Stock Picks | Strict Rule Portfolio - How Do You Achieve It?

11th Oct '20 by MiserableJacktPotato

38 comments 1189 reads

Hi all,

Bit of a long post that's probably more of a thought experiment than something I would actually execute, unless some of you can convince me it's a great idea! :D

Apologies of this is just a rerun of a post someone else has done in the past, feel free to link that and we can revisit that one. :)

Essentially I don't understand how a strict rule portfolio would work in the real world of a small PI and also I have recognised issues with how I pick stocks, though they're nothing new and probably just restating things that have been written about 100,000 times before.

Summary of the issue:

The waffle section goes into a lot more detail on the thought process but, I don't really have clear rules on what shares to buy, position sizes or have a plan with how or when to dispose of them. Position sizing is usually just "how much cash do I have right now". My biases are killing my ability to pick successful stocks or maybe my confirmation biases are playing havoc with my ability to recall what shares I looked at and why I rejected them. Probably both.

Then I remembered the NAPS portfolio and I remembered others use heavily rule based processes (SIF and Magic Hat come to mind though I don't recall right now what their criteria are), maybe there's something I can leverage in a similar way….

The Plan:

Well, potential plan, I'm looking to start a discussion and see what others think of it as an idea.

So my shares are generally small cap, have high QM. I can screen for that. I'm not very bright, but the fine folks at Stockopedia are, so rather than try to come up with KPIs for my screen based on all kinds of numbers I don't really understand fully, I would leverage my subscription and their brains and use the StockRanks. Screen for market cap above £50m below £700m, Q, M, QM and G all above 80.

Easy peasy.

https://www.stockopedia.com/screens/qm-smallcap-864858

But wait IGPJ - there's already out of the box screens that do something similar - yes there is but they don't fit the plan and I shall explain why.

So, you have to remember I only have a reasonably small pot, I can't commit to much more than £20k (well I could but…

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troytea

12th Oct '20

interesting thoughts.
I do run strict rules based portfolios and rebalance quarterly (I’m with interactive investor so I get trading credits which expire after 3 months), on a portfolio of about 30 ( 3 different rule sets, 10 stocks for each rule set) stocks normally 5 or 6 get churned. It works very well for me but your trading costs are high, can you not find cheaper?

I would be loathe to introduce a value into a qm portfolio as then you would exclude some nice companies which are valued highly for a reason e.g. GAW. possibly think about having 2 portfolios running alongside each other a VM and QM.

I would think £1000 is low for a position; personally I would have fewer but more concentrated with a limited budget - my own portfolio is larger hence 30 stocks but even as it hopefully grows, 30 is my max.

all the best with your ventures

MiserableJacktPotato

Thanks, this is interesting, so it is possible, that’s good to know.

Yes, I know my trading costs are high, I was looking for suggestions to reduce them. One thing I could do is rebalance on the cheap trade Wednesdays Halifax run, where it’s £4, should’ve thought of that before. But I’m very keen to get good suggestions for more competitive online brokers, I’ll look at II but (maybe wrongly) concerned about the risk of small players going under and taking my stocks with them.

I accept £1k is low. What do you think the realistic lowest position size should be? Someone below mentioned £4k, sound about right?

Yes, that’s pretty much what I do now, not unsuccessfully but my decisions are arbitrary. I could tell you why I decided to buy/sell at the time but not based on any consistent rule. Especially selling. Thanks for taking the input :)

Thanks for the feedback, couple of interesting points to look into there :)

some thoughts feel free to discard

1. Have you calculated trading costs for the portfolio if using 5 stocks at 4K per holding vs 10 stocks at 2k per holding

2. Are you comfortable with 5 stocks. A lot of conviction people are, I’m not one of those. It’s a question that only you can answer. Do you need to rebalance quarterly, the NAPS portfolio is annual and that does well. I rebalance quarterly for two reasons - trading credits and keeps my interest.

3. Rather than introduce a value element, my preference would be to order by qm or something and pick the top x. Unless there are any in that x which you are not happy with -I normally exclude for recent pws and a few other things but up to you.

4. Sometimes I’ve had to hold my nose and buy. GAW being one of them, I kept thinking it’s eye wateringly expensive. But it keeps on delivering...

HHR

I have been investing for 26 years and consider myself an average performer achieving 11% compound over that time net of all costs.

I am posting because I have encountered several of the problems discussed on this thread.

These are my personal thoughts and they won't apply to, or be of use to everyone, so I am sure many will disagree with my thinking and that's fine.

