freshness. Barber et al found that nearly 50% of all recommendations are left unchanged when they are revisited, approximately 300 days after they were first made. Earnings forecasts, in contrast, are generally more responsive to short-term news events (being revised on a quarterly or even monthly basis).

Among the most compelling research that found in favour of earning upgrades was a 1996 study by Phillip McKnight and Steven Todd. They assessed the revision anomaly across Europe and found that stocks with the greatest number of upward revisions in earnings, net of downward revisions, achieved significantly higher returns than otherwise similar stocks. They tracked a portfolio of shares in the highest 20% of net upward revisions and found that it outperformed the bottom 20% of upward revisions by more than 16% annually.

McKnight and Todd concluded that an EPS revisions strategy worked so effectively because ‘bad news travels quickly, but good news travels slowly’. In other words, investors are quick to respond to downgrades, which means the market is acting efficiently at pricing-in bad news. But with positive revisions, investors are more likely to take a wait-and-see approach. They blamed this on investors being all too aware that analysts can be susceptible to bias and being over-optimistic. As a result, the impact of earnings upgrades on share prices – and the underlying information that is driving those upgrades - takes time to be fully priced in.

Stocks on the move

As you can see from the Rules below, our Earnings Upgrade Momentum screen mainly focuses in on stocks that have seen over the past month the greatest percentage earnings-per-share upgrades for the year after next (remember you can fork any of our screens to add your own interpretation).

Among the top qualifying stocks currently on the screen is Carphone Warehouse (LON:CPW), the mobile phone retailer. It recently moved to take control of its retail operations across Europe by buying-out US joint venture partner Best Buy in a deal it said would be earnings enhancing. Combined with a robust fourth quarter trading update, the company’s shares were propelled by more than 50p to over 240p.

On each of our stock reports, we show the recent change in consensus for the next year – as you can see from this chart, brokers have dramatically upgraded their 2013 EPS forecasts of late, up by 34.8% over the past month. It will be interesting to see whether this has now been priced in or whether Carphone Warehouse shares can keep up their price momentum in the coming months.

Shares in betting group Betfair (LON:BET) leapt in April on news that it had become a $1.5 billion target of private equity company CVC. While buy-out talks were terminated last week, Betfair’s new management team have been keen to stress that their efforts to turnaround the company’s fortunes are beginning to bear fruit. It recently said it was on course to beat full year earnings guidance and that it was enjoying ‘strong strategic momentum’. Brokers have upgraded their two-year EPS forecasts by 29.1% over the past month, signalling optimism that investors might be on to a winner.

Commercial vehicle hire company Northgate (LON:NTG) has seen its share price double to 334p since last June but hire rates in its UK and Spanish markets have dipped recently, causing a near-term reduction in forecasts. However, Northgate seems to be a bet on improving economic conditions in those markets, with two-year consensus forecasts upgraded by 17.7% over the past month. We’ll hear more from Northgate when it reports its full year results at the end of June, but recent statements indicate that it is confident of growing its business in the UK and squeezing better returns from investments in expansion.

Brokers have been gradually downgrading their EPS forecasts for hedge fund manager Man (LON:EMG) over the past 12 months but there are signs that sentiment might be changing. Since taking the reigns as CEO in February, Emmanuel Roman has been trying to stem redemptions from the group’s funds, albeit unsuccessfully. However, over the past month there has been an 11% upgrade in consensus EPS forecasts for the next two years, helped by news that Man intends to redeem much of its debt and may begin buying back its own shares. That has breathed life into the share price, which has risen from 105p to 129p over the past four weeks.

One final company that may be worth mentioning from the Earnings Upgrade Momentum screen right now is ARM Holdings (LON:ARM), which makes chips for iPhones among other things. ARM has been a remarkable story stock over the past three years, in which time it has added £10 to its share price (currently around 1093p). While recent headlines have begun to raise doubts about its ability to continue growing, it’s notable that 20 of its brokers upgraded their two-year earnings forecasts for the stock during the past month, representing a consensus increase of 5.26%. Over the same period, the share price increased in value by 221p, currently leaving it within a whisker of its 52 week high. Still, by many valuation metrics, it now looks super expensive so, again, it will be fascinating to see whether the stock can maintain its momentum.

Weight of momentum

Last week, I wrote about how companies surprising versus consensus expectations were enjoying some strong share price performances. Joining the dots between these kinds of earnings ‘surprises’ and positive price momentum is grounded in a whole host of research. It turns out that surprises sometimes cause a price lag that can take months for the market to correct and as momentum takes hold, investors can ride the wave. In many ways, earnings surprises and earnings upgrades are in the same investing league. Both events have been linked to several months of positive price momentum (or negative momentum in the case of downgrades and earnings disappointments) as the market slowly digests their implications.

Given the performance of the Earnings Upgrade Momentum screen over the past year, it seems that taking note of broker upgrades and the price momentum they can cause, could be a profitable strategy. As always, there is a need for caution, not least because any strategy based on following analysts brings with it questions about the credibility of the underlying analysis. Just like ‘buy’ and ‘sell’ recommendations, earnings revisions are susceptible to bias and the behavioural instincts that cause analysts to herd together. Still, the evidence of this screen so far suggest that there may be an interesting mispricing effect here for investors.

To use our screening tools amp; stock analysis, why not take a free two week trial.

Stockopedia

5 stocks beating earnings expectations

Ben Hobson — Wed, 15 May 2013 16:13:55 +0100

Beating earnings expectations tends to be a sure fire way for companies to hit the financial headlines and get a warm reception from shareholders on results day. For momentum investors with an eye for a surprise, keeping track of these City stars has long been acknowledged as a profitable strategy. Not only that, but a review of London listed stocks that have sprung positive surprises over the past year shows that a number of them also come with potentially attractive valuations.

Why earnings surprises matter

The investment case for earnings surprises isn’t new; academics have been studying the effectiveness of earnings surprise-based trading strategies for decades while some hedge funds swear by them. Back in 1968, two US finance professors called Ball and Brown started the debate with research showing that in any given year, companies with the largest increases in earnings also had the largest increases in share price. Although the findings were obviously expected, one unusual factor that emerged was that those same stocks saw their share prices carry on rising over a period of up to three months after reporting their earnings.

This sort of pricing lag is a sensitive subject for those who believe the stock market is efficient. Ordinarily you might expect the market to seamlessly incorporate the full implications of an earning surprise into a stock price, but in study after study this is shown not to be the case. Naturally, academics have turned their attention to finding out what causes this so-called ‘post earnings announcement drift’, or earnings momentum, and why the market can be so inefficient at pricing-in earnings news.

What many have since concluded is that it’s the ‘surprise’ component of an earnings announcement that causes the delay. In particular, analysts and investors are slow to react to the full implications of the news – a factor that’s widely believed to be a major driver of price momentum generally. A 2005 study by Jegadeesh and Livnat found that analysts can take as long as six months to incorporate earnings and revenue surprises into their forecasts.

There have been numerous attempts to quantify how much of an opportunity earnings surprises represent to investors. In Leonard Zacks’ Handbook of Equity Market Anomalies US professor Daniel Taylor reviews various research and finds that the returns to a long-short strategy based on buying shares in companies with extreme earnings surprises range from 2.84% to 6.88% per quarter.

Another point worth noting is the likelihood that earnings surprises can become a habit for companies. In Trading on Corporate Earnings News, Shon and Zhou find that companies that have positively surprised the market with better than expected earnings in the past are more likely to produce a positive surprise again in the future and vice versa – serial disappointers are more likely to continue to miss expectations.

On the hunt for surprises with a value twist

So how do you go about digging around in the market for companies that have sprung earnings surprises but still pack a value punch? Using our screening software, we set out to find stocks that have produced substantial earnings surprises during the past year as well as how each of them rated based on their relative attractiveness as value stocks (using our ValueRank tool). Currently there are over 50 companies qualifying for our Earnings Surprise Screen which looks for cheap, moving stocks showing analyst upgrades.

Among those delivering the very highest percentage earnings surprises is insurance company Phoenix Group (LON:PHNX), which tops the list with earnings results on 22 March that beat consensus estimates by 63.9%. Phoenix is a £1.4bn market cap manager of closed life insurance businesses that are in run-off. At 644p, the shares have traded in a fairly narrow range since the company’s results but it is showing some very positive price momentum indications. It also ranks very highly as a potential value stock candidate. CEO Clive Carver has pledged to build the business through ‘further organic enhancements and a renewed focus on growth’.

By comparison, specialist insurer Beazley (LON:BEZ) has seen even better price momentum from a base of 199p on 7 February after beating consensus forecasts by 26.8%. News of record profits and promises of further growth have gently pushed the shares up to 231p over the past three months. That makes Beazley very much a momentum stock (as this Momentum chart shows) but one that retains some pretty strong value credentials too.

Several technology companies are notable inclusions on the screen, including Vislink (LON:VLK), which is a video and communications technology company highlighted recently by Paul in his Small Cap Reports. It beat consensus earnings estimates by 42.9% in its results on 25 March but despite some movement, the share price has yet to break much above where it was when the surprise was sprung. With high relative scores across a range of value metrics, Vislink is in the top 10% of the market based on its ValueRank. With its share price improving recently, it will be interesting to see whether momentum will build over time.

Another highly placed technology candidate on the screen is Cohort (LON:CHRT), which specialises in systems and support in defence, security and aerospace markets. Its earnings surprise came on 25 June last year, when it beat consensus forecasts by 31%. At 128p, the shares are 40p higher than they were last summer but at that price Cohort still qualifies as a high ranking value stock. Interestingly, its shares responded very quickly to the earnings news, rising by 21p to 109.5p on results day, before drifting higher over several months and eventually peaking at 151p in February.

Finally, shares in Molins have lost ground since the company announced its results at the end of February despite beating earnings forecasts by 17%. Molins makes machinery used in the tobacco, packaging and scientific instruments markets and frequently comes up as a potential value investing candidate. A big issue for prospective investors however, is the size of its pension fund liabilities, which has dogged the company for years and played a big part in depressing its value. A deficit recovery plan is currently costing the company £1.2 million per year, with a revaluation later this year potentially seeing those repayments having to rise.

Surprise, surprise…

For investors on the look out for gems in the market, earnings surprises are an interesting starting point. But beware, canny management teams are well aware of the effect of surprises and some research suggests they can be all too willing to ‘walk down’ the expectations of analysts just so they can become heroes on results day. So a look over the longer term earnings record could be in order. Overall, evidence suggests that searching out stocks with strong earnings momentum and decent value credentials can be a profitable approach. In frothy markets, where valuations have risen significantly in recent months, it could be a strategy worth exploring. Subscribers can see the full list of stocks on our screen here.

Stockopedia

Sprue Aegis bid - a win for sound investment methodologies

Edward Croft — Tue, 30 Apr 2013 09:46:58 +0100

Yesterday's announcement that the $5bn Jarden Corporation was making a bid for ICAP Securities Exchange tiddler Sprue Aegis wouldn't have threatened many headlines, but hidden within this story and the share price breakout are plenty of pearls that investors can learn from.

Sprue Aegis is the kind of company that the City neglects to its regret but that private investors are so able to take advantage of. On average only £15,000 of Sprue's shares have traded each day over the last few months. Clearly institutional fund managers can't trade companies like this without the share price soaring so they tend to completely ignore them unless they can pick up a big line of stock in a placing. It's for this reason that one can so often find hidden gems amongst the smallest companies on the market.

Sprue has certainly been a hidden gem in recent years but what the Jarden Corporation knows that the City doesn't is that Sprue has built up an impressive track record of innovation, execution and excellence in its tiny niche - clearly they think it worth bidding up for.

What's in the silly name?

Sprue Aegis is a fairly young company with a fascinating story beginning in 1998. The founders had decided on their business model before they even decided what products to make. They wished to build plastic electronics devices in a global market without strong brands where the user experience was poor. But it was only when they spotted a broken fire alarm hanging from a ceiling that the proverbial lightbulb switched on.

15 years later and Sprue is the UK market leader in home safety products (smoke and carbon monoxide alarms), with exclusive supplier status to Tesco and Bamp;Q and exclusive rights to distribute many of minority shareholder Jarden Corporations products too. Meanwhile increasing domestic safety legislation across Europe provides a growing market for the company to sell into.

