Tag Archives: action

Generating 15% Returns Using The Growth Rating System

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

Achieving 16.7% Returns With The Value Score

Summary What is the OSV Action Score? What is the OSV Value Score? How was the Value Score created? The Quality Score produces 16.8% CAGR in the tests that I’ve performed for the upcoming “Action Score” that I’m implementing into Old School Value. Next is the Value Score. Here is the full table of results again. stocks are bought at the beginning of the year held for one year rebalanced after 1 year commissions and fees are not included into these results If you followed this strategy, the 16.74% is the max return. After fees, it likely comes down to 13-14% range annualized. Here’s How I Created the Value Score When you create a ranking system (or even a screener) the higher the number of criteria, the worse the performance becomes. When picking individual stocks, making sure a stock passes lots of checks is a good strategy because you allocate based on your conviction. However, when you try to employ any sort of quantitative strategy, it is not a good idea to list 20 different criteria that must be passed. Of all the tests I’ve performed, a strategy with lots of checks consistently lose to the market by a wide margin. I mention this because people ask me whether I’ve tried combining several of the best performing value screeners on display. I have. And the results are pathetic. It severely handcuffs the number of stocks that pass and the screen ultimately fails. When you pick stocks individually, you have to be precise and picky. For anything quant based, it needs to be looser as you are buying a bunch. As I mentioned in the Quality Score article, instead of blindly coming up with metrics for each Q, V and G, I already had a list of metrics for each methodology based on previous research papers and proven results. Then the theory was tested and confirmed via backtesting. In its purest form, the Value Score is based on the following 3 factors: P/FCF – best range is less than P/FCF of 10 EV/EBIT – best range is less than 11 P/B ratio – preference for P/B to be less than 3 Here’s the initial backtest to confirm the theory for a 20 stock holding portfolio. Eliminating OTC stocks, financials, energy, mining or utilities and the results continue the outperformance. Great. Backtest works with the selected metrics. It now comes down to how well the same idea can be applied when creating a ranked database. To further clean up the results, additional weightings were applied to each of the above ratios. Then all the stocks are further ranked with the Piotroski score again to eliminate low quality stocks. P/FCF has the biggest impact on the results and receives the highest weighting EV/EBIT does a great job of identifying cheap stocks and receives the second highest weighting P/B acts as a “cleaning” filter to remove stocks where you overpay for assets. Also a way to remove bad stocks you wouldn’t want to own no matter how cheap it looks The Piotroski score is assigned a fairly high weighting so that the list removes “lotto” stocks and potential black swan stocks The Value Rank Results Even if I did follow this strategy, it’s not an easy one to follow. There is a LOT of volatility. If you can’t stomach big moves and have faith in the process, you are doomed. If you focus too much on beating the market each year instead of an absolute long term return, you are doomed. When buying and holding the top 20 ranked Value stocks each year for the entire universe of stocks, the scoring system achieves 16.74% CAGR. If you start with $10k, you’d end up with $138k after 16.5 years. Eliminate OTC, financials, miners, utilities and energy again and the results are shockingly great at 19.4% CAGR. $10k becomes $203.6K after 16.5 years. But what I don’t like about the Value Rank on its own is the lack of downside protection in 2008. Cheap stocks and growth stocks get hammered the most during severe bear years. But a -40% return is a huge blow and a can easily shatter your faith in the system and process. Something to think about. Top 20 Value Stocks from 2015 Here is the list of top 20 stocks that make up the Value Score portfolio starting from Jan 1, 2015 so that you get a sense of what type of stocks the Value Rating is selecting. Disclosure No positions in any stocks mentioned.

Terraform Power: No More Blood On The Streets, Time To Take Profit

Summary I suggested a long position in Terraform Power on November 20th as panic made the valuation very compelling. Recent newsflow has been positive and generated a 50% rally in the stock since my article was published. It is time to reassess the investment thesis and decide whether to keep or sell the position. Less than a month ago I wrote an article on Terraform Power (NASDAQ: TERP ) titled ” Terraform Power : buying when there is blood on the streets?” At the time the stock was trading at $8.4 and it has been on a rollercoaster since then with a lot of news coming in. At the moment of writing this article the stock is at $12.40 and, including the 35c dividend, generated a 52% performance in less than a month. That was quicker than I expected. But such a big move deserves some additional analysis in order to understand if the time has come to close the position. Recent newsflow A few days after my article, the company announced some management changes . This was not good news as the clear message sent to investors was that objective number one was to save the overall Sunedison / Terraform Power / Terraform Global Group. They called it “organizational alignment”; the way I read it was: TERP is in much better shape than Sunedison (NYSE: SUNE ) and needs to provide some help. As expected the stock reacted negatively once the decision was digested and understood: some of the risk is switching back to Terraform from Sunedison as the Group is trying to go back to the initial yieldco drop down strategy, thus putting at risk TERP’s balance sheet. My own reaction was frustration as the investment thesis was certainly weakened by the news. Luckily a few days later (December 1st) reputable hedge fund investor David Tepper of Appaloosa disclosed a very large position in the company and sent a letter to management highlighting his concerns on corporate governance: “Thus, it is obvious that the deterioration in TERP’s security prices and credit profile this month results from (among other things): (1) the transmission of financial stress related to its “Sponsor’s” ambitious growth objectives and over-extended financial commitments; and (2) TERP’s incomplete and selective disclosures”. Market reaction was massive and Tepper’s involvement acted as a confidence booster. What particularly pleased the markets was that such a high profile hedge fund manager built a significant stake (9.5%) and took an activist role (something he rarely does) to push for a change and more protection for TERP shareholders. It really looked like the older brother trying to protect the younger one from bullies. The market appreciated and I recovered all my confidence in the stock and the investment thesis. The third important announcement was the revision of the Vivint acquisition . I am not sure how much weight Tepper’s letter had in the revision but that was clearly another positive. The change in the terms was not massive (the price was reduced 13% or $123 mln) while the reduction in the commitment on future purchases was more significant, with positive elements such as the downward price adjustment to achieve minimum returns. Overall I would say this was a positive but not “massively” positive. Stock reaction The following chart shows the stock performance since my previous article: TERP data by YCharts As you can see there has been a lot of volatility and a dramatic recovery during the month of December. This recovery was exclusively newsflow driven as many stocks in the energy yieldco space suffered significant losses during the same period of time (KMI comes to mind). Change to the investment thesis At the time of my previous post Terraform Power was extremely unloved and panic was pushing investors out. It was trading around book value pre minorities and had a yield of 16.8%. At the moment the stock is trading significantly above book value and on a yield of 11.3%. I believe there is still some value in the stock but it is not such a compelling story anymore. I believe upside from here in the short term is limited, especially if we consider that, while the stock went up 55%, credit markets deteriorated further in December, putting a lot of pressure and scrutiny on highly leveraged balance sheets. As a result I believe it is time to cash out and wait for better opportunities to arise.