How to turn your strategy into a portfolio
This is the third article in our series exploring how you can build a systematic portfolio of shares by using the tools on Stockopedia. Previously we examined why a strong underlying investment strategy is essential for any systematic investor. We also introduced an example value strategy as the first of three potential approaches to the market that might suit most investors (please note that it's important to do your own research or seek professional advice when deciding on your underlying strategy). In this article, we are going to show you how to take such a strategy and generate a potential portfolio of shares from it.
A recap on the value strategy
Our example value strategy has several components and we’ll explore the specific metrics behind them in more detail shortly. First, we have used Joel Greenblatt’s Magic Formula to find “cheap” and “good” stocks in the market and have added in an additional filter the Piotroski F-Score, a checklist that scores a company’s fundamental momentum – helping us to find stocks that are “improving”.
As a quick aside, the thinking behind this combination is that it's a strategy that shouldn’t keep you awake at night. When market conditions aren’t playing to your favour, there should be some security in knowing that focusing on a diversified portfolio of cheap, good quality stocks with improving financials is a sound long-term philosophy. For that reason, you're unlikely to have to walk away from it, although - like any approach - it may experience periods of underperformance from time to time.
Let’s do this…
Because our value strategy is based on a couple of ‘guru’ screens that are already a feature of Stockopedia, there are really easy ways to blend them to get the result we want pretty quickly (more on that later). But because every single metric and parameter can be changed or amended depending on what you want to see, we’re going to go from the ground up and build this screen from scratch. The good news is that it’s really easy.
From Stockopedia’s homepage, hover over the dropdown Strategies menu and select the option to Create a Screen. Here you’ll find the mission control page for building any kind of strategy that you want. After you have given your screen a name – in this case we’ve used Systematic Value - Cheap, Good & Improving – you can begin inputting the parameters needed for this strategy.
First up… Magic Formula
Our first filter relates to market capitalisation – as a precaution against small-cap disasters we don’t want anything valued at less than £30 million (or even higher if you prefer). Once you have entered your requirement, hit the Add a Screening Rule button to create another one.
In Greenblatt’s method, he takes the earning yield for every company in the market, lists them in descending order and then ranks them: 1,2,3,4 etc. He does exactly the same for Return on Capital Employed and then adds the two ranks together to get a score – the lower the score the better. By adding Magic Formula Rank % to the screen, Stockopedia does all that work for you. Click Add Basic Ratio and search for “magic formula” – click Magic Formula Rank % and choose only stocks ranked 85% or higher. This also automatically strips out any financial stocks, which Greenblatt requires in his strategy.
In addition we want to filter out any stocks with ‘outlier’ data. Sometimes companies have ridiculously cheap valuations or ridiculously high profitability scores due to an anomaly in their accounts. To do this, instead of Basic Ratio this time we select ‘+Rankings’ so that we can rank the market for both Earnings Yield % and then again for ROCE % Greenblatt. Let’s select all stocks that are below a 99% rank for these metrics to filter out the outliers.
The final Basic Ratio to add to our strategy screen is the Piotroski F-Score. As we discussed in the last article, Piotroski’s checklist of financial health asks some demanding questions of each stock relating to a range of metrics and indicators. You can read more about each item on the checklist here. The advantage of the F-Score is that it acts like an all-in-one safety net that can be applied to virtually any strategy. In fact, in our value investing book (which you can download here) we discuss how the F-Score is actually a self-sufficient and highly effective standalone strategy when digging around for the cheapest stocks in the market.
Because of the range of tests involved, calculating the F-Score for individual stocks is demanding enough – doing it for all the high ranking Magic Formula stocks in the market would be tortuous. But it’s no problem here, because selecting Piotroski F-Score as our final Basic Ratio handles the whole job. Searching for Piotroski F-Score stocks that are greater than 6 allows us to remove the poorest financial quality stocks from the equation. Ideally we’d prefer to invest in stocks that rank 8 or 9.
Finally, specify how you want your list sorted – in this case we want it sorted according to the Magic Formula rank – and then click Get Qualifying Shares.
How to handle the results
By tweaking the formula – either choosing higher or lower Magic Formula or F-Score ranks you can raise or lower the number of qualifying stocks. Here we have got an illustrative list of 29 qualifying stocks.
An alternative way to set up our strategy would be to begin with Stockopedia’s Greenblatt Magic Formula screen and then fork it. "Forking" is Stockopedia’s way of implementing your own changes to any screen by clicking on the Fork It button on the top right of the screen. It gives you the option to introduce or change ratios from our GuruModels as you wish – and in this case, we would simply add the Piotroski F-Score.
At this stage, you have numerous options. As a registered Stockopedia member, the screen will remain in Your Screens and will automatically update as company results come out (including interims). You can download the results in different file formats and you can transfer stocks from here into your portfolio (or an entirely new portfolio) using the buttons at the bottom of the page.
By clicking on a company name you will be taken through to its StockReport, which gives a detailed overview of its fundamentals. This is the basis for further research and it can’t be overemphasised that this raw initial list is one that requires intense scrutiny.
To transfer stocks into your portfolio, tick the boxes next to each stock you want to move. By clicking "Add to Folio" and following the steps, the companies are copied into your portfolio section where you can get a snapshot of share price performances and a range of other data.
In the next article in this series, we will take a close look at how you can refine your portfolio, how you should review and rebalance it and how to manage the costs of running it. For many investors in the stockmarket, it’s this ongoing management that can be the difference between success and failure over the long-term.
In this series:
How to get started in the stockmarket with Stockopedia
How to create your ideal investing strategy (value, growth, dividends)
How to turn a strategy into a portfolio with Stockopedia
How to give your portfolio the best chance of success
How to manage your portfolio over the longer term
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