I'm not going to go into the details of the story here as there are some excellent write ups about Sprue Aegis already on the web. Glasshalfull has promoted the investment case extensively on the Motley Fool and on ADVFN, while all credit should go to David Stredder for bringing the company to many private investor's awareness at his Mello meetings.

Beyond the 'story'...

As many will know from my speech amp; presentation at Master Investor, I am not the kind of investor who gets too swayed by stories. Stories separate fools from their capital endlessly - what matters most are the fundamentals of a business. As the father of value investing, Benjamin Graham, stated so clearly - "in the short run the market is a voting machine, but in the long run it's a weighing machine" - placing capital in companies with strong fundamentals at attractive prices is the way to investment success and it's this ethic that drives the ongoing development of our feature set at Stockopedia.

Those paying attention lately around Stockopedia will have noticed we've launched a set of ranks for every company in the market. Sprue Aegis before the bid yesterday was the second highest ranked company in the entire UK stock market out of more than 2000 stocks based on our proprietary 'CompositeRank' which equally weights four contributing factors - QualityRank, ValueRank, GrowthRank and MomentumRank.

It is not easy at all to rank highly on these lists. The QualityRank favours the kind of profile that Warren Buffett might prefer - those displaying very high margins, profitability, cash flow and earnings quality. The GrowthRank favours companies with exceptional historic and forecast earnings growth. While the ValueRank and MomentumRank obviously highlight companies that are cheap and with fast moving share prices. Finding companies ranking highly across the board using the CompositeRank is another way to find hidden gems in the stock market - just as for Sprue Aegis which was ranking 99/100 before the bid and most importantly 93/100 on the QualityRank.

As I discussed in a previous post - Warren Buffett became exceptionally wealthy by focusing on buying cheap, safe, high quality stocks. Being so small, Sprue Aegis could always be at the mercy of competitive threats should a big competitor enter the domain, but given the company's powerful position in its niche and the fact that the market for these products isn't that big you have to wonder why any big competitor would bother. Indeed for a competitor - it's much easier to just buy companies like Sprue outright than attempt to recreate them using hired hands which is why they tend to end up as buyout candidates. Not that the board of Sprue Aegis has budged at all - they responded to the bid by saying - "Due to illiquidity and the tightly-held nature of the shareholder base, the Company's share price as quoted on the ISDX does not reflect fair value and is therefore irrelevant" and that they "are unable to recommend that Sprue Aegis shareholders accept the Offer"

In conclusion

The point of this article is not to highlight Sprue Aegis in particular but to illustrate several things about the way the stock market works.

Firstly, the market in small caps and especially micro cap stocks is terribly inefficient as institutional money can't unlock the value. It's a hunting ground for frontier minded private investors and private corporate buyers.
Secondly, the stock market always eventually unlocks the value in cheap, growing, quality companies but often over timeframes can be rather inconvenient - the patient are rewarded.
Thirdly, there are several ways to find these hidden gems in the market - you can diligently read bulletin boards or go to company events and hope to stumble upon a good story and/or you can use a robust systematic approach such as we promote at Stockopedia to filter the market quickly down to these kind of candidate stocks.

For those that don't have the time to endlessly read bulletin boards or those that want to cut through the crap that is so often posted by over-enthusiastic shareholders online, the analysis tools at Stockopedia are, as Prospect Magazine described them yesterday, "a godsend". Sprue Aegis, to me, is another example of the kind of stock that David Stevenson wrote about in his recent article in FT Money.

"How might an ordinary investor, who does his or her own stockpicking, unearth a gem like Dart? Most likely using web-based, online systems such as those developed by Stockopedia."

For the full list of top ranked stocks you can browse the Share Directory or fork this screen here - we'll be adding these ranks to Stock Reports soon. Alternatively, the FT's choice the Screen of Screens provides another way to find hidden gems. Just remember to DYOR !

Stockopedia

Master Investor 2013 - visit our stall and watch the presentation !

Edward Croft — Fri, 26 Apr 2013 18:14:58 +0100

We've just been setting up our stall in preparation for the Master Investor Conference in Islington tomorrow. It starts at 9am and runs through the afternoon so there's plenty of time to come and visit us on the stall where we'll be running live presentations of the Stockopedia engine's capabilities all day. I'll personally also be running a 25 minute presentation from the new 'Rising Stars' stage at 12.20pm at the very front of the auditorium - so if you are in the vicinity then and want an alternative to Evil's main stage speech come and visit.

We'll also be explaining many of the site features and showing off our pan-European share coverage which we are anticipating will launch early next week. Europe is a fantastic fishing ground for bargains right now and the shares trading on the major recognised exchanges qualify for ISAs and SIPPs. We are excited to be opening up the ability to analyse continental shares to the private investor for the first time in the UK.

It's also a great chance for us to talk to subscribers face to face and learn of any issues you have been having with the software and what features you'd most like us to focus on next. We learnt a huge amount at the UK Investor Show and have already pushed out some new features that were requested there (only a fortnight ago !). We are still developing fast and have two new developers joining the team next month so get your requests in now and you'll see them built into the site.

Master Investor is obviously one of the longest running big investor shows in the UK and has changed format somewhat this year. There's the second stage I've already discussed and a cafe right in the middle of all the stalls which I think is a welcome addition as it provides a congregating area for people who normally get lost in the maze.

Hope to see you there.

Stockopedia

Quality small and mid-cap stocks offer dividend hunters new prey

Ben Hobson — Fri, 26 Apr 2013 10:31:38 +0100

Following on from our Quarterly Strategies Review, we thought we’d take a closer look at the recent performance of our Guru income screens. As we’ve mentioned, blue chip dividend stocks were an appealing prospect for investors last year but the blistering pace of the market in the first quarter of 2013 has shaken the yield tree quite considerably.

We track the performance of our strategy indices here and, as the following chart shows, income has done well overall as a strategy – but not perhaps in the way you’d expect. With surging prices and increasingly attractive yields, good quality smaller stocks have proved to be most attractive to investors of late.

Sleeping Dogs

For dividend hunters with a pure focus on high yield, going after the largest and theoretically safest stocks in the market have been for many months a useful solution to the limp returns on offer from cash and gilts. Throughout last year, one of the best known dividend strategies tracked on Stockopedia – Dividend Dogs of the FTSE 100 – put in a stellar performance as the index bounced off its spring lows and climbed through the year. Over 12 months, the Dividend Dogs delivered a 25.9% return (before dividends) versus 9.8% for the wider FTSE 100.

We might have expected that strong performance to continue into 2013 but, intriguingly, it hasn’t quite been the case yet. Over the first three months of the year the Dividend Dogs strategy has turned a 5.41% profit against 8.7% for the index. Part of the reason seems to be that despite some strong performers, a small number of the top ten stocks qualifying as Dividend Dogs have seen their share prices dip slightly in 2013, among them RSA Insurance, Aviva and Royal Dutch Shell. For long term income investors, those wavering share prices may not matter. After all, if your hold period is (near to) forever, lower prices ought to mean higher yields for anyone buying up the shares now!

Indeed, when Michael O’Higgins first presented his Dividend Dogs (or Dogs of the Dow) strategy, his primary focus was on picking large and (supposedly) reliable stocks because of their attractive dividends rather than their capacity to deliver capital growth. Still, while it’s a simple strategy to follow, one of the downsides is that its preference for size and yield doesn’t come with any other quality safety nets. So it’s interesting to observe that among all the income strategies tracked by Stockopedia, those delivering the best performance in Q1 (also ranking in the top ten performers across all our guru screens) are instead two that focus on quality and growth companies.

Mid-Cap Quality + Yield = Outperformance

In the Quarterly Strategies Review we noted that of all the guru models we track, those that outperformed in the first three months tended to have an emphasis on quality and growth factors. That pattern clearly makes its presence felt among the income screens too, with Winning Growth amp; Income (+16.85%) and the SocGen-esque Quality Income (+16.11%) easily outstripping the rest. For investors looking for a way to play the current trend towards good quality growth stocks, the dividend element could be worth watching. While the shares on these screens are generally smaller than the Dividend Dogs and their yields are lower, they aren’t that low.

Winning Growth amp; Income is a dividend-focused strategy based loosely on the ‘Growth amp; Income Winners’ screen outlined in Kevin Matras’ excellent book, Finding #1 Stocks. He begins by looking for solid growth parameters then drills down to the best dividend payers of the group. In Matras’ version of the screen the primary filter is the US-focused Zacks Rank (a proprietary metric that tracks analyst forecasts) but we’ve simplified this to just look for a positive change in analyst forecasts over the last quarter instead.

Across the top 14 shares currently qualifying for the Winning Growth amp; Income screen, the average yield is a respectable 4.76%, with the top yielder being specialist savings company Hansard Global on 11.2% (although yields like that do tend to set the dividend cut alarm bells ringing!). With a couple of exceptions most have market caps of sub-£200 million, with the smallest being Animalcare and Vislink, so the interest for growth and small cap investors is plain.

If fast growing small cap dividends aren’t your thing then the Quality Income screen should offer a more rigorous quality list of income stocks. This approach uses the Piotroski F-Score to seek out dividend payers that are at the top of their game in terms of financial discipline. Here, the market caps are naturally larger (mostly £1bn+) and so are the rolling yields but with the exception of utility group SSE, none of them are Dividend Dogs. Moreover, this screen offers more potential for sector diversification than the Dogs approach of simply picking the top 10 yielders in the FTSE 100.

What Next?

Recent analysis by Capita Registrars has pointed to some interesting dividend trends over recent months. In particular, the absence of one-off special dividends in Q1 pulled down the overall average pay-out, while the prospective 12 month yield for equities fell to 4.0% from 4.5%.

Still, while some of the large cap-focused GuruModel income screens delivered muted performances during the first quarter, the principles behind high yield strategies still look robust. In our book, How to Make Money in Dividend Stocks, we go into detail about why income strategies have consistently delivered market beating returns and, even as the world economy starts to heal, we would expect them to continue to do well in what remains a yield starved world.

Speaking of yield, those investors who may ordinarily have overlooked dividend payers in favour of good quality growth stocks, perhaps ought to look twice. The track record of capital growth from income stocks coupled with the yields still on offer from certain sections of the market suggests that it might just be possible to get two bites of the cherry.

The table below shows the percentage capital gains of all the income GuruModel screens we’ve been modelling over the first quarter together with the average current and rolling yields that those screens are now showing.

First Quarter Dividend GuruModel Performances
Screen	YTD Capital Gain	Avg Current Yield	Avg 1-Year Rolling Yield
Winning Growth amp; Income	16.9%	4.7%	4.7%
Quality Income	16.1%	3.7% (1)	4.4%
Large Cap Dividend Attraction	11.7%	3.5%	3.8%
Best Dividends	10.7%	2.1%	2.3%
Dividend Achievers	6.5%	1.9%	2.1%
Forecast Dogs of the FTSE 100	6.4%	5.4%	6.0%
Geraldine Weiss Lite Dividend	6.3%	1.9%	1.9%
Dividend Dogs of the FTSE 100	5.4%	5.6%	5.6%
PYAD	4.3%	5.5%	2.1%

(1) Does not include proposed return of cash by Persimmon plc

Of course, do remember that our screens are just intended as a starting point for further analysis an inspiration – you can “fork” or tweak any of our income screens to add your take on the screening parameters, and our stock reports provide much more detail on each company to allow you to dig into the income profile.

To try out our stock screening and fundamental analysis toolkit, you can sign up for a two week free trial here.

Stockopedia

Quarterly Strategies Review: Quality strategies soar but dividend stocks suffer

Ben Hobson — Tue, 23 Apr 2013 09:17:00 +0100

Investors needed to be doing something special to outperform the FTSE 100 during the first three months of 2013, rising as it did by 8.7pc. While there was little concrete evidence that the global economy is fully on the mend, equities became an increasingly attractive option against cash and bonds – and it was a strategy that paid off handsomely.

Indeed, the mini bull run that got underway six weeks before the close of last year continued largely unabated – driving up the index to 6504 points in mid-March before a modest retreat. Heading into the second quarter, creeping concerns, particularly on the subject of commodity prices have introduced some more serious looking wobbles to the FTSE. That uncertainty chimes with the views of some analysts who think that ‘Sell in May’ (or earlier) would be a judicious move this year.

