Traits vs Trends: Screening for success in 2023

The psychological landmark of New Year is a funny thing. If global stock markets were sentient, I would suggest that they have (like me) taken a healthy attitude to the new year. Unlike me, their commitment to a healthy 2023 has overcome the hurdle of the first weekend in January.

And there are plenty of signs that the markets’ upward momentum is not one of those resolutions that will be abandoned before February. Inflation and US wage growth seem to have peaked, while Christmas updates from UK retailers suggest that a consumer crisis has been averted. Ammunition for bullish forecasters is rife.

The trouble is that forecasting in the new year, though fun to read and write, can be dangerous for private investors. The calendar has ticked over but that doesn’t mean we know much more now than we did at the end of 2022. The trends that started in December have persisted, but we still don’t know how long they will last. No-one does.

But market traits persist. History has shown us that regardless of the wider economic or political conditions, good stocks beat bad stocks, cheap stocks beat expensive stocks and winning stocks beat losing stocks. At Stockopedia, we strongly advocate the use of these traits as the most stress-free way to profit from the stock market.

Traits: Idea generation for 2023

And that is how we will continue to generate ideas in 2023 - by identifying quality, cheap, upward trending stocks. As ever, the best attitude for investors is discipline: have a plan and stick to it. Noise from the markets sometime makes that tricky and so I will be using the screens below to generate ideas and help maintain discipline.

Quality: Best of the Best

Large Cap Quality: Screens for companies with a market capitalisation of over £10bn from any country. It aims to identify companies which have a track record (5yr average) of generating strong profits out of revenue (operating margin >15%) and assets (ROCE >15%) as well as strong cash flows (CROIC >15%). Plus efficient capital management demonstrated by a cash conversion cycle and net gearing less than the market average.

UK Small Cap Quality: Screens for British companies with a market capitalisation between £20m and £500m (small cap). Sales growing at a compound annual rate of more than 10% a year and earnings growing faster than that. A long-term (5yr average) track record for generating strong profits from both revenue (operating margin >15%) and capital employed (ROCE >15%). Net gearing less than the market average.

Growth Screen based on Philip Fisher's checklist: This screen is based on Philip Fisher Growth - a based on the US investor’s 15 point checklist for finding growth stocks. It looks for a track record of strong sales growth, above average net margins and a low price-to-earnings growth rate over five years. This version of the screen aims to identify companies that are growing quickly without excessive debt.

Value: Quality or growth at a reasonable price

Turnaround - Piotroski screen: This screen is based on the classic value strategy by famous finance academic Joseph Piotroski. In this version of the screen, the cheapest 20% of the market by their Price to Book ratio are first selected, and filtered further to find those with the most improving fundamental health trends using the Piotroski F-Score.

Quality at a reasonable price: This screen identifies high quality companies with low gearing and a recent track record of earnings growth and a longer term (5yr average)record of generating decent profits from revenue (operating margin >15%) and assets (ROCE >15%). The screen identifies companies which are decent value compared to their own recent history (forecast P/E < 5yr average P/E)and the sector average.

Growth at a Reasonable Price: This guru screen is a strategy that aims to highlight companies that are growing but still reasonably priced by the market. It's an approach suggested by journalist and investor David Stevenson in his book, Smarter Stock Picking and identifies stocks with EPS growth, a below average P/E ratio, a high ROCE and share price with positive relative strength.

Contrarian Stocks: This screen uses Stockopedia's style ranking system to identify contrarian ideas - stocks which are high quality and good value but are currently suffering from low momentum.

Cheap for a reason: Screens can also be used to help avoid disasters. Stocks with a high value ranking (>75) might look tempting, especially when markets are favouring value stocks, but sometimes stocks are cheap for a reason. This screen highlights good value stocks which have high levels of debt and are struggling to cover the interest on their debt with profits.

Momentum: Marching Upwards

Large Caps on a roll: This screen identifies UK-listed companies with a market cap greater than £10bn which have outperformed their sector in the last six months and recorded positive share price growth. They have a momentum rank of greater than 90.

Momentum stocks with more to gain: This screen identifies the highest ranked stocks on the VM scale - companies which have both high momentum, but are still good value. The companies have all outperformed the market in the last three and six months, but still have a forward PE ratio less than the historic average.

Trends: Idea generation for 2023

But it’s also fun to identify stocks which could benefit from long and short-term trends. We’re not saying that this should be the core of your portfolio. This is the kind of peripheral investing that should only be undertaken with money that you are willing to take a few more risks with. Again, screens can be useful for identifying opportunities. Here are some for 2023.

Reliable dividends: This screen identifies UK companies which pay a dividend currently yielding more than 5%. The screen identifies companies whose dividends are covered more than twice by earnings, with a stable balance sheet.

Inflation-busters: This screen identifies companies which are paying a dividend which is covered by earnings and currently yielding more than current inflation (will be updated as inflation moves).

Sector-specific screens: In 2023, there are many structural trends which could have an impact on individual sectors. A commodities super cycle, for example, is being forecast as demand for certain materials increases. The potential boon for the mining sector is something that we will be looking at in the next few weeks. Economic upheaval is also having an impact on the financials sector, which Roland will dig into next week.

I still like companies in innovative sectors - tech and healthcare, for example - where momentum has stumbled somewhat in the past year. For companies in structurally growing sectors, a high return on invested capital (ROIC) can make a big difference to long-term profits. This screen therefore identifies companies in the tech and healthcare sectors which have an ROIC of more than 20% which they invest back into the business (i.e. don’t pay a dividend). It is only a starting point - any ideas will require more research to assess whether the company is investing in the right places (research and development costs are higher than marketing costs), capital base really is growing (Capex is higher than depreciation) and the return on investment is higher than the cost of that investment (ROIC greater than the WACC). But I am hopeful this screen will help unearth some ideas of incredibly high quality companies outside of the mainstream which could provide excellent returns over the long run.