1) Personally I would advise against changing strategy, instead I would go back again and look at the successful investments you have made and figure out a method based on those successes. Once you have that, you can improve it as required and apply a strict rules to encourage yourself to adhere to it.
Although there are many ways to make money in the stock market I think it's important to have a method suited to one's personality and make up.
I have tried (unsuccessfully) applying the methods of Jim O'Neil, Ben Graham, Kenneth Fisher and Victor Sperandeo and although I would have no hesitation in recommending their books to anyone, for me personally, I found I lost money trying their methods. It was only when I tried to apply Jim Slater and Peter Lynch that I made money consistently

2) It took me years to work out what was going on in point 1. Once I did I resolved to only buy what I call 'leader' stocks. To my surprise my performance didn't improve very much. I resisted going back and doing another 'strategic review' as I knew the first one was valid. However eventually poor performance forced another strategic review. To my utter amazement I found that I wasn't actually applying my strategy to buy leaders! My discipline had improved but similar to your experience, I was still following too many hunches and buying 'bargains' and 'story stocks'. Now I have absolutely bullet proof checks in place to force me to stick to my method

3) Have you read '100 Baggers: Stocks that Return 100-to-1 and How to Find Them' ? This book makes a couple of interesting points from a study of all 100 baggers;
i) not many of them started their 100 bag as micro-caps. Instead most of them were what I would call mid-caps when they started,
ii) he also talks about the 'when to sell' question. Over my 26 year investing career I have invested in 140 companies so I am a pretty long term investor. Two of those companies multibagged from where I purchased (Sage and Rightmove) but regrettably I sold them when they doubled! If I had held just one of them to today my 11% compound return would be more like 15% and if I had held both of them it would be heading for 18%. So selling winners is my biggest investing mistake by far.
This problem gets discussed in the above book and the author suggests NEVER completely selling a winner. I appreciate this throws up loads of dilemmas in tying up capital in winners, wasting valuable time, getting stressed out etc and it won't suit everyone but nevertheless this is now my strategy once a share has doubled (or more) I top slice out my original stake and then retain a holding until the company de-lists or I die!

4) On the subject of 'story stocks', I too have a weakness for them although I still believe that there are some jewels in the sea of mud. Here are my personal quick fire checks to differentiate a good story stock from a 'sucker stock';
i) how long has the company been listed? More than 5 years and perhaps the true objective of the company is to milk their salaries and options while spinning out their story as long as they can,
ii) I used to think that management holdings guarded against rip offs but now I think 'sucker stocks' have worked out that PIs look for significant management holdings as a safety margin and will be lured in. Also I think some of the ipos are now so deceitful the only way nomads will sponsor them is if management has a holding. I think the managements of many 'sucker stocks' don't care if they lose all their equity providing they can cash in up front and along the journey! So personally I think significant management holdings in pre-profit story stocks can be a red flag (although I still consider it a good sign in profitable companies),
iii) with a story stock I always ask myself 'why hasn't private equity or a trade buyer snapped this up?' I have found simply asking that question honestly and rigourously weeds out most 'sucker stocks'. Occasionally you can come up with valid reasons and when that happens I am more prepared to believe the story
iv) does the company promote itself on rns and at investor fairs etc - not always a bad sign but often is

As I said at the start we are all different so this is just my personal experience and opinion of the problems discussed in your thread.

Thank you for crafting this very detailed response. I shall peruse and inwardly digest. There's a lot more quality feedback coming through than I expected! My main take away from your post (not the only takeaway, there's loads of great info), read more books :)

I'm especially excited by the 100 baggers start as mid-caps, this could go some way to solving some of the problems mentioned below, especially spreads and liquidity which one would have to expect will be much better in bigger companies.

I've learnt, like you, not to sell out of winning positions completely - I now (rightly or wrongly!) sell half on a double and then just let the rest run. The position is, essentially "free" at that point (yes I know it's a psychological trick of the mind). Boo, Computacenter, SFor (and numerous others) I've picked them and sold them and been left holding head in hands.

Thanks -

BTW I meant William O'Neil not Jim but it's too late to edit.

Best of luck.

andrewdb

I think Nick has pointed out some time ago that a VR > ~95 does not improve performance (my memory may be incorrect)- not sure if this applies to Q and M though

Bluesky Ventura

11% is better than average, and excellent advice as well. Again if you can avoid story stocks and people telling them, it really can improve the performance of the whole portfolio.

