High Flyers - How To Beat The Market In Expensive And Highly Priced Shares

26th Oct '15 by Edward Croft

32 comments 53728 reads

Last week Domino’s Pizza broke out to yet another stunning new high. This is a share we bought at 75p in 2004 for our family investment club and I’m proud to say we still hold. It’s now trading at 1043p per share making it a 14 bagger over an 11 year period - a 27% annualised capital return before dividends. Domino’s hasn’t just been a long term winner…. it’s been a standout performer in almost every 2 year period since it first bounced up from its lows back in 2001. Even in the last 2 years this stock has doubled in price and in all this time it’s almost never, ever been cheap. Since the financial crisis I don’t think Domino’s has traded beneath a Price Earnings ratio of 23, which begs the question of when on earth could a value investor have ever bought this share? If Value Investors admit they couldn’t then isn’t there something that they are missing?

DOMINO_S_PIZZA_Share_Chart___Live_Charts

The problem with value investing

We human beings are genetically hard-wired to look for bargains. If you can pick something up for less than it’s worth you might just have a happy outcome and a few spare pennies in your pocket to boot. It’s a strategy that works in the flea market and it works just as well in the stock market. Buying cheap is the core tenet of value investing - the strategy that has minted thousands of stock market millionaires and quite a number of billionaires too.

But there’s a problem at the heart of value investing which leads to a certain blindness. Value Investors have an inability to consider any stock that is even remotely pricey. Take a look at this chart and you’ll understand why.

The chart shows the performance of the cheapest 20% of the stock market (green line) vs the most expensive 20% of the stock market (red line) over the last 2 years according to the Stockopedia Value Rank. There’s about 200 stocks in each of those portfolios, but the cheap set of stocks has outperformed the expensive set by a massive 32%.

These results, from the last few years in the UK, are very typical for stock markets. Cheap shares tend to outperform expensive shares. So any rational investor, when asked to pick a winning portfolio of 50 stocks, would…

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Edward Croft

29th Oct '15

Indeed 2001-2007 would have been a great time to own Domino's - it ten-bagged between the low in 2001 to 2007 - and has "only" six-bagged since. I managed to pick some up both for my p.a. and my family account in 2004, right at the arrow in the image below. It took me till 2004 to get fully back into the market after the great bear between 2000-2002.

I think Domino's has been a classic example of Nicholas Darvas' 'box model' - where a stock stepwise breaks out of consolidation zones to dramatic effect - red boxes above. Buying breakouts is a form of momentum trading and it can be wonderfully effective. Most investors wait for new lows - not new highs... but in market leaders like Domino's it really pays to buy when they break out of consolidation phases to new highs on good news. There can be a big opportunity cost if you get stuck in a high QM stock during a consolidation phase - often a good strategy is to set alerts and buy the breakouts. It's ironically often a lower risk way to play them. See Minervini/O'Neil et al.

PJ0077

30th Oct '15

This is surely a question of your definition of Value Investing.

If Value Investing is defined as being reliant on a quantitative search centered on past profitability it will always miss (explosive) growth stocks which will 'look' expensive relative to past profitability. You seem to be using a similar definition in your opening paragraph "in all this time it's almost never ever been cheap"

But what if you define Value Investing as a search for stocks trading well below what they are intrinsically worth, a calculation based on an estimate of future profitability? Back in 2004, value would have been apparent to any investor correctly forecasting rapid growth in 2004.

To quote Buffet:In our opinion, the two approaches are joined at the hip: Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive.

PS I find your closing remarks confusing. You say on one hand that "my general rule of thumb.. is to watch them like a hawk" and a few sentences later write that you last investment club meeting was in 2005 "sometimes it pays to do nothing"!