For those investors prepared to take a ‘quant’ approach to the market, ditching the froth and frenzy that comes with rising markets in favour of systematic strategies, worked well - albeit not as well as in some previous quarters, presumably reflecting the way a rising market tide indiscriminately lifts all boats. Most of the screening strategies modelled at Stockopedia did beat the market, with 56pc of the GuruModel investment portfolios (long and short) outperforming the FTSE 100. Taking into account the murky world of fund fees, which can take a sizeable percentage bite out of returns, then the vast majority of these models from the masters of finance would likely have trounced net managed fund returns.

Overall, 30 of the long only strategies produced increases ranging from 8.9pc to 20.0pc. Over 12 months, the Stockopedia Composite Index of these models has produced a return of 16.2pc versus 9.43pc for the index of leading shares.

Quality rules but bargains still on offer

Among the top performing guru portfolios there was a definite trend towards ‘quality’ stocks with a growth flavour. However, the very best performance was reserved for the volatile Ben Graham-inspired ‘Net Nets’ bargain stock screen, which just edged a 20pc return. Graham’s ultra conservative valuation model, which digs out stocks trading at less than liquidation value by a sizeable margin, has continued to turn up valuation turnarounds. That performance has sustained its position at the top of the bargain screen list into the second quarter.

Meanwhile, the F-Score checklist for financial strength – as developed by Joseph Piotroski (one Stockopedia’s favourite finance professors!) – continued to prove its mettle. Piotroski’s price-to-book value screen delivered an 18.8pc return while a quality approach of simply tracking stocks with high F-Scores would have produced a handy 11.5pc performance. Evidence then, if any were needed, that a checklist for finding shares with improving financial discipline delivers results.

Elsewhere among the ‘quality’ screens, the Warren Buffett inspired Buffettology-esque Sustainable Growth (+17.0pc) and Historical Growth (+15.0pc) both featured in the top ten performers. Likewise, the SocGen-esque Quality Income strategy, which searches out high F-Score dividend payers, excelled with a 16.1pc return (before dividends).

Unsurprisingly given the market’s strength, momentum strategies were also in contention with Earnings Upgrades (+19.97pc) and Value Momentum (17.19pc) both inside the top ten. Bill O’Neill’s CAN-SLIM (+15.4) strategy took the top spot among the growth strategies, followed by Robbie Burns’ Naked Trader-inspired screen, which produced a 12.3pc return. Interestingly, over 12 months, our take on the Naked Trader screen actually edges O’Neill on performance (22.66pc versus 19.59pc). But even more astonishing is the remarkably smooth trajectory that the Robbie Burns inspired portfolio has produced – take a look at this!

Mixed news on dividends

While a couple of the income strategies jockeyed for position towards the top of the performance league (including Quality Income and Winning Growth amp; Income (16.85pc), a handful of dividend screens actually underperformed in the first quarter. Dividend Dogs of the FTSE 100 (+5.41pc), Forecast Dogs of the FTSE 100 (+6.37pc) and Dividend Achievers (+6.46pc) were all underwhelming. Part of the reason seems to be that a small but significant number of dividend ‘regulars’ – including the likes of RSA Insurance, Aviva and Shell – saw their share prices fall in the first quarter and that affected the figures.

While our performance measures don’t yet include dividend income, recent analysis by Capita Registrars has pointed to some interesting changes in dividends over the past three months. In particular, rising share prices and slowing dividend growth put the brakes on 12-month prospective yields during the first quarter – down to 4.0pc from 4.5pc. So it will be interesting to see how those dividend strategies play out this year.

What to watch in the second quarter

It remains to be seen whether signs that investors are turning away from yield in favour of quality and growth will continue. With many market watchers predicting some sort of correction in equity prices in the near future it might be too early to say that dividend stocks are completely out of favour. In fact, even on a prospective yield of 4.0pc, it would be difficult to say that dividends have lost their sparkle.

What is perhaps more clear is that value plays are becoming harder to come by. With rising share prices, the basket of potentially undervalued stocks that were on offer just three months ago has shrunk dramatically. So for the time being, as Mark Slater pointed out at the UK Investor Show, the focus has switched to quality and those stocks that continue to offer investors the expectation of continued earnings growth.

If you are looking for a lead on where to find the best performing stocks in the market, Stockopedia’s new look Share Directory is the perfect place to start. It runs the rule over every single share and now includes a ranking system that scores them all from 0-100 (worst to best) on any basis – value, growth, quality or momentum.

Stockopedia

Investing: Should the Past be a guide to the Future?

Stockopedia Features — Fri, 19 Apr 2013 13:32:34 +0100

As regular readers of Stockopedia will know, we are big believers in learning from data and statistical techniques what investing strategies have worked when. This kind of "quant" thinking is embedded in our stock reports - which feature risk indicators that have been found to be predictive like the Piotroski F-Score - and in our screening centre where we are tracking the performance of a wide range of different strategies - from Quality to Value to Growth to Income over time.

Leveraging an analysis of what's worked well in the past to develop investment and risk reduction strategies for the future makes sense to us. As George Santayana once wrote, those who cannot remember the past are condemned to repeat it.

The recent explosion of data availability and the falling cost of computing power also makes this kind of screening amp; modeling based on historically significant factors an important tool in the investing tool-box.

That said, it's also important to be careful with historical analysis too lest it lead you astray. It should serve as a useful device, but needs to be handled with caution too.

3 Pitfalls to be Wary Of

As wise regulators the world over like to remind us, past performance is not necessarily a guide to future performance! This counsel is of course true at many levels and there are lots of potential pitfalls in naively extrapolating from the past, including:

Mean Reversion - Far too often investors suffer from the phenomenon of “performance chasing”. As soon as they see a hot asset class or sector, they pull their money out of their other investments and pour it into the new object of their affection. That's clearly a bad idea! Markets often experience mean-reversion (this means that, when asset prices deviate too much from their long-term trend, they will often come right back - for good or for ill).
Data Mining - As we'll discuss in another article, another danger of focusing too much on the past is excessive "data mining" or confusing correlation with causation. If you look hard enough, you will likely find some seemingly effective rule that looks great, in the past. The issue is that the market has only one past but many possible futures. Even if stocks have rallied the first Friday in June for the past 30 years, it doesn’t mean they will rally again this year. It's always worth giving something the sniff test - does it make sense in the real world?
Dynamic Markets - And, of course, markets tend to be dynamic and reflexive, meaning that they can experience feedback loops which lead to changes in the behavior of market participants. If some investing approach has worked in the past, it may become accepted wisdom. Everyone piles in (think the lust for dividend stocks at the moment!). As a result, it may well become priced in / be arbitraged away and stop working.

Patterns Tend to Persist

In spite of all this, there are still important investing lessons that can and should be learnt from the past. Often, there are market structural reasons for certain anomalies - or patterns of market behaviour - to persist. On that note, it's worth remembering the words of Buffett in his piece on value investing, The SuperInvestors of Graham amp; Doddsville:

"[S]ome of the more commercially minded among you may wonder why I am writing this article. Adding many converts to the value approach will perforce narrow the spreads between price and value. I can only tell you that the secret has been out for 50 years, ever since Ben Graham and Dave Dodd wrote Security Analysis, yet I have seen no trend toward value investing in the 35 years that I've practiced it. There seems to be some perverse human characteristic that likes to make easy things difficult. The academic world, if anything, has actually backed away from the teaching of value investing over the last 30 years. It's likely to continue that way. Ships will sail around the world but the Flat Earth Society will flourish. There will continue to be wide discrepancies between price and value in the marketplace, and those who read their Graham amp; Dodd will continue to prosper."

Another great example of persistence is the Accrual Effect, one of the strongest anomalies ever discovered. This work found that companies with low levels of accounting accruals (the non-cash component of earnings) tend to exhibit better stock market performance than companies with high levels of accruals. When Sloan wrote the original paper in 1997, he found that the strategy resulted in an average annual compounded return of almost 18%. A subsequent study in 2006 found that - despite widespread awareness by hedge funds and other potential arbitrageurs of the research - an accrual-based strategy still beat the market by more than 9% a year!

So History Rhymes...

The reality is that - as one blogger has sagely noted, just about everything in the world of investing is somehow based on past performance. After all, what else (other than tea-leaves) is there to base your judgements on? Every investing theory is based on past performance, from CAPM to the efficient frontier, as is just about every investing book ever written. Even the "full backing of the US Government" is based on past performance.

"I always chuckle to myself when somebody will throw out the proverbial "Of course, past performance is no indicator of future returns", like he was Moses coming down from the mountain carrying two stone tablets. Invariably, that same person will "prove" his point using...guess what....past performance".

Famed hockey player Wayne Gretzky summed up his secret to success when he said, “go where the puck will be, not where it is". This is good advice. In our minds, it's important to use the past to inform your view of the future, while always recognising that the future may be - and likely will be - unpredictably different. There's no such thing as a sure thing but you can improve your odds by learning from the lessons of the past. History doesn't repeat itself - but it rhymes.

Stockopedia

Why blending value and momentum is a WISE investment strategy

Edward Croft — Fri, 05 Apr 2013 08:30:06 +0100

Last year I noted that blending a strategy designed to include cheap stocks with rising stocks could be the 'ultimate market strategy'. The evidence that Value amp; Momentum are excellent bedfellows is utterly compelling. The two strategies are complementary as value tends to prosper when momentum lags and vice versa. Given that the returns to value and momentum are fairly uncorrelated investors in both can reap additional returns for less volatility.

If you are a hardcore value investor it's worth seriously considering if you could really stomach the inevitable 3 or 4 year periods where you massively underperform the market. As mentioned in the article linked above the career of Tony Dye (a dedicated value investing fund manager) famously didn't survive the dotcom bubble, while others threw in the towel right at the wrong time.

While momentum investing is anaethma to most serious investors, there's a growing body of research that shows it should be taken just as seriously as growth investing and clearly a dose of it might just save a few careers. So if you wanted to build a systematic investment process around value and momentum how might you go about it?

Getting WISE

Societe Generale's quant team have been running a so-called 'WISE' investment strategy across various markets for over 8 years. At it's core the strategy blends a few value and momentum ratios through a very simple scoring system. The results historically have been quite impressive - especially given the large cap bias - with the original backtest showing a 12.6% annual performance on the long/short portfolio.

The team backtested all the traditional value ratios (P/E, P/B, Yield, P/S, P/CF) including the enterprise value ratios (EV/EBIT, EV/EBITDA, EV/Sales) and added in the 'growth relative ratios' for good measure (PEG and its enterprise ratio cousin the VEG).

They studied each company's ratio on an absolute basis against the entire universe (e.g. large caps in Europe), against their local market index (e.g. FTSE 100) and against their sector. They also tested each ratio relative to each stock and sector's historical average in what looks like a very comprehensive backtest.

On the momentum side they tested the classic pure price momentum ratios (like 6 month relative strength) but also heavily tested earnings surprise ratios - like earnings revisions, upgrades and downgrades.

To figure out which ratios to include in the end portfolio, they picked the ratios that generated portfolios of stocks with the highest Sharpe Ratios - essentially these are the portfolios offering the highest returns for the least volatility.

Value Ratios Winners: While "in most cases we were able to observe an average outperformance of value stocks" they surprisingly found that the growth relative ratios (PEG and lesser known VEG) carried less volatility. The four winning value ratios (with annualised added value of between 7% and 10.5%) proved to be the Price to Cashflow relative to the sector, Price to Sales relative to sector, PEG (12 months forward PE vs Expected Growth), VEG ( EV/EBIT vs Expected Growth).

Momentum Ratio Winners: The winning ratios from a momentum perspective proved to be weighted towards earnings surprises - the balance of upward vs downward earnings revisions, standardised unexpected earnings, unexpected returns around earnings announcements, six month absolute price strength.

What's fascinating about momentum strategies versus value strategies is that they work on completely different timeframes. The winning value ratios all work best on 12-24 month time horizons, whereas the momentum ratios work best on 3-6 month time horizons. As a result, the optimal blended portfolios have holding periods of 12 months - a boon for individual investors who want to put this kind of strategy to work, but don't want to trade like amphetamine fueled schizophrenic rabbits.

Show me the money?

Admirably for a City Quant team, Societe Generale used a simple scoring method to pick the combined portfolio. Each company is ranked from 1 to 10 according to the decile of each ratio, which are then summed to generate an average value and average momentum score - the combined average provides a 'WISE' score for every company in the market and the top ranked stocks are picked for purchase.

