The SIF Folio unpicked: What I do and why I do it

Since launching the SIF folio in April 2016, I’ve added 64 stocks to my Stock in Focus fantasy fund, sold 45 of them, and written 118 weekly columns.

The value of the fund has risen by 41% plus dividends over the last two years. This compares fairly well to a gain of 13% plus dividends for the benchmark FTSE All-Share index:

SIF is certainly not the best-performing Fantasy Fund on Stockopedia. But what it does offer is a clear set of rules for selecting stocks, a high level of documentation, and as much transparency as I can manage.

Every trading decision I make is documented in my weekly articles. And the screen I use to select stocks is also available for other community members to view and adapt (the Stock in Focus screen is here).

For the last 16 months, I’ve also been buying each new stock selection for my personal holdings. So the SIF fund manager has some skin in the game too!

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Don’t lose money

When I started the SIF portfolio, my goal was to develop a set of rules that would select affordable growth stocks with good fundamentals. I wanted to avoid stocks that needed a lot of individual research, such as special situations and pure growth plays.

At the core of my thinking was Warren Buffett’s first rule of investing: don’t lose money.

The idea was that by avoiding big losers, I’d be able to beat the market without needing to take too much risk.

This may sound boring, but it has worked well so far. The 45 stocks I’ve bought and sold since April 2016 have delivered an average annualised total return of 31% (including dividends and costs). However, I’m painfully aware that my system has yet to be tested in a bear market.

How my rules work

I’ve received a number of questions about the rules I use in my screen (which you can see here). So I’m going to include these in full, and spend a little time explaining the thinking behind them.

Market cap of at least £50m and bid-offer spread of less than 4% - In my opinion, micro-cap and illiquid stocks generally need detailed research and long holding periods to achieve good results.

A rolling forecast P/E of between 5 and 30 - This rule was designed to be a simple way of ruling out ‘hot’ growth stocks and deep value stocks/value traps.

Earnings yield of at least 8% - this ratio is calculated as EBIT (operating profit) divided by enterprise value.

In my view, this is one of the most useful metrics around. It shows how much profit a company is generating for its owners, independent of tax and debt/equity structure. Unlike operating margin, this gives us a good idea of the kind of returns we might expect from a stock.

Forecast dividend yield of at least 1.5% - For a profitable, well-financed company, I believe a dividend is a useful indicator of cash generation and financial discipline. I discussed dividends in more depth back in June.

Piotroski F-Score of at least 6/9 - this is a great tool, in my view. It provides a snapshot of a company’s fundamental health, cash generation and profit growth. If you’re not familiar with the F-Score, I’d encourage you to drill down into this rating on any StockReport page, or read more here.

Net debt less than four times trailing net profit - Excess debt lay behind the recent failures of Carillion and Conviviality. But many more companies survive debt-related meltdowns by swapping debt for equity and diluting their original shareholders to oblivion. I’m keen to avoid this fate.

I usually compare debt with net profit, rather than the more commonly used EBITDA. I think net profits provide a better indication of how quickly a company could repay its debts, without having to make damaging cuts to spending.

Rolling PEG ratio of less than 1.2 - Made famous by the late Jim Slater, the rolling PEG (price/earnings growth) ratio is one of my favourite growth metrics.

The premise is that a faster earnings growth justifies a higher P/E. The PEG ratio enables easy comparisons between stocks.

Rolling forecast eps growth of more than 5% - Inflation means that a certain amount of growth is necessary to stand still. I’m looking for companies that are actively expanding, so I’ve specified minimum expected earnings growth of 5%.

Forecast sales growth above 0% - As above. If sales are falling, it usually means a company is shrinking, restructuring or having problems.

At least one broker estimate - some small caps don’t have broker coverage. This means no consensus forecasts are available to satisfy my rules. I exclude these companies.

1-year relative strength (RS 1y) greater than 0 - relative strength measures the performance of a stock relative to its index. A positive value means that the stock has beaten the market over the period in question. This is said to be a useful indicator of momentum.

Price/book ratio greater than 0 - stocks with a negative book value usually have dodgy balance sheets. For example, they may have a massive pension deficit. I prefer to avoid situations like this.

Holding period: All stocks are held for a fixed minimum of nine months before being reviewed. If they still pass all of my screening rules at that time, they remain on the portfolio on a rolling monthly review. If they don’t, they’re sold.

Stop losses/top slicing - I don’t use stop losses at all. I’ve never had good results with them personally. I rarely sell early in SIF -- when I have done, it’s usually turned out to be a mistake.

The only time I will top slice is in the unlikely event that a stock doubles in value. In that case I’ll sell half the holding, so that I’m guaranteed a profit.

Of course, having a set of rules is one thing. Living with them is quite another. So how has my foray into systematic investing worked out?

More comfortable than I expected

I think this approach suits me. On the whole, I’ve quite enjoyed following a rules-based strategy. It makes the research and selection process much more manageable and it’s the best way I’ve found to make consistent decisions over long periods.

Another advantage is that because the timing of buys and sells is controlled by my rules, I’ve found that I focus more on the investment process and less on returns. It also feels easier to sell losers and hold onto winners.

Still some challenges

From time to time, the SIF rules have led me to select stocks or sectors I would otherwise have avoided. Examples include late-cycle housebuilders (most recently Bovis) and CFD firm Plus500, which is currently the portfolio’s biggest riser.

However, these situations have generally turned out well. So I’m becoming more comfortable with them, hence last week’s purchase of Bilby.

The biggest challenge has probably been accepting that some opportunities aren’t a good fit and can’t be acted on. For example, in the wake of the Brexit referendum, I thought there were a lot of bargains on offer. But negative relative strength ruled them out of the screen. Similarly, multi-bagging growth stocks such as Boohoo and Fever-Tree have also been ruled out.

What next?

The SIF rules won’t suit everyone and can probably be improved on. But I’ve found a lot of satisfaction in following a rules-based process. I’m looking forward to learning more as the fund continues to evolve.

As always, I’m grateful for your readership and feedback -- the quality of discussion here on Stockopedia is always very high, and adds huge value for the community.

Disclosure: Roland owns shares of Bilby, Bovis Homes Group and Plus500.