A Decision-making Process for Equity Investors

Buying stock is always easy. But, for independent-minded portfolio managers, the decision-making always comes down to a matter of choice and therein lies a problem. This week we had two stocks under consideration to buy for the WMA Cara Natural Resources Portfolio: the large cap diversified metal and coal miner Teck Resources (TECK) and small cap oil producer Earthstone Energy (ESTE).

Using our proprietary WMA research, both stocks were rated STRONG BUYs, but for different reasons. One was based on Value, the other on Growth.

Before we discuss our proprietary investment decision system, some background is necessary.

What stocks we buy is a decision based on a deep analysis of corporate fundamentals that are scored against a global universe of about 5100 companies and on a sector universe, which for Natural Resources is about 660 basic materials and energy companies.

Growth, Value and Yield are the three determining criteria for our portfolios, but for Natural Resources a lesser consideration is Yield. Also, for most portfolios, the more important studies are based on the Global Universe whereas for the Natural Resources portfolio, we make decisions based mostly on Sector Rankings, always seeking top ranked companies.

While it is true that sometimes good companies are not always good stocks, over long periods of time, those companies that exhibit the strongest fundamentals are typically the outperformers in the market.

Based on fundamental research, our decision this week was to buy Earthstone Energy (ESTE), which we did buy on Thursday. ESTE was rated STRONG BUY for Growth and BUY for Value. On the other hand, TECK was rated STRONG BUY for Value, but the data led us to rate the company a SELL based on Growth, which caused us to hold off purchasing TECK.

The ‘When’ to buy or sell is a market timing decision that we base on a proprietary multivariate analysis of trends and cycles. One nuance in timing decisions is that early in the long cycle for the broad equity market, we tend to favour Growth and whereas later in the cycle Value is favored.

Exhibits 1 through 4 contain the latest metrics for TECK and ESTE. As noted, Exhibit 1 and 2 are for 660 sector-ranked stocks and Exhibits 3 and 4 are for the 5100 stocks in our global universe.





Another nuance is that later in a long cycle for the broad market, both Growth and Value metrics for commodity based Natural Resource companies tend to be superior to interest rate based Financial and Utility companies. These exhibit scores show that to be the case at this point in the long cycle.

From Exhibit 1, you can see that TECK did not make the Growth cut because the EPS and Sales forecasts put TECK in the 6.1 percentile, even though their 1-month and 3-month revisions are excellent. TECK could not be selected for Yield due to its low 8.5 percentile ranking.

From Exhibit 2, you can see that TECK is clearly a Value stock: Valuation, PE, P/E Spread, MV/EBITDA, and Book Value scores average out to enough to get over the bar in the Natural Resources sector.  To keep these exhibits to a reasonable size, some important columnar data was removed; however, the data we manage is quite deep and broad enough for a thorough analysis.

Globally, the Valuation numbers are even better, as noted in Exhibit 4, because the latter part of an economic cycle is the sweet spot for commodity producers, but as noted, we like to keep comparisons on the sector level.  Valuation also considers Revisions, Financials, and Profitability, which are all okay with TECK.

Like TECK, ESTE is ranked a Value stock but ESTE also made the Growth cut because its EPS and Sales forecasts scored the 80.9 percentile, even though Revisions are less favourable than is the case with TECK. ESTE also cannot be selected for Yield due to its 0.0% percentile score.

Making investment decisions based on corporate fundamental data as reported by companies and analyzed by professional analysts is what we do. Hopefully you will find this insight helpful in your own decision-making process.


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