How to build your own WISE portfolio

Societe General run indices based on these WISE scores around the world - all can be investigated at the excellent sgindex.com portal and there may well be ETFs based upon them (DYOR!). New stocks in the latest WISE basket for UK investors include 3i (LON:III), Berkeley Group (LON:BKG), and Mondi (LON:MNDI).

But how would our readership at Stockopedia go about building their own value/momentum portfolios in a similar way? Well we've news for you on that front.

Last week we discussed O'Shaugnessy's 'composite value' ratios that, while composed differently, are scored in a very similar way to the ones in the SocGen paper. We have been generating our own sets of value, growth, momentum and quality factors which are in beta testing. For those that want to road test our 'highly beta' ValueRank, MomentumRank, QualityRank and GrowthRank you can search for the ratios in the Stockopedia Screener. They all score from zero (worst) to 100 (best) for each category. If you haven't got a subscription to Stockopedia please do take a 2 week free trial and check it out.

We plan on releasing these more officially in the next couple of weeks after we've had some time to finesse them and may start tracking their performance. I anticipate we will iterate on the composition of each rank based on subscriber feedback in coming weeks but you can search for them in the knowledge base - for the time being please consider them black box constructs. We also plan on launching blended composite scores (Value+Momentum, Quality+Value, Growth+Momentum etc) so that you'll be able to build your own WISE-style investment strategy quite easily. And the boon for individual investors is that this will work across the entire UK stock market - hopefully helping you pick better small caps too!

Stockopedia

Is Bitcoin the world's most perfect speculative material?

Edward Croft — Wed, 03 Apr 2013 10:35:30 +0100

I'm sure that it can't have escaped most people's attention that the price of Bitcoin has absolutely soared in recent weeks. The price of the innovative, cryptographically secured, digital currency has burst through some newsworthy levels - reaching $100 per bitcoin last week while the total value of all bitcoin in circulation reached a net value of $1 billion shortly after. Since Easter the price rise has accelerated to the point where I wouldn't be surprised if it burst through the £100 per bitcoin barrier within 48 hours.

These astonishing moves have caught the eye of the BBC, Economist, Moneyweek and the international press. This added media attention is adding fuel to what is already a very hot fire and the question that nobody seems to be able to answer is - how high can this thing go?

What the hell is a bitcoin anyway?

Before even attempting to answer how high it can go, it's worth recapping on what a bitcoin is to those who are completely befuddled - there's a good primer on Wikipedia, and a quick web search will throw up dozens of links that will give a fuller explanation than the next paragraph.

I am no expert, but have read up as much as most people will ever be willing to - so here's my take. In brief, it's a decentralised, open-source, digital form of money transacted peer-to-peer to and from virtual 'wallets' that can be downloaded from bitcoin.org and third party websites. It was born from the mind of an anonymous Japanese hacker (or group of hackers) who is/are generally known by the avatar "Satoshi Nakamoto".

The currency is secured not by the faith of e.g. the US government, but by trust in the cryptography that backs it. The money supply of bitcoin grows gradually, as new coin is paid to programmers who spend time verifying the so-called 'blockchain' - the history of all transactions in the network to ensure no duplicate transactions.

You can buy or sell bitcoin for regular currencies such as the pound or dollar and can 'spend' your bitcoin at an increasing number of venues as we'll see. 80% of the transactions between Bitcoin and 'real' money happen at the website MtGox which is Japanese owned.

Who is using Bitcoin?

One of the reasons that bitcoin has gained notoriety and acceptance is because transactions made in it are completely anonymous. As a result it's gained much use amongst illicit activites on the web. A website called The Silk Road allows members to buy drugs such as cocaine and marijuana anonymously while paying with bitcoin, where reportedly at least $2m per month is changing hands. Meanwhile US poker players (where paying with real money is banned) enjoy transacting in bitcoin as an alternative.

But bitcoin isn't just being used amongst in black markets. Bitpay ( a paypal for bitcoin transactions ) announced yesterday that they had added 4,500 merchants and were transacting over $3m per month. Meanwhile there are plenty of reports that some VCs in Silicon Valley are only accepting bitcoin startups, while typical bitcoin startup investments (of which there are many) are reportedly between $500k and $1m.

The VCs love bitcoin as it's uses are manifold - imagine you want to send money across the world. If you have to choose between a $40 Western Union transfer and a completely free Bitcoin transfer what do you think the poor of the world will chooose? Of if you want to start an online business in Tanzania which transacts completely internationally? Bitcoin, or something like it, has the ability to disrupt and disintermediate the traditional banking world.

Currencies generally act as both a means of exchange and as a store of value. In terms of bitcoin's use as a means of exchange, the value of the currency is clearly very low - the bitcoin economy is stil pretty negligible though growing at a clip. But the price is rising ferociously suggesting that many are buying it as a store of value or more likely just out of sheer curiosity…

Why bitcoin gets the blood going...

A few gathered thoughts on what is blowing this bubble.

Libertarian ideology... Over the last decade we've seen central bankers go party together in a frenzy of monetisation. The debasing of national currencies is not isolated to a single country but is happening the world over. There are reams of Randian, Libertarian dissenters who can't stand this kind of thing, who see these actions as a grand act of state theft and worry about a Weimar style hyper-inflation. Historically, the voice of dissent has been led by a small group of Austrian economists and Gold bugs pleading a return to the gold standard. But the rise of Bitcoin perhaps illustrates that the future of this debate may be centred elsewhere - amongst the growing group of technocrats centered in Silcon Valley and its decentralised home online.
Utterly democratised.. Bitcoin as an open source, peer-to-peer network is completely decentralised and out of the grasp of the state. It's a modern, exciting, brilliant concept. Peer to peer networks have thrived in spite of the best efforts of the powers that be to stamp them out. Torrent networks continue to ruin the profitability of film and music publishers in spite of lawsuits and big name site take downs. Even if bitcoin were stamped out, there are already 40 other digital currencies out there ready to take it's place as the leading digital currency.
Techno-utopianism... In a future technological world - are we really going to go back to the gold standard - a relic of the past to replace fiat money? So the thinking goes, the industrial revolution gave birth to a new form of paper money… can't the technological revolution give birth to its own?
Limited Supply… The supply of bitcoin is extremely limited. It's still hard to get hold of. There will only ever be 21 million bitcoin in circulation (though potentially it is infinitely divisible). As we've seen a tiny amount of demand for this thing can and will lead to soaring prices.
Parity is $470,000… Those who have done the maths (not me) have stated that for bitcoin to replace the dollar it will have to rise to a value of $470,000 per bitcoin. Clearly this is a fantasy today, but its the kind of number that puts stars in people's eyes.
Hedge the future? Many smart people are aware of the history of fiat currencies. They are always monstrously debased. If there's a place in a man's portfolio for a slice of gold, isn't there a place for another futuristic currency hedge?
$1bn to… All the bitcoin in the world is only worth just over $1bn. Clearly there is a lot of room for both the bitcoin economy and investment demand to grow.

If the crash comes…?

We perhaps ought to be prudent and ask what the downside for bitcoin is - how low could it go? Bitcoin may be destroyed by governments the world over who have a vested interest in stamping out any threat to their sovereign ability to control the money supply - although most agree that this is unlikely. There's also the serious risk that a digital construct like Bitcoin can be completely hacked - given that the programmer behind bitcoin is a mythical anonymous programmer rather than a verified legal individual you can understand why some are concerned. If you think it's bad that the UK or US government can debase the £ or $ at 4% annually then imagine if bitcoin was debased rather more aggressively - frankly, yes it could go to zero.

But if bitcoin really is as secure as its proponents suggest then there's no reason why it can't continue to rise in value over the long term. This is a bubble that is fueled as much by curiosity as by belief. But anyone holding bitcoin or buying it has to expect a very, very wild ride as it has crashed many times before.

Given all the above, I can't help but feel that bitcoin is the ultimate raw bubble material - it's only worth what people will it to be worth. This article is written on a day that Bitcoin reached $137, up over 40% in a matter of days. That suggests either a step change in demand or a blow-off top. I reserve judgement. George Soros may have once said that "when I see a bubble I buy", but with this bubble you'd better hold onto your hat.

Please join the conversation and air your thoughts in the comments below.

[Disclosure, I hold zero bitcoin ]

Stockopedia

Can you beat the market with blended Value Ratios ?

Edward Croft — Wed, 27 Mar 2013 09:11:11 +0000

Anyone who has read our book "How to Make Money in Value Stocks" will be well primed in the idea that buying cheap stocks is a strategy that beats the market. This is hardly surprising. If you can buy productive assets on sale you ought to do no worse than even. What is surprising is the extent to which these stocks in general outperform.

Benjamin Graham once said that 'in the short run the market is a voting machine but in the long run it's a weighing machine' snappily illustrating one of the critical ideas for stock market success - that the market over-reacts but eventually corrects itself. But to pick up the extra profit that can be made by exploiting this corrective mechanism, investors have long debated what is meant by 'cheap'.

What is cheap? Different strokes for different folks?

Generalising grossly, most valuation is done by comparing a company's share price against either what it can earn or what it owns. Price/Earnings ratios, Price/Cashflow ratios, Dividend Yield, Earnings Yield, EV/EBITDA ratios etc all aim to judge price against what a company can earn, while Price/Book, Price/Tangible Book, Price/Net current assets, Price/Cash and so on all compare price against what it owns.

Investors are a hugely sectarian bunch and defend their preferred valuation metrics from all comers. But frankly, over the very long term there isn't that much difference in which ratio one prefers to use. The returns to ALL value ratios are highly correlated over the long run and have very similar return profiles.

What one does find though is that during different market cycles, different ratios enjoy their time in the sun. A brief glance at recent history shows that this is so:

In the late nineties the Price to Sales ratio was most effective as dotcom companies failed to generate any earnings but flew to the moon.
In the recoveries from most bear markets (2002+, 2009+ etc) the biggest bargains judged by asset based measures (P/B, P/C) often massively outperform.
Between 2002-2007, EV/EBITDA based metrics were all the rage as the credit bubble grew and private equity sought to buy companies outright.
In the current yield deprived times we live in, the dividend yield has been the most successful value metric as investors have thirsted for income.

All this begs the question as to how can one build a perennial strategy based on a single favoured ratio? If you stick to your use of e.g. the P/B ratio at all times you could find that you massively underperform the market for a 3 year period. Nobody enjoys that kind of underperformance and frankly the majority of investors end up throwing in the towel on their strategy right at the wrong time. Is there a solution?

Beating them all with a 'composite' value ratio

James O'Shaugnessy, in his latest edition of the classic "What Works on Wall St" illustrates how to build a composite value factor based on an average ranking of 6 ratios - P/S, P/E, P/B, P/CF, EBITDA/EV, and Shareholder Yield (dividends+buybacks).

Each company in the market is ranked from 1 to 100 for each of the se value ratios and the composite is calculated as the average of all. Given the above background about how different ratios perform better in different eras, it's perhaps unsurprising that if you buy the cheapest stocks in the market based on this composite measure you get better overall returns with less risk than using the ratios individually.

For example between 1964 and 2009 - using Price/Sales alone - the best 10% of stocks by Price to Sales rebalanced annually returned 14.49% with a standard deviation (volatility) of 20.68%. But by using the composite value factor instead the return was improved to 17.3% and the standard deviation reduced to 17.1%. O'Shaugnessy implied that these returns could be even further improved by filtering the universe further for higher quality stock.

Does it really work?

I've been reading the recently published "Quantitative Value" book which backtests several versions of O'Shaugnessy's composite value factors and finds a very similar profit profile. They also illustrate that the composite value ratio beats all the other single value ratios bar one - the 'earnings yield' or EBIT/Enterprise Value. For those that don't know this ratio is a core part of Joel Greenblatt's "Magic Formula" and very popular amongst value investors.

To my mind, the lay investor can more easily get his head around the concept of a composite value ranking than most ratios which are full of technical jargon, so we are considering adding something along these lines to the StockReports and Screener on Stockopedia. I'd be interested to hear your thoughts on this in the comments below.

We are also keen to build out composite rankings based on other metrics along Growth, Momentum (timing) and Quality axes too. I know that a lot of 'serious' stock pickers may scoff at the idea that these kinds of things work in the stock market, but the fact remains that in the long run the stock market is a weighing machine and building systematically good, cheap, quality portfolios is a very sensible proposition - we will continue to do all we can to encourage investors along that path!