Ken Lowes

2nd Nov '15

I really enjoyed your article Ed because until the very last paragraph it caused within me a burning question-- when would you sell? During the period of holding Domino had some very short but sever corrections 48% in 2007 over 6 months and two further periods in excess of 30% since. So we are left with two thoughts neglect isn't a bad thing, "some of the time" and hindsight investment works 100% "all of the time". I go back a very long way starting my investment career around the time that Slater Walker went bust, yes the same Slater. I was introduced to Elliot Wave which was conceived in a bygone era and worked for one man. It has only ever worked in hindsight for me but it does give a possible warning of a major turn. Dow theory was another, Fibonacci another I wont go on. There are two components to investing and only two-- you buy and you sell- my problem and I would suggest many others is when!! Buy and hold works providing you live long enough and you didn't buy at the top, trading works but only until it doesn't. Stockopedia is probably one of the best programmes available to the private investor and is full of useful information to assist with buying, but when do you sell?

Ken - that's easy - you sell when a stock reaches its maximum share price.

But seriously - it's important to set rules for exit as well as entry. If you don't have strict sell criteria you can end up changing your reasons for owning a stock while you own it. Self-deception is rife when owning winners.

There are lots of sell strategies that "work". For high QM shares... the key turning point is normally a loss of momentum so a lot of very standard technical stop loss strategies can work well. If a Domino's investor had used the 200 day moving average as a timing rule they'd have preserved the majority of their gains all the way up.

Hindsight as you say is a wonderful thing.

I've often used the difference between the 200d Moving Average and the current share price as an indicator of whether a share is too over-extended. William O'Neil once said that you should sell whenever a share moves 70% or more above its 200 day moving average. I find that's too 'loose' for UK stock markets. Most UK stocks never get that far ahead of their average prices - story stocks might but they'll have much spikier price action.

Domino's is currently 34% above it's 200d MA... which is quite punchy. If you look at the history above whenever the share has risen this far above the 200d MA it's normally led to a consolidation phase. Here's my spreadsheet analysis:

How much further could Domino's go? Well statistically, since 2008 the share price has only been this far above the 200d moving average 2.1% of the time.

You really didn't expect me not to back test your 200 day moving average Ed. My only reason for the reply is in case a Newbie read about the 200 day moving average and thought it was a gift from the gods. I used an exponential rather than simple 200 day moving average as it gave less trades and starting in June 2004 at 62p assuming one only traded when there were two clear days above or below the average the following is the result. You would have bought and sold 38 times up to June 2014 and although the price had risen to 555p you would have netted approximately 89 points rather than 493 assuming buy and hold, plus costs on 38 trades. By this time even the most determined investor would have probably given up just in time to miss the uninterrupted rise to 1080p. The problem with many such concepts is the sideways movement, I think the Americans call it being whipsawed. As we all know many shares spend some time going sideways. Source ShareScope.

schober

Looking at the log graph of Domino's Pizza (LON:DOM), I see that up to 2007 there was a steady geometric rate of increase but after 2009 it rose in fits an d starts with long periods of consolidation. Is there any known reason for this change in behaviour - or perhaps its just chance?

I never suggested an investor should use a moving average crossover system Ken. That's just mindless TA and can lead to endless churn - especially during consolidation phases. Moving averages though can be very useful for timing exits after long trends - that's why I posted the charts - especially the second one.

Judgement based trading requires... judgement. An investor with some capacity for judgement may be able to recognise consolidation phases, and thus not attempt to buy shares right after the climax of a huge move when a stock is likely over-extended w.r.t. valuation. It's better to buy off sound price bases after most of the churn in ownership has occurred - there's lots of great literature on the topic. The consolidation process can take 6 months or more after big price runs have happened. I wouldn't be surprised if Domino's starts to consolidate again soon given the history and given that only 2% of the time has it traded higher vs its 200d MA.

While I've had a lot of success trading stocks out of consolidation bases, I gave up on it as it's too much admin - I don't like watching stock charts every single day.

These days I just run a mechanical cyclically rebalanced portfolio, with some judgement based manual stop losses and variable amounts of short selling to limit downside volatility. Works well for me, gets me far higher returns than I did before and is much less stressful.

"When to sell" for me therefore has become a question of 1. cyclically checking my screens to see if stocks still qualify on a calendar driven basis - if they don't they go, 2. finding suitable short sale candidates for hedging. 3. regularly pruning loss-making trades.