As always DYOR

BSV

Nick Ray

Very roughly, there seems to be little benefit to pushing harder than Q>80 but you can push M as hard as you like. Go for M>=99 if you like! For V it's more like V>=5 but even V>=2 is usually OK. (In other words only extremely expensive stocks sound a note of caution.)

V itself is a bit of a mess because it merges various metrics which don't all have similar probability distributions. If you want a value metric, then P/FCF between 10 and 40 (roughly rank 20 to rank 80) is one I tend to use.

Volatility is a good substitute for a value metric though - low volatility suggests investors are roughly in agreement about how to value the stock.

William K

13th Oct '20

I agree, Nick Ray.

'V itself is a bit of a mess because it merges various metrics which don't all have similar probability distributions.'

In fact a high V is sometimes synonymous with debt that has escalated out of control and should be regarded with caution.

DWit199

Nick,

Have you done any work on how quickly factors revert to the mean in a portfolio? My own observations on a 30 share high QM portfolio suggest that Q and V are relatively stable but that M is hard to maintain.

aflash

Here are some counter-arguments.

Mark Douglas (Trading in the Zone) adresses the problem of consistency in his lectures which can be found on youtube.

Once an investor has honed his method to his personality he has an Edge.

However it increases the Probability of success only.

Any value judgement applied to individual choices reduces chances of profit because there are so many other factors and players.

Tossing a coin is used as an illustration. The chances are 50:50. Heads may fall several times but that does not increase the chances that Tails will fall next time.

To get around the investor interferring with what his method tells him, Douglas says all selections must be traded. He even recommends trading one share when going through a bad patch.

So over-trading, commission, spread and position size are problems but second-guessing your system to avoid those problems will lead to inferior results too.

This comment is under review

intuitive6191

Why is Bluesky Ventura's post above under review? There is nothing wrong with the post.

Gromley

Indeed, I can see nothing wrong with bsv's post either other than it mentions spreadbetting.

Certainly people would be right to be wary of spreadbets - they can be a quick road to ruin.

However, there is no compunction with Spreadbets to either overtrade or use excessive margin. There is no reason whatsoever you cannot put £20k in to the SB account and only 'buy' £20k worth of shares and hold them for 3 months, 6months or whatever.

One of the things that Ed's NAPS have thrown up over the years is that even portfolios of 20 stocks can be quite volatile - Ed actually wrote a good piece on this last year

With only £20k your dealing costs for a 20 stock portfolio are already quite prohibitive in a stock account, so going to 30 or 40 positions would be a no no.

However if you did want to go for greater diversification, this is where spread bets could help.

The structure of SBs is that you do not pay a fixed transaction fee - instead you suffer a slightly higher spread. Effectively the "transaction fee" is on a percentage basis rather than fixed.

The effect therefore is that "dealing costs" for smaller positions are better with SBs than conventional accounts and the converse is true for larger position.

The cross-over point is usually around £1,000 - £2,000.

So if you did want to go for say a 40 share portfolio of £500 each - it would be economical in a spread-bet account.

The other possible advantage of Spreadbets is that if you do want to rebalance, they provide a natural breakpoint in that the contracts are typically 3 month, 6 month (or with some providers 9 months). I a particular stock qualifies for renewal in the portfolio then you can roll over the position for a reduced spread; otherwise close the old position and open the new one.

Nick,
Have you done any work on how quickly factors revert to the mean in a portfolio? My own observations on a 30 share high QM portfolio suggest that Q and V are relatively stable but that M is hard to maintain.

M goes up and down like a yo-yo as the price changes whereas Q tends to only move significantly on trading updates. V is similar to Q. So there is a lot of noise on the M rank.

Here's an example for a recently discussed stock: Ergomed (LON:ERGO)

Apologies Everyone,

It was me red flag myself to avoid anyone else red-flagging me. I just wanted to test what comments get moderated or not. I seem to attract a lot of red flags and moderation removals.

That's an interesting chart for Ergomed that nicely emphasises the volatility of M.

In my original question I was thinking more about the various factors at portfolio level. If you purchased a large portfolio of very high M shares, over time and without any portfolio changes you would expect the average value of M to fall from (say) 95+ at the outset to settle around 50 in the long term. Assuming a portfolio of 20 - 40 shares, how quickly would the average momentum decay? Could this guide our portfolio management by providing some indication of the required trading frequency to maintain momentum?

Strict Rule Portfolio - how do you achieve it?

Summary of the issue:

The Plan:

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MiserableJacktPotato

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