Stockopedia

Budget 2013 – Initial reaction for investors

Ben Hobson — Wed, 20 Mar 2013 14:14:51 +0000

With virtually no money to play with, Chancellor George Osborne has proposed a ‘fiscally neutral’ Budget, but there were a few point of interest for investors…

An abolition on the payment of stamp duty (0.5pc) from next April on the purchase of shares quoted on the Alternative Investment Market in a move designed to force capital into smaller companies. This should remove the distortion between investing in shares and spread-betting for those stocks and should help liquidity. Read more about this here. Marcus Stuttard, the head of AIM, has been reported as saying that stamp duty is a barrier to capital raising for small caps. Separately, the Government is already consulting on allowing investors to buy shares through ISAs.
All the major housebuilders have seen their share prices rise on news that the Government is set to pump more cash in to supporting buyers of new homes. The ‘Help to Buy’ shared equity scheme will see the Government lend up to 20pc of the cost of a new home to help potential buyers secure a deposit and mortgage. Buyers will have to stump up a deposit of 5pc before the Government steps in with interest-free loans of up to 20pc on homes worth less than £600,000. A second part of the scheme involves a £130bn mortgage guarantee scheme to help current homeowners move up the property ladder.
Shares in UK gas producer Igas Energy (LON:IGAS) jumped on news that the Government will introduce a new tax regime for shale gas development in the UK to promote early investment.
Confirmation that the Government will later this year sign contracts for future North Sea decommissioning relief, which Osborne said was already increasing investment there.
Ramp;D credit increased to 10pc – which is good news for innovators.
Shares in many brewers and pub groups have moved into positive territory on news that the beer duty escalator has been scrapped and a penny knocked off the price of a pint.

Stockopedia

How to make money from analyst research – Part 1

Ben Hobson — Wed, 20 Mar 2013 09:46:58 +0000

Understanding analyst research, who writes it and what it tells you

Over the past 15 years, DIY investors have enjoyed some notable improvements in the availability of market data and sophisticated execution capabilities. But while the tools to make investment decisions have got better, one issue that continues to divide opinion is the usefulness amp; availability of analyst research.

Most investors are familiar with the ‘buy’ and ‘sell’ recommendations from City analysts that routinely crop up in the financial press. Journalists feast on these signals without necessarily giving them much thought or context, and bulletin boards buzz about their meaning. But the detailed research behind these recommendations is often either hidden away or leaves the investor wondering about its reliability, accuracy and value.

In this mini-series of articles we are going to explore some of the reasons why analyst research is both loved and loathed by investors and whether trading off recommendations it a viable strategy. We will also show you how you can profit from analyst research by using the tricks, tools and screens available at Stockopedia to get a new insight into what it really means.

Who writes this stuff?

If the stockmarket is an engine and information is the oil then analysts are best thought of as the mechanics. They may not enjoy the glamour or compensation of the traders and investors who drive the car, but without analysts the engine would soon grind to a halt. When Richard Wyckoff wrote Studies in Ticker Tape Reading back in 1910, he not only introduced the world to the science of market analysis but he also kicked off increasing academic and professional interest in how markets and companies can and should be analysed.

Since then the role of the analyst has become more defined and more influential – but has also come under major scrutiny from regulators and academics. Research notes are routinely produced on the day of company results (final and interim), trading updates and major news. Analysts enjoy special access to management teams when discussing events, forecasts and in the development of their financial models, which means that their insight and opinions ought to be of interest to any investor, although often it is restricted to a privileged few.

Who is research produced for?

Market players – from investment banks to boutique brokers – employ analysts to cover companies, advise clients and ultimately encourage them to trade shares. But structural problems in a sometimes myopic market mean that the information and insight they produce doesn’t get to everyone. Unless you are a client of the firm in question, getting your hands on the research notes of the best analysts can be a challenge. Often this information is only designed for the eyes of institutions that pay fees or offer fixed-commission business, with disclaimers and restrictions stemming the flow to a broader base of recipients. This situation led the United States to introduce Regulation Fair Disclosure back in 2000 to ensure that sell-side analysts were not getting access to special information from management which is not available to the market at large.

On this side of the pond, things are lamentably much further behind. However, the emergence of independent research houses, which often charge companies for coverage, has tried to open the door to a great deal more independent analysis. This work is distributed for free and is therefore more widely accessible by individual investors. The London Stock Exchange has encouraged this type of fee-based research, particularly for smaller companies, as a means of improving visibility and liquidity. Smaller companies often don’t attract mainstream research beyond what a house broker might produce, which can be a deterrent to both institutions and individuals that might otherwise want to invest. As a result, fee-based research has flourished, though the impartiality of the research produced under these arrangements should be questioned.

How reliable are the opinions?

While the selective dissemination of research is a bugbear of information-hungry investors, it isn’t the only criticism of analyst coverage. Over the past ten years regulators and academics have scrutinised the independence of analyst forecasts, their accuracy and how predictive they really are. An interesting observation here is that there is a weight of evidence that analysts issue far more ‘buy’ recommendations than they do ‘sells’. This is believed to be the case because a bullish stance encourages trading and makes corporate clients happy even though it might not necessarily reflect the reality of the fundamentals.

Changes have been made in the way analyst notes are presented, such as clarifying the relationships between the company and the broker, but many believe that a lot of research can still be biased and of varying quality. In some instances, it’s claimed, research notes can turn out to be at best just a rehash of company news rather than thoughtful analysis or, at worst, a biased siren song ahead of impending calamity.

In large and mid-cap stocks, the credibility of analyst research is likely to be improved by the number of analysts covering the stocks. Usually, multiple analysts from a broad range of banks and brokers will put out notes, making it easier to identify divergence from what’s known as the ‘consensus’ view. At this higher end, the concerns tend to focus on whether there is any movement of information between Chinese walls inside investment banks and the pressures that an analyst might feel if, say, his firm also provides corporate finance advice, investment banking or even brokerage services to the company. Some observers suggest that analysts from the house broker will be among the most conservative of all the analysts tracking a company, perhaps with a view to letting the company beat forecasts – and hopefully seeing its share price rise as a result.

Further down the scale, the research supporting smaller, less liquid companies presents different issues. AIM companies can, and often do, hire Nominated Advisers (the buffer between the company and the stock exchange) that also act as brokers. This doubling-up means that it’s possible for the only research on the company to have come from a firm that already has strong fee-based links to it, which again gives rise to concerns about potential conflicts. The emergence of independent research boutiques that charge companies for research services have partially resolved this problem but, again, critics point to the potential for influence in research that the company itself has paid for.

Is following analysts an investment strategy worth considering?

There have been numerous academic studies into the quality and the predictive nature (or otherwise) of analyst research – with very mixed results. As we will discuss later, work by David Dreman and James Montier has shown that it's important not to be too swayed by the opinions of these so-called "experts" as their forecasting track record is generally not good. Still, one of the largest UK studies was carried out in 1984 by Dimson and Marsh from the LondonBusinessSchool. They examined 4,000 stock return forecasts for 200 of the largest UK shares provided by 35 different firms of brokers and analysts. They found that analysis did indeed provide a ‘small but potentially useful degree of forecasting ability’. But they also concluded that a large part of the information content in the forecasts was quickly discounted in the market place within the first month.

For individual investors, keeping track of what analysts are saying about stocks is virtually impossible without access to top quality data and the tools to use it. At Stockopedia, our Stock Reports include details of the analysts covering a particular company, the consensus broker recommendation and the trend in the consensus forecast over recent months. This information helps to lift the lid on how each company in the market is being perceived by the analyst community.

In the next article in this series, we will explore whether it is possible to make money by following analyst recommendations. We will look at the evidence that these recommendations can be profitable (or otherwise), the factors that can adversely influence recommendations and the costs of such a strategy.

In this series:
1. Understanding analyst research, who writes it and what it tells you
2. Can you make money from analyst recommendations?
3. How to think differently and use analyst research to your advantage
4. Putting it all together – three strategies to make money from analyst research

Stockopedia

Index funds are parasites and are going to kill the market

Edward Croft — Fri, 15 Mar 2013 15:48:20 +0000

Everywhere you go these days you hear yet another investor singing the virtues of investing in low cost index trackers. Frankly the sales pitch makes sense doesn't it? It's very easy to understand and goes something like this:

"The majority of active fund managers underperform the market averages so why should you pay 2% for the privilege? If you buy an index fund you can guarantee average performance and thus beat the average fund manager."

It seems that this idea is winning. The mainstream press sings the praises of low cost passive investing, while the knives are out for active fat cat fund managers. Meanwhile a Tsunami of money in the fund management industry is flowing into passive vehicles, and the flow of funds into the big providers like Vanguard is quite astonishing. The advisory community is voting with its feet and has decided that index investing is the light.

But my nostrils have started flaring from a growing stench of groupthink and I can't help thinking that somehow this is all going to end in tears.

The ultimate piggyback ride

In a way, index investing is the ultimate piggyback ride on the coattails of the active management community. If you think about it, the selection of stocks that are included within the major indices is solely due to the discerning opinion of the active management community. These professionals bid the price of a stock up until it becomes a candidate for promotion to the relevant major index - such as the FTSE100 or Samp;P500. At this point index funds jump on the bandwagon and buy. The idea that this is a 'passive' process is beyond me - it's an active decision to ride on the coattails of other people's decision making.

The irony is that index funds haven't had to pay the salaries of the people who pick their stocks for them. Index investing has been monstrously successful partly due to the fact that through this trick they've kept the costs of management extremely low. If there were any justice index funds would pay a tax to the active management community for their service.

But piggybacking can only be a successful strategy if you don't get too heavy for your ride. As index investors have started to dominate the stock markets they have started to create some terrible unintended consequences. The horse's knees are starting to buckle.

When success breeds failure

There was an excellent paper written in 2010 by Professor Jeffrey Wurgler of NYU Stern School of Business that I highly recommend reading. He preaches that the stock market has only a finite capacity to absorb passive investment funds without materially and detrimentally impacting the market.

The wall of money investing in passive trackers is causing prices to detach from reality - inclusion in the Samp;P500 index causes a 9% jump on average in the stocks price - but it doesn't stop there. There is evidence that Samp;P 500 membership creates a price premium of 40% over non members. Many commentators, including the excellent blog at Psyfitec have warned of a looming 'index bubble', while Morck and Yang suggest that investing in these indices is essentially a "large cap growth and momentum strategy that can't last forever - this "index bubble" will pop".

But there's more, he suggests the whole market structure is creaking. When a stock is added to an index it's price action detaches from the rest of the market and it "begins to move more closely with its new 499 neighbours. It is as if it has joined a new school of fish". This accentuates gross price distortions and means that real valuations are less likely to be realised.

The delicious irony is that this creates an environment where large cap active fund managers can no longer harvest their expected returns from value situations. We've seen many great investors, even legends like Bill Miller, lose their way in recent years. Could it be that passive investors are slowly killing the hand that fed them in the first place? That active investors actually underperform due to the growing load on their back? I can't help but hear the echo of Aesop's fables in this story - that index investors are killing the goose that laid their golden egg.

Don't throw the baby out with the bathwater

Everybody should read John Bogle's classic "The Little Book of Common Sense Investing". His teachings on the 'relentless rules of humble arithmetic' and minimising costs are priceless. Passive investing has huge merits but there are perhaps better ways to do it than investing in the big market cap weighted index trackers.

In this respect, Joel Greenblatt's latest book, "The big secret for the small investor" is a great eye-opener. It preaches that many would be better off investing in equally weighted or fundamentally weighted funds. But even better than this is to build your own portfolio around solid and sound investment principles. Greenblatt preaches a mantra that we at Stockopedia stand by, that you can beat these index funds by creating your own low cost systematic investment strategy and investing directly in the underlying shares. We are building the tools to do this and believe fundamentally that it's a saner approach than the growing madness in much of the institutional money management world.

How to build a systematic portfolio with Stockopedia – Part 5

Ben Hobson — Fri, 08 Mar 2013 13:46:14 +0000

Tips for managing a systematic portfolio

This is the fifth and final article in our series looking at how you can build a systematic portfolio of shares by using the tools available at Stockopedia. In the first four articles we explored the steps that any investor needs to take in approaching the market, defining a strategy, constructing a portfolio and giving it the best chance of success. In this article we’ll look at a few of the things to think about when managing that portfolio over time.