The whole process becomes a bit more like gardening - sowing some crop early in the season, pruning and weeding weekly, hedging in case of bad weather and reaping later in the season.

Rusty2

21st Dec '15

Just come across this article, very interesting. I do agree about Next (LON:NXT), always looks too expensive but I'm considering it now it has fallen back. I do hold a few of those on the High Flyers list, in fact considering selling most of them. Another one that probably has been on their before is Ashtead (LON:AHT), thats gone up over x10 in just over 5 years, does not always look expensive as goes up and down quite a bit. Clarkson (LON:CKN) is another, I did hold this year but sold out around 2800p.

underscored

This is possibly quite an important article, http://www.valuewalk.com/2015/11/39-of-stocks-have-a-negative-lifetime-total-return/. A small number of stocks drive the performance of any index. Outperformance is possibly reliant on owning the right stocks at the right time http://www.bloombergview.com/articles/2015-11-11/why-indexing-beats-stock-picking.

Yes probably true but your second link is not working.

http://www.bloombergview.com/articles/2015-11-11/why-indexing-beats-stock-picking

22nd Dec '15

That's an old argument. One of the best articles on the subject was by William Bernstein. http://www.efficientfrontier.com/ef/900/15st.htm

While I admire Bernstein, I do believe that argument is a nonsense. While it's great to own an Apple or an ASOS at the right time you don't have to to do exceptionally well in the stock market. The StockRanks history has shown that half the market is rubbish, but owning the other half can help you do rather well. Sensible factor investing works well.

The index investing camp is incredibly good at marketing and seeding mantras into the media. There are literally armies of Bogleheads out there who believe that the whole world should join them in their market cap weighted, 'own the world', be-average-to-win, investing philosophy. It's just so much bunk and could well lead to disaster. I wrote this a few years ago and stick by it - http://www.stockopedia.com/content/index-funds-are-parasites-and-are-going-to-kill-the-market-71683/

Hi Ed,

Thanks for the reply, ignoring the significant numbers of junk is clearly important.

The message I have taken home from this article and the other articles such as the ones I posted are not to be afraid of stocks just because they are expensive, and have started to load up on high QM stocks, keeping each position size small. One thing I would be interested to see in this context is the frequency of ASOS type blow-outs whilst a stock has a QM rank of 90+.

RobertScott

4th Sep '19

Hello Ed .

As a " life-long " chartist l now intend to use the very best Q + V stocks to trade per my chart method .

Back testing over the last five years on daily , weekly and monthly charts seem to prove the strategy's efficacy .

Thank you for all of your comments and good work .

Regards , Robert .

Hello again .

l feel obliged to mention that through years of observation , since 1980 , the Darvas Box system of trading always seemed to be a worthwhile strategy .

Perhaps my inborn tight-waddiness prevented me from buying into any stock's new high per the Darvas method .

Yours , R .

qvg

24th Oct '19

Thanks Ed, just two questions.
You give the link to the High Flyer screen in the article. Otherwise how do you get to it - i could not find it using the screens tab.
Any data on the historical performance of the the High Flyer Screen, ideally by region?

PLS1nve5t

I think you need to look under "Ranks", "QM rankings" - gl

@qvg - you can either go here and look at the highest QM Rank screen - https://www.stockopedia.com/screen-groups/top-stock-ranks-8229?edition=gb, or alternatively check in the Styles folder and look for High Flyers https://www.stockopedia.com/screen-groups/stock-rank-styles-8234?edition=gb

Ultimately you'll end up in one of these two screens:

25th Oct '19

Ed, I'm afraid none of those links work. The first 2 there is a problem and the second 2 the shares are all blanked out.

Robert Scoggins

21st Jan '20

Thanks pka for your story .

As an unreconstructed chartist , l feel obliged to emphasize the importance of using a stop-loss of whatever sort is acceptable to your tolerance of risk .

Take care .

High Flyers - how to beat the market in expensive and highly priced shares

The problem with value investing

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Edward Croft

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