Tag Archives: investing

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

Proposed Allocation

Two weeks ago I wrote an article on Seeking Alpha discussing the ETFs that will comprise the core of our future portfolio . My goal, in all aspects of my life, is to always be learning and growing. Part of that process is to challenge myself and my ideas. My wife and I have run a bifurcated portfolio , comprised almost exclusively of individual stocks, for the past several years. While I thoroughly enjoy researching and valuing companies currently, I can see that the day is coming when I’ll want to be a much more passive investor. I anticipate achieving semi-retirement a couple years out, and at that time I’d like to transition to a portfolio which is maybe 30% individual stocks… with the rest being index ETFs and cash. Recently, I have begun to think it’s arrogant to think that our portfolio of (mostly) individual stocks can provide the diversification we require… while ‘not’ also requiring a great deal of time to manage. I also received a few comments and emails last week asking me why I wasn’t just proposing a portfolio of strictly ETF and index funds. I want to retain 20% to 30% of the portfolio in individual funds, because there are some truly amazing companies available to the investing public. I expect these companies to compound our capital for decades to come! So why not just invest in these amazing individual companies?! Two reasons: 1) I may be wrong, and it’s pure arrogance to think otherwise; and 2) I don’t believe there are enough of these truly amazing companies, that I could build a diversified portfolio out of them… even if I had the time to manage it. Simply put, I am looking to strike the right risk/reward balance. With that background expressed, below is my desired portfolio allocation. Please note that this includes my wife’s and my capital, as well as the trust fund we set up for our children. 25% Individual Stocks 20% Cash (or cash equivalents)* 15% Vanguard Total Stock Market ETF (NYSEARCA: VTI ) 15% Vanguard FTSE Emerging Markets ETF (NYSEARCA: VWO ) 15% Vanguard FTSE All-World ex-U.S. ETF (NYSEARCA: VEU ) 10% Vanguard REIT ETF (NYSEARCA: VNQ ) *Reduced by 10% when bonds re-enter our portfolio Individual Stocks First, let’s talk about what these categories mean. Within Individual Stocks, I mean both the amazing companies I want to hold for the long term (like Union Pacific (NYSE: UNP ), Visa (NYSE: V ), Coca-Cola (NYSE: KO ), etc.) and the “Deep Value” opportunities that present themselves from time to time. While these “Deep Value” opportunities usually manifest themselves as small and under-reported companies, they can also take the form of commodities or alternatives. Agricultural commodities are looking interesting to me today and gold will likely be appealing in a few months. My intention with this group is that the vast majority of this group be long term holdings… and the remainder be allocated toward alternatives and deep-value trades. Bonds You may have noticed, correctly may I add, that our portfolio will not have a bond allocation for the foreseeable future. Given our young age, mid-thirties, and the ultra-low interest rates… we have chosen to shift any bond allocation to other areas of our portfolio. If rates were to suddenly jump a tremendous amount, it’s possible bonds could join our portfolio… but it’s not likely for the foreseeable future. U.S. Stocks The next question I am likely to receive surrounds how we could only allocate 15% to U.S. Stocks (in the form of Vanguard’s Total Stock Market ETF ( VTI )). I will be quick to point out that the ‘vast’ majority of the individual stocks we invest in, are in fact US stocks. Therefore, it’s reasonable to assume that nearly 40% (25% individual stocks and 15% VTI) will be invested in U.S. stocks. Given that I am paid in U.S. dollars and the property we own is in the U.S., I don’t feel like we are short-changing our homeland. Around 40% of the world’s global equity capitalization is sold on U.S.-based markets. Therefore, I feel my U.S. stock allocation is right where I want it to be, especially when you back cash out of the equation. Emerging Markets I frequently receive email questions concerning why I think Emerging Markets are so well-represented in our portfolio. The simple fact is that the majority of global growth will come from countries which are now called “emerging”. Around most of the developed world, populations are barely growing… if they are growing at all. However, the populations of “emerging” markets are growing much more rapidly. There is some elevated risk that those local governments won’t enforce the rule of law, or more likely that those governments will nationalize your investment, but I think that is a risk in developed countries as well… just a little bit smaller risk. Foreign Stocks There are a ton of companies in this world, with plenty of market capitalization to go with them. To gain exposure to these markets, we will utilize Vanguard’s FTSE All World ex-U.S. ETF ( VEU ). It is important to note that nearly one-fifth (18%) of this ETF is comprised of companies from emerging market economies, so there is this overlap. The rest of the ETF is comprised of companies from developed counties (like Germany, the U.K., Japan, etc.). Real Estate Cash-flowing real estate can be a great investment. Unfortunately, our investable capital is not enough to purchase a diversified real estate portfolio in our part of Florida. We can, however, invest in real estate through Vanguard’s REIT ETF ( VNQ ), with the added benefit of instant diversification and much-improved liquidity. If I had the time and inclination to be a full-time landlord, I would prefer to go that route… but it seems unlikely on any large scale. So, with the funds listed above, we intend to transition to a simpler… and less time consuming… investment approach. Last week, I sent an email out to our subscribers discussing which current investments I was looking to rotate out of in the coming months. I also identified a few of the investments I shouldn’t have made, as I think it’s important to learn from our mistakes. If you would like to receive emails like these in the future, sign up for our email list by completing the box on the right side of our homepage. I hope this holy week is fully of good times and great memories for you all. Take care. What do you think of our allocations, and how do they compare to your own? Disclosure: Long VWO, KO, UNP, V. This article is for informational purposes only and should not be considered a recommendation for anyone to buy, sell, or hold any equities. I am not a financial professional. The information above can be found at Vanguard.com.