During the series we introduced a example Systematic Value strategy to explain how a portfolio can be created. We built the strategy by merging the metrics and parameters of Joel Greenblatt’s Magic Formula and Joseph Piotroski’s F-Score. What that gave us was a focus on good quality cheap stocks that that display a strong and improving financial health. According to Greenblatt, Magic Formula stocks should be bought in batches of between five and seven every two to three months over a year (although for simplicity we made all our theoretical purchases at the same time).

The next question is when to sell? For many of us it's natural to take an active interest in how the portfolio is performing and changing and making active selling decision may seem like a critical component of being your own fund manager. But this needs careful thought because individual decisions can be costly since our human ‘fear and greed’ responses come into play. If you’re interested in implementing a systematic approach, it might be better to eliminate any possibility of your heart ruling your head by having and sticking to a strict system of periodic rebalancing.

In this series:
How to get started in the stockmarket with Stockopedia
How to create your ideal investing strategy (value, growth, dividends)
How to turn a strategy into a portfolio with Stockopedia
How to give your portfolio the best chance of success
How to manage your portfolio over the longer term

What is rebalancing?

Rebalancing involves tweaking a portfolio that has drifted away from what it set out to do when you first started. Having some sort of rebalancing strategy is essential because, over time, the make-up of all those shares in your portfolio will change – even if you do nothing. As markets rise and fall some stocks will increase substantially in value while others may fall by the wayside or even blow up. Portfolio rebalancing means that as some assets appreciate and others depreciate, you periodically adjust your positions to stay in line with your original plan. This involves taking the counter intuitive action of selling investments that are doing well. This is all tied up with the idea of mean reversion - markets and stocks tend to move in cycles, meaning that a poorly performing asset won't always do badly and a high-flyer may eventually come back down to earth.

People often tend to talk about rebalancing only in the context of how much money you have invested in bonds compared to shares, but it can equally apply to your underlying stock selection strategy. At this point, some hardened stockpickers may object “but what about running my winners” and “cutting my losers” or, put another way, doesn't this amount to the cardinal sin of averaging down? The short answer... if you fancy yourself as a stockpicker and as someone who can control their fear and greed response and time the selling of investments, you probably shouldn’t be running a systematic strategy. But it’s precisely because most people struggle to manage their emotions that systematic strategies do so well on a relative basis.

Rebalancing the Stockopedia way

We track all the 60+ Guru Models available on Stockopedia as portfolios. Like our Systematic Value example, some of these strategies may originally have been much longer-term buy-and-hold deep value strategies but - for tracking purposes at least - we rebalance all of them strictly every three months. What this means is that, every quarter, the portfolios are checked against which stocks are qualifying for the original screening criteria. If a stock is no longer qualifying, it is sold, and you use the proceeds of that sale to replace it with another stock that is qualifying.

However, this is all done on a friction-less basis (i.e. without taking transaction costs into account), which makes it viable to do the rebalancing frequently even for a smaller portfolio. In the real world, this high level of trading activity may well land you with huge trading and tax costs. Our original research into the cost effectiveness of running your own fund found that £50,000 fully invested in 25 stocks will cost around 1.96% annually to run. You can read more about that research here. That cost assumes you are buying and selling 80% of the portfolio every year which is around the average turnover rate for an institutional fund.

Annual rebalancing is likely to be optimal

The Vanguard Investment Strategy Group has done some useful work on the topic of rebalancing. Looking at US stock and bond market data from 1926 through to 2009 they found that risk-adjusted returns are not meaningfully different if a portfolio is rebalanced monthly, quarterly, or annually. However, the number of rebalancing events and resulting costs increase significantly. For that reason, they concluded that, for most broadly diversified portfolios, annual or semi-annual monitoring - with rebalancing once an investment exceeded a 5% threshold - is likely to produce a reasonable balance between risk control and cost minimisation for most investors.

This ties into the advice of other well known professional investors. Joel Greenblatt envisaged that his Magic Formula portfolio should be rebalanced annually, selling losers one week before the year-mark and winners one week after the year mark (although this guidance relates to specific US tax considerations), while the late quantitative theorist, Robert Haugen suggested that trades should be staggered monthly in 1/12th tranches so that whole portfolio is rebalanced over the course of a year rather than all at once.

The advantage of this kind of systematic rebalancing is that it entirely does away with the thorny issues about which stocks to sell and when. As Greenblatt has noted, when it comes to long-term investing, doing “less” is often “more”. Let’s say you own a stock that triples, but your rebalancing date is 11 months away. What do you do? You wait! Let’s say you own a stock that halves, but your rebalancing date is five months away. What do you do? You wait!

It is certainly true that you could miss out some potential gains and duck some losses by not taking matters into your own hands at certain times. But the question is whether you believe in the underlying system or in your own discretionary management skills?

As a quick aside, and as we discussed in the last article, the issue of diversification is essential for investors to consider and this is very likely to involve some human judgement calls. As it turned out, our portfolio also had a fairly hefty (40%) exposure to Industrials. If you’re limiting the concentration of stocks in any one industry, be sure to select new stocks from the latest lists with that in mind.

If you do decide to start making your own sell decisions more actively, there’s some great guidance from legendary investors on how to do this. At Stockopedia we have written at length on some of the theories about when investors should sell shares, both from a fundamentals perspective and a technical standpoint. Value investing legend Ben Graham suggested selling after a price increase of 50% while growth and momentum-focused US fund manager William O’Neill looks for rapid breakout, momentum stocks and bails out of non-performing duds as quickly as possible. Overall, the advice still seems to be to establish a systematic buy and sell strategy that remains steadfast to the original strategy or sets percentage thresholds that suit you – and then stick to it.

Investing tools at your disposal

In this series we have endeavoured to explain how you can become your own fund manager with the tools available at Stockopedia. From developing a strategy that matches your investment preferences to building and refining a portfolio and managing it in the long term, we have the tools to help you do it. Whether you are building your own screen from the ground up or using the tried and tested methods of some of the world’s most successful investors for inspiration, a systematic strategy has some major advantages. In particular, it can improve your decision making process by giving very clear ideas about which stocks are worth closer inspection and which should be avoided. It can also give you an advantage by taking away the risks of emotional attachment and giving you the opportunity to be contrarian with confidence.

With Stockopedia at your disposal, you can throw off the shackles of costly funds and step into the market in the knowledge that you are armed with the best data and some of the cleverest investing tools around.

If you like what you are hearing and are ready to begin exploring the tools available at Stockopedia, click here to get started.

Stockopedia

London Value Investor Conference 2013 featuring Anthony Bolton amp; Howard Marks

Stockopedia Features — Thu, 07 Mar 2013 08:00:20 +0000

Stockopedia has managed to secure a very limited number of discounted tickets to the forthcoming London Value Investor Conference 2013. This year's conference takes place on 9th May 2013 at Central Hall Westminster with the following excellent speaker line-up:

David Harding, Winton Capital - Searching for Value in Data
Howard Marks, Oaktree Capital - The Most Important Thing
Anthony Bolton, Fidelity China Special Situations Fund - Special Qamp;A Session
Nick Purves and Ian Lance, RWC - New Challenges for Value Investors - Is this time different?
Michael Price, MFP Investors - The Peter Cundill Foundation Address
Richard Oldfield, Oldfield Partners - Still Simple, Still not Easy
Plus speakers from smaller, less well known funds

As part of their presentation, each of the speakers will give at least one current investment idea. Winton Capital has also kindly agreed to sponsor a drinks reception after the event, which will be a great opportunity for networking amongst the value investing community.

With 10 weeks to go, the number of delegates attending is already well ahead of the total who came last year. It is expected that the 2013 conference will be the largest gathering of value investors ever outside of the USA.

In order to claim your special £100 discount on this conference,
please use the code "STOCKOPEDIA123" when signing up here:

Click here to claim your £100 discount

The last London Value Investor Conference donated its profits to the children's charity, the SMA Trust. This year's conference will be supporting the children's charity Place2be.

We hope to see you all at the London Value Investor conference!

Stockopedia

How to build a systematic portfolio with Stockopedia – Part 4

Ben Hobson — Wed, 06 Mar 2013 12:58:41 +0000

How to give your portfolio the best chance of success

Welcome to the fourth article in our series exploring how you can build a portfolio of shares by using the tools available at Stockopedia. So far we have examined why a strong underlying investment strategy is essential for any systematic investor and how that strategy can be brought to life and used to screen the market for stocks. With our concept portfolio now created we are going to look further at some of the factors that are important in managing it in the long-term.

Before we crack on, here is a quick recap on where we’ve got to during the first three articles in the series. Having taken the decision to invest directly in the stockmarket, we have looked at some of the key considerations that you should make before parting with any cash. We have also discussed why it is essential to choose an investment strategy that suits you and we have introduced a Systematic Value strategy, which is one of the approaches we like at Stockopedia. In the last article we ran through the steps needed to take all the components of that Value strategy and apply them to the market by using our tools. At the time, there were 29 stocks qualifying for the screen, which we transferred to our portfolio.

In this series:
How to get started in the stockmarket with Stockopedia
How to create your ideal investing strategy (value, growth, dividends)
How to turn a strategy into a portfolio with Stockopedia
How to give your portfolio the best chance of success
How to manage your portfolio over the longer term

At this point it is worth pointing out that the strategy, the screen and the portfolio are hypothetical examples. Yes, they are real, the metrics are all correct and the Stockopedia tools have saved us doing what would have been a near-impossible job by hand. But don’t interpret this as investment advice; it is simply an illustration of how our tools can be used. It’s essential to do your own research or if necessary seek professional advice before deciding on underlying strategies.

Dealing with your portfolio

Our Systematic Value screen combines the metrics and parameters required in Joel Greenblatt’s Magic Formula and Joseph Piotroski’s F-Score. It will continue to update in real time in the My Screens section of Stockopedia. As companies across the market issue results (annual or interim) and prices move, stocks will be promoted and demoted as their qualification for the screen changes. This constantly updated list of new candidates will be essential when it comes to making changes to the portfolio at a later date.

Having exported all 29 stocks to the Portfolio Watchlist section of Stockopedia, we need to decide which of them to buy and then input the details of those trades as a Model Portfolio. For the sake of brevity, we are going to do this in a simplified way – by spreading a theoretical investment pot of £50,000 across 25 theoretical stock purchases. This is very simple to do – just click the blue Edit Position button next to each share and then Add a Transaction. You can include various details including the share price, the number of shares acquired, costs of the trade and the overall transaction cost.

From our portfolio, to get to the nice roundish number of 25 stocks, we disregarded three dual-listed stocks and one oil company. We paid close to £2,000 for each of the others, which included £10 each for dealing costs and £10 each for stamp duty at 0.5%.

Keeping costs down

Earlier in this series we mentioned the findings of some in-house research into the costs of running your own portfolio. Specifically, we wanted to know the point at which it becomes more cost-effective to go it alone as opposed to simply buying a fund. You can read about the findings of that research here. Based on those calculations, our pot of just short of £50,000 spread across 25 stocks ought to cost around 1.96% per year – which is very competitive against a fund. That figure includes selling and buying 80% of the stocks annually and incorporates the costs of bid/ask spreads, taxes and trading.

It is worth noting that 12 of our 25 companies are AIM quoted, which means they don’t qualify under ISA rules and could attract capital gains tax when they are sold. This needs careful consideration, not least because our portfolio also generates a dividend yield of 3.5% (against a market median of 3.05%). In general terms, and depending on individual circumstances, it is important to examine how we could protect the Main Market listed stocks (and likely dividend payers) by using a tax wrapper like an ISA or SIPP where possible.

Managing and understanding your portfolio better

Our portfolio is inspired by the thinking of successful US fund manager, Joel Greenblatt, who suggested buying a basket of 20-30 good companies at attractive prices. His approach to constructing a portfolio actually involves buying between five and seven stocks every two to three months over a 12 month period (which we have skipped) and then selling each one after 12 months. He says that the proceeds from sales should be reinvested and that the whole strategy should be continued over a long-term (3-5+ year) period. By insisting on a portfolio of this size, Greenblatt aimed to mitigate against the risk of individual failures by diversifying. However, until now we haven’t looked in any detail at the precise make-up of the portfolio and whether it raises any concerns. This is where Stockopedia tools come in useful.

