Data-Driven Stock Selection
There is no such thing as an undisciplined stock picker, at least not one who is a successful portfolio manager. Finding something good to buy in capital markets requires looking for it and that requires orientation. Some call it style; we call it discipline.
To find a good value stock or growth stock or income stock requires a study and evaluation of the reported corporate data that relates to value, growth or dividend yield. In the same sense, gold prospectors will tell you the best place to discover gold is to go to places where gold orebodies have already been located.
Every week we study a global universe of over 4100 reporting companies, sifting through about 50 data points each and comparing these company results on a relative basis.
Like any gold prospector, we all have our favorite tools; but our discipline requires quite similar research methodologies. To find the best Value companies, for instance, we look to valuation, price-earnings ratios, financial situation, return on equity and book values. On the other hand, for the best Growth companies, we
study revenue and earnings growth, revenue and earnings per share revisions, PEG ratios, and profitability among other data. For Income stocks, we compare yields, financial situation, profitability and so forth.
In a very few cases, a top-ranked Value, Growth or Yield company scores well in a second category.
As researchers, we review the following fundamental data points for each of 4100 companies in our study universe. Using proprietary ranking criteria, we configure the weekly scores into Value, Growth and Yield composite rankings of these companies from #1 to #4100. This research is somewhat like handicapping racehorses where you know that quality (i.e., best of breed) usually, but not always, wins.
1. Revenue Growth, which is based on the evolution of the turnover of the company between the last year and the three coming years according to consensus estimates. The higher the growth is (from a relative viewpoint), the better the rating is. The goal is to rank companies according to estimated sales and to identify
companies with the highest growth.
2. Valuation, which is based on the ratio between enterprise value and its turnover for the current fiscal year and the next one. The lower the valuation is, the better the rating is. The goal is to rank companies according to valuation and to identify companies with the lowest valuation.
3. Financial Situation, which is based on the evolution of the net debt of the company relative to its EBITDA (operating revenue) as well as free cash flow as a percent of enterprise value. The higher the cash is, the better the rating is. The goal is to rank companies according to financial situation and to identify companies with the soundest balance sheets.
4. Profitability, which is based on net margin of the company for the current year and the next one according to consensus estimates. The higher the ratio is, the better the rating is. The goal is to rank
companies according to the “Net income/revenue” ratio to identify those which have a high payoff.
5. Price Earnings Ratio, which compares the company’s current share price to its per-share earnings for the current fiscal year and the next one. The lower the PER is, the better the rating is. The goal is to rank companies according to their earnings multiples and identify those that are inexpensive.
6. Yield, which is based on the dividend relative to its share price. The higher the dividend yield is, the better the rating is. The goal is to identify companies that can supply a high and sustainable dividend return to the shareholders.
7. Analyst Consensus, which is based on analyst recommendations. It provides an indication of the position taken by most analysts polled by Bloomberg and Thomson Reuters. The goal is to identify companies that benefit from the maximum majority of buy recommendations.
8. EPS revisions, which is based on the evolution of EPS (earnings per share) revisions of the company over time. During the most recent week, or quarter, or year, EPS estimates of analysts as guided by management are usually revised upward or downward. From a relative point of view, we rank companies highest according to analyst estimates that are rising the most.
9. Revenue revisions, which is based on the evolution of revenue revisions of the company for the current fiscal quarter or year and the next one. The more revenue estimates are revised upward (from a relative point of view), the more rating is high. The goal is to rank companies according to analyst estimates and to identify companies with the best revenue estimates.
10. Price-to-earnings growth. This metric uses our composite growth rate for each company (4-week, 3-month, 6-month, and year/year for both sales and EPS). A growth stock can look pricey, but when normalized for sales and earnings growth, we can compare apples to apples among our growth stock finalists.
11. Return on Equity. We use this classic measure of return to company owners to complement the firm profitability measure above. Higher RoE companies should draw more investor interest.
12. Price to Book Value. To round out our valuation criteria (company valuation and PER), we look at the ratio of market price of a company to what its assets are worth. All else being equal, a company stock trading closer to its book value represents a better buy.
From the full database of 4114 global companies dated May 9, using our proprietary search criteria, we computed as follows the top-10 ranked Growth and top-10 ranked Value-ranked companies, removing a few due to non-US listings or illiquidity factors. We also removed from the list one that ranked #5 for both Growth and Value because we are illustrating the differences in relative rankings for Growth, Value and Yield criteria.
The company names are unimportant for our purposes here.
Given that our 10 Growth stocks ranked #1 to #14 (out of 4114 companies), the average was 7.1 with Growth composite scores and an average 91.3 for Growth Composite ranking — from 95.16 (highest) to 87.10.
But for these 10 top-ranked Growth companies (averaging 7.1 out of 4114, which beats 99.83% of the universe), their Value ranking averaged just 1164.7, which was good enough only for beating 71.7% of the universe. Not bad; but not spectacular.
If we were goldminers, that 99.83% ranking is the equivalent of visible gold. Handicappers would equate it to 2018 Kentucky Derby winning horse Justifier in terms of breeding. Other stocks, like other horses, can win; however, at the end of the day, it is the best quality that usually wins.
As for the top-10 Value stocks, our universe of 4114 contained many that are listed exclusively in China or Switzerland exchanges, so we removed these. Accordingly, our Top-10 average ranking was 12.2 (from #4 to #19). The average Value score was 92.5 compared to 76.2 for the Top-10 Growth companies. And for the Top-10 Value companies, their Composite Growth score was just 56.0, and their Growth ranking averaged 844.2, which was good enough for beating 79.5% of the universe. Not bad at all; but again clearly not
Obviously, one can expect to find a higher Yield ranking in the top Value companies than in the top Growth companies, which the table shows to be the case.
Next, let’s examine some of the detailed fundamental data that went into the Composite scoring.
This table is for the same Top-10 Growth and Top-10 Value companies.
You will see that the criteria for selecting Growth versus Value is in line with what we anticipated. But this table also gives us insights as to a company’s relative standing in terms of financial situation and operating result comparables, something we can easily and immediately glean from a well-designed computer database system and the quality data we put into it.
As investors in capital markets, we are not in the guessing game. We make fact-based decisions based on the principles illustrated here.
This article is an insight to our research methodology. Next week, we shall delve into Value investing, looking at the Growth vs Value argument (after over 10 years of growth outperformance), and present our new WMA Deep Value portfolio, that we believe should be a winner going forward from this stage in the stock market cycle.
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