If you can't find the perfect stock - why not synthesise one?

Wednesday, Dec 12 2012 by
If you cant find the perfect stock  why not synthesise one

Surely the simplest way to become rich in the stock market is to find the perfect young growth stock, fully invest, and ride it for 30 years. But a piece in the FT at the weekend caught my eye which illustrated just how hard it is to find long term winners in the market. The piece highlighted the biggest winners in the UK over the last 30 years -  an unusual selection of stocks which certainly didn't fit the expected profile. The truth is that near perfect companies are very hard to find, and when you do find them, they are often acquired or taken private, leaving little of the long term reward in your pocket. Anyone screening the market to find the ideal stock may find their labours are only rarely rewarded. What is an investor to do?

The profile of a perfect buy and hold stock

Many investors will agree on the characteristics of their perfect buy and hold stock - it often goes something like this:

  • high growth rate (EPS, Sales) 
  • low valuation (PE ratio, Price to Book, Price to Cashflow)  
  • high profitability (Return on Equity, margins) 
  • consistent, sustainable upward trend in profitability 
  • low leverage, good interest cover 
  • Mid-cap (with room to grow) rather than a 'penny' stock 
  • Good price performance in last year - low volatility of share price

Intuitively one imagines that a stock continuously showing a profile like this over many years will strongly outperform the stock market. It would look like a classic 'GARP' stock (growth at a reasonable price). The trouble is that everyone knows this. It's so very obvious that these characteristics are desirable that thousands upon thousands of investors look for them on a daily basis.

As a result, stocks often display a profile such as this only fleetingly - as when investors do find them they get bid up to a premium, reducing the future returns for new investors, and ensuring they drop out of candidacy from the list.

So what is an investor to do? Many will seek to be patient, alert and pounce on the opportunities when they arrive. Some such as Warren Buffett will step in on bad news, or when the macro environment looks frightening to others. But in regular times, for those who can't watch the market like a hawk, there is indeed an answer.

What if, instead…

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5 Comments on this Article show/hide all

grafull 30th Jun '15 1 of 5

Good ,thoughtful piece Edward. I haven't read Naked Trader but will look at it next.
I assume your comments refer to the UK market. I will certainly read Haugen.

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Edward Croft 30th Jun '15 2 of 5

Yes this is quite an old article, but the late Robert Haugen has been a huge influence ... his writing is really for the uber-geeks, but if you are into that sort of stuff he's quite entertaining. I recommend "The Inefficient Stock Market" if you can get a copy. There's some great chapters on what works and why.

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UK Value Investor 30th Jun '15 3 of 5

Ed, this may be an old article but it's a hugely important one, for me at least.

My goal is to have a portfolio which is high yield, high total return and low risk, perhaps a little bit like the High Yield Portfolio (HYP) approach at the Motley Fool. The portfolio overall should have a fairly steadily growing dividend (whether reinvested or not) and relatively low volatility.

The HYP way to achieve this is to buy a basket of 15 stocks that each more or less exhibit those characteristics. In other words, each stock is a classic "blue chip" stock with a progressive dividend and low volatility shares.

But my approach doesn't work like that and it's sometimes hard to get the concept across. As per your (or Haugen's) synthesis idea, the portfolio contains high growth companies, low growth companies, super-steady companies and not so steady companies, high yield stocks and low yield stocks.

Very few of them, perhaps 5 out of 30, exhibit all of my key criteria of high yield, high growth, low risk. However, in aggregate they do. Once they are all mixed together into a portfolio the result is high yield, high growth and low risk.

I guess it's kind of like baking a cake. You take some butter, salt, flour, milk, eggs, etc, none of which look like a cake, mix them together, stick them in the oven for a bit and hey presto, a cake, which looks nothing like any of its constituent parts.

I have occasionally been accused of holding a mish-mash of stocks with no common theme. Next time someone says that I'll point them to this article.



Blog: UK Value Investor
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herbie47 30th Jun '15 4 of 5

In reply to UK Value Investor, post #3

Hmmm, not sure about your cakes, haha.

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UK Value Investor 1st Jul '15 5 of 5

In reply to herbie47, post #4

I must admit I am significantly more experienced with eating cakes than I am with making them.

Blog: UK Value Investor
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About Edward Croft

Edward Croft

CEO at Stockopedia where I weave code, prose and investing strategies to help investors beat the stock markets. I've a background in the City and asset management but now am more interested in building great stock selection tools for the use of investors online.   Traditionally investors online have had very poor access to the best statistics, analytics and strategies for the stock market and our aim is to set that straight.  High Quality fundamental information has been prohibitively expensive in the past and often annoyingly dull. People these days don't just want to know the PE Ratio and look at a balance sheet. They expect a layer of interpretation over data, signal from noise and the ability to know at a glance whether a stock is worth investigating or not. All this is possible using great design and the insights gleaned from quantitative research.  Stockopedia is where we try to make it happen ! more »


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