How to think about diversification

Among the tabs on the Portfolio screen, clicking on Allocation will give you a breakdown of your sector, style and maximum position exposure.

In terms of style, you can see that this is a small-cap value portfolio, which is unsurprising given its Magic Formula nature. Clearly, we could have increase the market cap filter if we wanted a portfolio that was more mid to large-cap oriented but many of the most interesting mispricing opportunities tend to be in the under-researched small-cap part of the market, so we'll leave it for now.

Opinions are generally divided on the subject of diversification but, unless you're prepared to devote a lot of time to monitoring your investments, it's usually a good idea not to be overly exposed to one stock or sector. A good rule of thumb is that no stock should be more than 10% of your portfolio, ideally less than 5%, and no industry should be more than 25% of your portfolio.

In this case, since we have equal-weighted the positions, the maximum position size initially is going to be no more than 4% so that's fine but it's worth keeping an eye over time as the position values change. As you can see however, nearly 40% of the portfolio is in Industrials, with the rest fairly well split among other sectors.

Of course, exposure like this may not be a bad thing: some analysts think Industrials are now emerging from weak economic conditions. In the context of our strategy – which looks for good quality companies with low share prices – that view of the sector makes sense but it may be worth considering some changes here.

You can also compare your portfolio weighting to the general market to see if any specific anomalies have arisen. This also shows how much more exposed this sample portfolio would be to Industrials than the overall market - 39.8% versus 14% for the overall market - so that's worth mulling over.

Elsewhere, by clicking Analysis you can see a breakdown of how your list of stocks rates against the market. For instance, you can compare forecast ratios – such as P/E, EPS and dividend yield – against market averages. In our case, the average P/E ratio is 12.2x versus 12.4x average for the market. Although this is a value-based strategy, the P/E is not as low as it would be for a pure bargain value strategy because of the over-riding Greenblatt / Piotroski focus on safety and quality (i.e better and typically more expensive companies). Of course, you pay a price to be able to sleep better at night.

You can also see whether any warning flags have been raised regarding general financial health, distress risk and earnings risk - in this case, the portfolio looks to be in good financial health, although it's worth reviewing each of the individual stock reports too to check for any red flags there too.

Up and running

Having established a strategy, created a screen and built up a list of positions, the Systematic Value portfolio (in this case) is now up and running. Regardless of which strategy and stocks you choose, the Stockopedia tools provide a huge amount of insight not only into how those stocks are performing but when risks or warnings emerge that you might not otherwise have been aware of.

In the fifth and final article in this series we will explore more general issues related to making sure the portfolio stays focused by rebalancing, boosting its performance from your portfolio and avoiding catastrophes. We will look at ways in which a strategy could be strengthened to suit your requirements as well as the behavioural rules you need to adopt to ensure the best chance of success.

If you like what you are hearing and are ready to begin exploring the tools available at Stockopedia, click here to get started.

Stockopedia

Stock Screening 'really, really matters' - FT Money on Stockopedia

Edward Croft — Sun, 24 Feb 2013 14:49:54 +0000

Just thought I should flag to subscribers this morning the excellent article "Stock screens to net the ones that got away" in the Financial Times Money section this weekend that references some of the work we are doing at Stockopedia.

David Stevenson's the Adventurous Investor column for FT Money is required reading for anyone who takes their investing seriously. Given that he so regularly covers opportunities in ETFs, structured products and derivatives, when he does decide to cover direct investment in stocks its always worth listening.

In the article he discusses how to ensure one doesn't miss out on great value stock opportunities such as that offered by the airline amp; logistics company Dart Group in 2012 - a stock which has now 'taken off' 140% in the last 12 months. Noting that some fund managers had made big profits in the stock, Stevenson asks...

How might an ordinary investor, who does his or her own stockpicking, unearth a gem like Dart? Most likely using web-based, online systems such as those developed by Stockopedia.

You need to use a website or system that can run the screens for you, and then identify the stocks that come up most often in each of them, which is exactly what Stockopedia has done.

Essentially, he is describing the process of Stockopedia's 'screen of screens' - which gathers the most highly qualifying stocks across all of our strategies. We have written extensively about the screen of screens - most notably in this article by Ben Hobson - and continue to be impressed by the performance of the portfolio we run based upon it. It has returned 41% in just 15 months since its inception before dividends and has been flagging Dart Group since late last year.

Stevenson wonders whether what stops us investing in these profitable opportunities may be our propensity to prefer to invest in safe names. He concludes with some of the sentiments of Joel Greenblatt, the hedge fund manager, who has argued in an interesting piece called "Adding Your Two Cents May Cost a Lot Over the Long Term" (summarised here) that we should just 'trust the quant', buy the lists and remove most or even all human stock picking from the equation.

But what does temper my admitted enthusiasm for purely using systematic investment strategies is the fact that some of our excellent contributors - such as Expecting Value and Value Stock Inquisition - had picked up on Dart Group before it was rising up to the top of the list on the Stockopedia Screen of Screens. If you'd been listening to them AND seen Dart Group prominently qualifying for selective turnaround strategies such as the Piotroski Low Price to Book screen, you'd have been very well placed to profit early. DYOR is therefore not just a wise risk-avoidance strategy but also a profit enhancing approach.

Of course, the danger in doing your own stock picking amongst value stocks is that you can end up falling in love with the story and get stuck in a value trap or a stock lacking a catalyst for a very long time. The great benefit of utilising an approach such as the screen of screens is that it blends value with momentum and other styles while remaining completely unemotional. Dart group qualified for the screen of screens right at the point the share price was starting to fire. Choose your weapons wisely !

Again - if you don't have a hard copy, I do recommend reading David Stevenson's article at the FT Website, and check out the Screen of Screens at this link.

Stockopedia

How to build a systematic portfolio with Stockopedia – Part 3

Ben Hobson — Fri, 22 Feb 2013 14:27:21 +0000

How to turn your strategy into a portfolio

This is the third article in our series exploring how you can build a systematic portfolio of shares by using the tools on Stockopedia. Previously we examined why a strong underlying investment strategy is essential for any systematic investor. We also introduced an example value strategy as the first of three potential approaches to the market that might suit most investors (please note that it's important to do your own research or seek professional advice when deciding on your underlying strategy). In this article, we are going to show you how to take such a strategy and generate a potential portfolio of shares from it.

A recap on the value strategy

Our example value strategy has several components and we’ll explore the specific metrics behind them in more detail shortly. First, we have used Joel Greenblatt’s Magic Formula to find “cheap” and “good” stocks in the market and have added in an additional filter the Piotroski F-Score, a checklist that scores a company’s fundamental momentum – helping us to find stocks that are “improving”.

As a quick aside, the thinking behind this combination is that it's a strategy that shouldn’t keep you awake at night. When market conditions aren’t playing to your favour, there should be some security in knowing that focusing on a diversified portfolio of cheap, good quality stocks with improving financials is a sound long-term philosophy. For that reason, you're unlikely to have to walk away from it, although - like any approach - it may experience periods of underperformance from time to time.

Let’s do this…

Because our value strategy is based on a couple of ‘guru’ screens that are already a feature of Stockopedia, there are really easy ways to blend them to get the result we want pretty quickly (more on that later). But because every single metric and parameter can be changed or amended depending on what you want to see, we’re going to go from the ground up and build this screen from scratch. The good news is that it’s really easy.

From Stockopedia’s homepage, hover over the dropdown Strategies menu and select the option to Create a Screen. Here you’ll find the mission control page for building any kind of strategy that you want. After you have given your screen a name – in this case we’ve used Systematic Value - Cheap, Good amp; Improving – you can begin inputting the parameters needed for this strategy.

First up… Magic Formula

Our first filter relates to market capitalisation – as a precaution against small-cap disasters we don’t want anything valued at less than £30 million (or even higher if you prefer). Once you have entered your requirement, hit the Add a Screening Rule button to create another one.

In Greenblatt’s method, he takes the earning yield for every company in the market, lists them in descending order and then ranks them: 1,2,3,4 etc. He does exactly the same for Return on Capital Employed and then adds the two ranks together to get a score – the lower the score the better. By adding Magic Formula Rank % to the screen, Stockopedia does all that work for you. Click Add Basic Ratio and search for “magic formula” – click Magic Formula Rank % and choose only stocks ranked 85% or higher. This also automatically strips out any financial stocks, which Greenblatt requires in his strategy.

In addition we want to filter out any stocks with ‘outlier’ data. Sometimes companies have ridiculously cheap valuations or ridiculously high profitability scores due to an anomaly in their accounts. To do this, instead of Basic Ratio this time we select ‘+Rankings’ so that we can rank the market for both Earnings Yield % and then again for ROCE % Greenblatt. Let’s select all stocks that are below a 99% rank for these metrics to filter out the outliers.

Next… Piotroski

The final Basic Ratio to add to our strategy screen is the Piotroski F-Score. As we discussed in the last article, Piotroski’s checklist of financial health asks some demanding questions of each stock relating to a range of metrics and indicators. You can read more about each item on the checklist here. The advantage of the F-Score is that it acts like an all-in-one safety net that can be applied to virtually any strategy. In fact, in our value investing book (which you can download here) we discuss how the F-Score is actually a self-sufficient and highly effective standalone strategy when digging around for the cheapest stocks in the market.

Because of the range of tests involved, calculating the F-Score for individual stocks is demanding enough – doing it for all the high ranking Magic Formula stocks in the market would be tortuous. But it’s no problem here, because selecting Piotroski F-Score as our final Basic Ratio handles the whole job. Searching for Piotroski F-Score stocks that are greater than 6 allows us to remove the poorest financial quality stocks from the equation. Ideally we’d prefer to invest in stocks that rank 8 or 9.

Finally, specify how you want your list sorted – in this case we want it sorted according to the Magic Formula rank – and then click Get Qualifying Shares.

How to handle the results

By tweaking the formula – either choosing higher or lower Magic Formula or F-Score ranks you can raise or lower the number of qualifying stocks. Here we have got an illustrative list of 29 qualifying stocks.

An alternative way to set up our strategy would be to begin with Stockopedia’s Greenblatt Magic Formula screen and then fork it. "Forking" is Stockopedia’s way of implementing your own changes to any screen by clicking on the Fork It button on the top right of the screen. It gives you the option to introduce or change ratios from our GuruModels as you wish – and in this case, we would simply add the Piotroski F-Score.

At this stage, you have numerous options. As a registered Stockopedia member, the screen will remain in Your Screens and will automatically update as company results come out (including interims). You can download the results in different file formats and you can transfer stocks from here into your portfolio (or an entirely new portfolio) using the buttons at the bottom of the page.

By clicking on a company name you will be taken through to its StockReport, which gives a detailed overview of its fundamentals. This is the basis for further research and it can’t be overemphasised that this raw initial list is one that requires intense scrutiny.

To transfer stocks into your portfolio, tick the boxes next to each stock you want to move. By clicking "Add to Folio" and following the steps, the companies are copied into your portfolio section where you can get a snapshot of share price performances and a range of other data.

In the next article in this series, we will take a close look at how you can refine your portfolio, how you should review and rebalance it and how to manage the costs of running it. For many investors in the stockmarket, it’s this ongoing management that can be the difference between success and failure over the long-term.

If you like what you are hearing and are ready to begin exploring the tools available at Stockopedia, click here to get started.

In this series:

How to get started in the stockmarket with Stockopedia
How to create your ideal investing strategy (value, growth, dividends)
How to turn a strategy into a portfolio with Stockopedia
How to give your portfolio the best chance of success
How to manage your portfolio over the longer term

Stockopedia

Beware the quot;Dash to Trashquot;

Edward Croft — Wed, 13 Feb 2013 10:23:12 +0000

What many don't realise is that sometimes in a stock market rally the quality of the stocks you own just doesn't matter. Indeed, when the whole market rallies there are times when it pays best to own junk. These periods have become known as a 'dash to trash' and understanding the phenomenon could just save you from an awful lot of pain when the music stops.

Over the last 15 months since we've been monitoring the performance of 65 stock screens and strategies in real time the market's preference for trash stocks in strong rallies has been obvious. If you navigate to the performance history page you can explore this phenomenon better. We've annotated the chart below to illustrate how the December-January rallies in both 2012 and 2013 have been characterised by the strong rebound of stocks we normally categorise as potential short sales.

