NOTE : This is a copy of a PowerStocks Research client newsletter issued on 17 Nov 2016
There are all manner of fundamental filters/screens published for seeking out shares that are most likely to outperform the market. Most of these have been extensively tested on US markets, but precious little been tested on SA markets.
The most extensive testing we have seen locally on the JSE to date was published in a 2013 Investment Analysts Journal, titled "Style-based effects on the Johannesburg Stock Exchange: A graphical time-series approach" by C Muller and M Ward. The research and testing was so comprehensive that we decided to provide this screen as one of five robust automated methods for our clients to seek out investment-grade shares.
The Muller & Ward research looked at all manner of fundamental metrics and combinations thereof from a company’s financial results, but in the end, after a lengthy 17-page dissertation, came to the following incredible conclusion:
How do we calculate a "combination style"? Simply put, for each of the 4 styles (1 year momentum, earnings yield (EY), return on capital (ROC), price-to-cashflow (PCF)) you rank each share in the TOP-150 universe from most desirable result (1 point) to least desirable result (150 points). You then add the ranks of the 4 styles of a share together to derive an overall score. You then sort the 150 shares by smallest overall score to largest overall score. Your best shares you then select from the top-10 or the top-20. Done!
Now, for best results they say you form portfolios from the top-10 or the top-20, but this may be hard for individual investors to do. However it can do no harm to select diversified shares from this top-20 universe to raise your odds of success. Also, this is an INVESTMENT strategy, so picking shares and holding for less than 1 year is likely to produce mixed results.
Additionally, although the strategy is persistent over longer time periods, the exact time at which you pick these shares can have a large impact on short-term performance. For example, picking these shares at the top of the business cycle or at the stock market peak just before the bear market, or picking the share when it is in a downtrend and not bottomed out yet, is obviously going to produce far less desirable results than doing it at the start of the new bull market or if you managed to pick the share as it has bottomed.
Granted, the stocks you pick using this method are likely to suffer less than the general market, but suffer they will (falling tide lowers all boats). So a big caveat here is ensuring you understand where we are in the stock market cycle and knowing if conditions are favourable or hazardous. This is known as understanding the macro-level environment, and we use a robust method discussed here to keep our clients out of trouble as best we can.
Anyhow, ignoring the current (generally bearish looking) macro-economic environment shown above, let us assume that right now, you want 10 of the best investable shares to choose from using this "Multi-style" methodology.
A simple click of one button on our JSE Share Watchlist (JSW) program reveals the following top-10 ranked shares:
PINNACLE is ranked 13th out of 150 for the highest earnings yield (EY = 1 divided by the P/E). It’s the 33rd most "productive" share from a return on capital (ROC) perspective and is the 15th best share ranked according to price-to-cashflow (PCF). Finally, it’s the 23rd fastest growing share (momentum) over the last 12 months. Add the 13+33+15+23 together and you get the overall ranking score of 84, which just so happens to be the lowest score overall, and that is why it is ranked 1st and at the top of the list. And so we go on until rank 10. It just so happens that two shares tie for 10th place, which is why the list has 11 shares.
What we have here, right now, ignoring the current macro-economic environment, are the best 10 shares when you look at two valuation metrics (EY and PCF), one quality metric (ROC) and momentum.
Now of course when conducting these screens it’s incredibly important to ensure that no shares in the list have old results we are basing decisions on. That’s what the AGE column is for, and right now 9 of 11 shares have relatively fresh results (8 of them based on finals and 1 on an interim) that are no longer than 140 days old, we have SAPPI off very fresh 48-day-old final and RAUBEX off a very fresh 78-day-old interim result.
For best results, you are to buy as many of these as possible, but obviously since 4 counters here are in the HEAVY CONSTRUCTION sector its silly to load up with all of them. Rather pick one or maybe two, to ensure a properly sector-diversified portfolio.
The HEAVY CONSTRUCTION shares dominate here because they obviously are coming off a heavy sell-off, which you can see in the HI column showing what % these shares are down from recent 6-month highs. MRHLD is down 26.7% and GROUP-5 is down 20.3% respectively.
Finally, rather than blindly buying your 5 or 10 shares, you can now deploy some technical analysis to determine the best times to be buying each, and so gradually filling up your portfolio.
This is merely a list of investable shares provided by the Ward & Muller approach. There are various other approaches that are likely to produce a different set of shares, many of which we provide our clients as well.
There are no guarantees with this approach, and as we have said, the macro environment can play a large role in your success. But other than some very detailed lengthy fundamental research and insider information, this is as good an automated screener as any, and certainly better than taking pot luck with whatever share takes your fancy because you "like" the company or read something in the news (sorry for you, this news was already priced into the share 3-6 months ago) or heard a hot-tip around the braai.
Dwaine van Vuuren
RecessionAlert, PowerStocks Research
Dwaine van Vuuren is a full-time trader, global investor and stock-market researcher. His passion for numbers and keen research & analytic ability has helped grow RecessionALERT.com (US based) and PowerStocks Research into companies used by hundreds of hedge funds, brokerage firms, financial advisers and private investors around the world. An enthusiastic educator, he will have you trading and investing with confidence & discipline.