Short selling screens are filled full of story stocks, glamour stocks and trash stocks. These are stocks on nosebleed valuations or those that have little or no profits, low or no dividends, little asset backing and high share price volatility. Why do these stocks rally so hard? Because there is a lot of implied optionality in these kinds of stocks. Some of them may have blue sky potential - intrepid drillers or high tech Ramp;D stories while others may be glamorous 'market darlings' that itch to have another leg up. When the macro environment feels a bit safer, or money is easier to come by people are more willing to go swimming with these sharks.

The danger comes when the market turns

But cyclical market downturns can be absolutely devastating to shortable stocks (glamour and trash). You can see in the chart above that between April and December 2012, when the stock market steadied itself, long strategies (quality, growth and value) outperformed short strategies (glamour/trash) by a huge margin of 30% - a margin that the shortable stocks won't ever be able to make up again though they may seem hell bent on trying.

This phenomenon of value amp; quality outperforming during bearish market periods has been well observed. The famous academics turned hedge fund managers Lakonishok, Vishny and Shleifer studied this phenomenon and confirmed that across typical bear markets value stocks decline less and outperform the market as a whole. For those that have read our book "How to Make Money in Value Stocks" this will come as no surprise.

The most important thing is to not get flattered in a market rally and be suckered into holding poor quality stocks. Investors can get complacent as they see their stocks rise - woozy even. But price is NOT value. Market rallies should be used as a chance to sell low quality stocks, not to fall in love!

The best time to buy trash is not now

Frankly the dash to trash this year is not very pronounced and the odds of continued outperformance are perhaps low. There really is only one type of market in which trash stocks massively outperform and that's during the rebound from the pit of bear markets.

In the 2002 and 2008 bear markets trash stocks had seen such massive price falls that they rebounded en masse with huge force. A research paper by Kent Daniel showed that over the 3 months between March and May 2009 the stocks that had held up the best during the financial crisis rose by only 6.5% but trash stocks - while those that that had collapsed the hardest rose by 156% !

So the point is - why hold trash now? Where is the upside given the significant risk of further market volatility?

How to filter low quality stocks from your portfolio

Given all this, I would suggest it's vital to take the trash out now! There are a few red flags and filters that we like to use at Stockopedia to highlight stocks that are potentially at a high risk of reversal. Any stocks showing more than a few of the following signs should be seriously considered for sale in market rallies.

High Price to Sales, High Price to Book, High Price to Earnings (the most expensive 20% of stocks are always at risk of severe reversal)
Altman Z-Score in distress zone (lt;= 1.8) (high bankruptcy risk)
Piotroski F-Score lt;= 3 (poor fundamental health)
Recent EPS Downgrades
Low Relative Strength

An example of what I'd call a low quality and vulnerable stock is the snippet of the Stock Report on the right.

Another quick way to find stocks that might have some of the above red flags is to eyeball our short selling lists for any stocks you may own.

And for those readers who aren't yet subscribers to Stockopedia, we still offer a 2 week free trial, so please take advantage to reposition your portfolio while this window still lasts.

Stockopedia

How to build a systematic portfolio with Stockopedia – Part 2

Ben Hobson — Tue, 12 Feb 2013 10:47:38 +0000

How to create your ideal value investing strategy

This is the second briefing note in a series that explores how you can build a portfolio of shares by using the tools available at Stockopedia. Previously we examined some of the key considerations that need to be made before getting started in the stockmarket (especially the fees trade-off when managing your own portfolio). In this article we tackle the main ingredient of any systematic approach to building a portfolio – the underlying strategy.

An investment strategy acts like a prism. There are more stocks and possible investment opportunities than you can possibly analyse or keep track of. Having a way to filter out low probability candidates and decide what’s important will save you valuable time. As Lewis Carroll observed, if you don't know where you’re going, any road will get you there. Just as a road map can help steer you to your final destination, an investing strategy can help you get your investments back on track if the markets steer you out of line.

Choosing a strategy is a highly personal decision for investors and you should do your own research or seek professional advice when deciding on one. To illustrate how best to use the tools on Stockopedia, this series will explore three of the most popular systematic investing approaches – value, growth and income. Some of the strategies we will discuss have made more than 30% over the past 12 months alone but past performance is no guarantee of the futre, of course. All of them are underpinned by strong academic and market evidence that they work in the long term but they will appeal to different investors depending on individual preferences and risk appetites. Later on in the series we will look at how you can use your preferred strategy to easily generate a portfolio.

Get the value advantage

The first of our preferred house approaches at Stockopedia is value investing, which is arguably the most successful stock selection strategies ever. We like value investing so much that we wrote a book about it – you can download it here. When Benjamin Graham began urging investors to scrutinise out-of-favour and apparently mispriced stocks in the aftermath of the Great Depression, he lit the touch paper on a technique that has not only endured but prospered. The success of his one-time student and value investing advocate Warren Buffett is testament to that.

But while few investors can resist the idea of scouring the market for a bargain, most have no idea how to do it. In large part, the challenge with value investing is that it is counterintuitive to almost all human instincts. Acting contrary to others and resisting glamour stocks in favour of unloved and occasionally obscure companies can be a fearsome prospect. But with the right systematic approach you can detach yourself from the natural instincts that can sway judgments and let the strategy do the hard work. Unlike a value hunter such as Buffett, who makes large bets on single stocks, you can become a value farmer by creating a broad value portfolio from which you can ‘harvest’ profits.

A rocket fuelled magic formula

“A cigar butt found on the street that has only one puff left in it may not offer much of a smoke, but the ‘bargain purchase’ will make that puff all profit.”

After decades of research and market testing it should come as no surprise that there is a multitude of value investing strategies at your disposal. These range from what Buffett describes as ‘cigar butt’ investing all the way through to buying good quality stocks at a fair price.

To illustrate how best to use our tools on Stockopedia, we have picked a variant of the value approach that looks for good quality companies that can be bought on the cheap but with the added comfort of displaying strong and improving financial characteristics. This particular strategy has been popularised both by Interactive Investor blogger, Richard Beddard, as well as Morgan Stanley and MFIE Capital. It’s a strategy that will appeal to contrarian investors seeking apparently mispriced stocks and are willing to accept the risk of casualties in return for some strong performances. It also brings with it some robust scrutiny of company financials as an indicator of which stocks are genuinely mispriced rather then being cheap for a good reason.

First step… quality

The ‘quality’ element of this strategy is based on what's known as Magic Formula Investing, as detailed in The Little Book That Beats The Market by US hedge fund manager, Joel Greenblatt (you can read much more about how and why it works here). The formula looks for two metrics in a stock: a high return on capital (a good company) and a high earnings yield (a cheap stock). Return on capital is a measure of how effective a company is at making a profit from its assets. The earnings yield takes its operating profit and divides it by its enterprise value – the higher the yield the ‘cheaper’ the stock. The screen ranks the market from high to low for each indicator and adds the two ranks together to get an overall Magic Formula.

For our purposes, Magic Formula is a useful starting point because it requires a diversified portfolio of between 20-30 stocks to hedge against fatalities. By producing a market rank it also offers a constant supply of potential stocks so there is no risk of suddenly finding a limited number of replacements when it comes to rebalancing the portfolio.

While Magic Formula has a claimed stellar record against the market even Greenblatt acknowledged that it wasn’t a magic bullet that always worked. Given that some of these stocks are likely to have even the bravest investors breaking a sweat, what’s needed is some extra security – and we get that from an academic tool called the Piotroski F-Score.

Next step… safety

The F-Score is essentially a toolkit designed to find which companies in a basket of apparently underpriced stocks display the best prospects for future outperformance. It was developed by US finance professor Joseph Piotroski as a way of analysing the cheapest stocks in the market using accounting-based criteria. Whereas Piotroski starts his own strategy by ranking the market on a price-to-book value basis, we’re replacing that with our list of Magic Formula stocks. But we can still use his nine-point checklist to dig deeper into our companies.

Importantly, the F-Score covers a range of fundamentals and ratios spanning profitability signals, leverage, liquidity and source of funds and, finally, operating efficiency. Each ‘pass’ scores one point, giving you a single overall figure at the end that indicates which companies are in the best financial shape. You can read more about the details of the Piotroski F-Score here. The additional safety filter that we will add is that we will have a preference for companies scoring between 6 and 9 out of 9 on this checklist. In his research, Piotroski claimed that by investing in companies scoring 8 or 9 over a 20-year test period through to 1996, investment returns could be increased by 7.5% each year.

A potent combination

Individually, Greenblatt’s Magic Formula and Piotroski’s F-Score have earned the admiration of investors and the strategies frequently put in market beating performances. But by combining them we bring together a quality-based value screen with a military-grade financial obstacle course that should produce stock candidates that really are worth further scrutiny. As we’ve mentioned, this combination hasn’t been lost by other analysts either. In 2010, investment strategies organisation MFIE tested a range of systematic value screens and found that with a blend of Magic Formula and Piotroski F-Score “you can increase your performance substantially”. The researchers also concluded that a portfolio of around 30 stocks bought and held for one year offered optimal diversification, which complements the Magic Formula/Piotroski twin approach.

Now for reality

In the next article in this series we’ll look at how you can take a sample strategy like this one, and screen the market to find the companies that qualify. Simultaneously, we will also share a sample investing strategy that covers growth stocks (and then dividend stocks). The important point here is that regardless of your strategy (and remember that these strategies can be tweaked and changed endlessly to suit your needs) the next step is to bring it to life. That means using Stockopedia’s tools to input the screening criteria to easily generate an initial potential portfolio of stocks.

If you like what you are hearing and are ready to begin exploring the tools available at Stockopedia, click here to get started.

In this series:

Stockopedia

Stockopedia | Stock Market Research Network

5 stocks on the move after broker upgrades

Who cares what brokers say?

Stocks on the move

Weight of momentum

5 stocks beating earnings expectations

Why earnings surprises matter

On the hunt for surprises with a value twist

Surprise, surprise…

Sprue Aegis bid - a win for sound investment methodologies

What's in the silly name?

Beyond the 'story'...

In conclusion

Master Investor 2013 - visit our stall and watch the presentation !

Quality small and mid-cap stocks offer dividend hunters new prey

Sleeping Dogs

Mid-Cap Quality + Yield = Outperformance

What Next?

Quarterly Strategies Review: Quality strategies soar but dividend stocks suffer

Quality rules but bargains still on offer

Mixed news on dividends

What to watch in the second quarter

Investing: Should the Past be a guide to the Future?

3 Pitfalls to be Wary Of

Patterns Tend to Persist

So History Rhymes...

Why blending value and momentum is a WISE investment strategy

Getting WISE

Show me the money?

How to build your own WISE portfolio

Is Bitcoin the world's most perfect speculative material?

What the hell is a bitcoin anyway?

Who is using Bitcoin?

Why bitcoin gets the blood going...

If the crash comes…?

Can you beat the market with blended Value Ratios ?

What is cheap? Different strokes for different folks?

Beating them all with a 'composite' value ratio

Does it really work?

Budget 2013 – Initial reaction for investors

How to make money from analyst research – Part 1

Understanding analyst research, who writes it and what it tells you

Who writes this stuff?

Who is research produced for?

How reliable are the opinions?

Is following analysts an investment strategy worth considering?

Index funds are parasites and are going to kill the market

The ultimate piggyback ride

When success breeds failure

Don't throw the baby out with the bathwater

Further reading:

How to build a systematic portfolio with Stockopedia – Part 5

Tips for managing a systematic portfolio

What is rebalancing?

Rebalancing the Stockopedia way

Annual rebalancing is likely to be optimal

Investing tools at your disposal

London Value Investor Conference 2013 featuring Anthony Bolton amp; Howard Marks

How to build a systematic portfolio with Stockopedia – Part 4

How to give your portfolio the best chance of success

Dealing with your portfolio

Keeping costs down

Managing and understanding your portfolio better

How to think about diversification

Up and running

Stock Screening 'really, really matters' - FT Money on Stockopedia

How to build a systematic portfolio with Stockopedia – Part 3

How to turn your strategy into a portfolio

A recap on the value strategy

Let’s do this…

First up… Magic Formula

Next… Piotroski

How to handle the results

Beware the quot;Dash to Trashquot;

The danger comes when the market turns

The best time to buy trash is not now

How to filter low quality stocks from your portfolio

How to build a systematic portfolio with Stockopedia – Part 2

How to create your ideal value investing strategy

Get the value advantage