YOUR SINGLE BEST IDEA FOR PROCESS IMPROVEMENT

Saturday, Sep 28 2019 by
16

Hello everyone!

This is not about share  recommendations. 

The idea behind this post is that we share the single best idea that we ever had to improve our share selection buying process.  (If you don't follow a process, then I am on not really seeking an answer from you, but if you want to ask a question, then please go ahead.)

My idea is to stop following share tips from any source, no matter how well informed. Following tips inevitably puts you behind the curve. A well designed screen will put you ahead of the curve. (I am an experienced  subscriber on here and can tell you that the screener section on here is extremely good. If you are not sure how to proceed, the help is absolutely first class!)

Because I have have made this post, I will also share with you my two next best ideas. I am looking for growth shares and my best advice is to look for rapidly growing sales and a high ROCE. Or a good shortcut is to look for a high growth rank.

If you consider yourself to be a successful investor, then please share your best idea on here. We can all benefit from this. It would also be helpful to tell us what you are looking for. Eg Income or growth or whatever.

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Disclaimer:  

As per our Terms of Use, Stockopedia is a financial news & data site, discussion forum and content aggregator. Our site should be used for educational & informational purposes only. We do not provide investment advice, recommendations or views as to whether an investment or strategy is suited to the investment needs of a specific individual. You should make your own decisions and seek independent professional advice before doing so. The author may own shares in any companies discussed, all opinions are his/her own & are general/impersonal. Remember: Shares can go down as well as up. Past performance is not a guide to future performance & investors may not get back the amount invested.


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30 Posts on this Thread show/hide all

kuronagi 30th Sep 11 of 30
8

My single best idea is to avoid any stock which has a large following of private investors as evidenced by activity on bulletin board eg ADVFN.

I am a retired investment professional (and a CFA) with many years of experience running my own retirement fund. Mainly on a long term buy hold basis and with a increasing proportion of small (mainly AIM) companies. My biggest mistakes are where I have been influenced by "group thought" via the BBs.

Examples of over-active BBs would include the likes of Burford Capital and Sirius Minerals.

Examples of under-active boards would include Avingtrans (AVG), Walker Greenbank (WGB) and Paypoint (PAY).

Possibly, the second most important idea is to exclude any company with significant debt. By significant, I would mean anything higher then around 30% net debt/equity.


Kuronagi


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Bonitabeach 30th Sep 12 of 30
2

In reply to post #517541

1. Understand what is meant by an "efficient market".

An old definition of an "efficient market":

50% buying and 50% selling; all convinced they are doing the right thing.

Bonitabeach

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clarea 30th Sep 13 of 30

In reply to post #517771

Hi re debt/equity is that the same as the net gearing stat on Stock ?

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pka 30th Sep 14 of 30
2

It's not my sole criterion for purchase, but I like to buy stocks, investment trusts or funds that have upward share price momentum. I measure that using the % 50dMA / 200dMA, which is easy to display in a Stockopedia screen. According to Stockopedia's glossary of terms:

https://www.stockopedia.com/ratios/

"What is the definition of % 50dMA / 200dMA?
This measures the security's 50 day Moving Average price divided by the 200 day Moving Average price.
Work by Seung-Chan Park has shown that companies whose 50d MA is far above the 200d MA significantly outperform those companies where the 50d MA is below the 200d MA."

Therefore one of my criteria for buying a stock, investment trust or fund is that the value of its % 50dMA / 200dMA is significantly greater than 100.

I consider selling a stock, investment trust or fund if its % 50dMA / 200dMA becomes less than 100, which means its 50d MA is below its 200d MA and the share price is recently on a downward trend. For me, this is a bit like a stop-loss criterion. Having sold a holding, I will consider reinvesting the proceeds in another stock, investment trust or fund that has a value of % 50dMA / 200dMA significantly greater than 100. If there are none available, I will leave the proceeds in cash.

I'm sure that this isn't a perfect process and there will be times when it won't work well, but it has the merit of simplicity for both buying and selling decisions. I hope that it will keep my out of the worst of major bear markets and that it will take me out of any disastrous investments before too much damage has been done to the overall value of my portfolio.

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kuronagi 30th Sep 15 of 30

In reply to post #517786

yes

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WarrantStar 3rd Oct 16 of 30
1

Thank you to all contributors for your great ideas!

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Edward Croft 3rd Oct 17 of 30
12

Frankly, as an active small investor, the most important rule to add to anyone's armoury is to only purchase stocks that have positive momentum.   I like to use Relative Strength and the 200d MA as indicators.  I look for positive 6m or 1y RS (ideally in the top 10% of the market) and a stock above its 200d MA.    Great to buy breakouts if you can, but as Jim Slater would have said "selection beats timing".

The reason momentum is so important is several:

  1. It's the most powerful 'factor' that drives stock returns.  Even Fama & French agree. It's a more powerful factor than value. i.e. better to buy 'strong' stocks than buy 'cheap' stocks.
  2. Large investors can't buy all at once.  Buying strong momentum shares means you are often buying on a rising tide of institutional money.  
  3. Using momentum as a factor helps position you both with the great turnaround stories (cheap but recovering fast), but also with the great market leaders / high flyers (high quality/growth stocks). 

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jjis 3rd Oct 18 of 30
7

My single best idea for improving performance is to ignore non dividend paying stocks which on average tend to be higher risk and lower return. This reduces the universe for your research & by concentrating on dividend payers you have the potential to significantly reduce portfolio risk. with the reduction in risk being achieved without a
corresponding reduction in return.

See this research paper from 2016: Called What Difference Do Dividends Make?

If that's of interest if not here's the abstract:

Abstract

We evaluate the investment benefits of dividend-paying stocks and make three major findings. First, high-dividend stocks have the least risk, yet return over 1.5% more per year than non-dividend payers. Second, the benefit of targeting dividend payers is conditional on investment style. Surprisingly, the benefit is largest for growth and small-cap stocks; the very firms that are usually thought to benefit the most from the reinvestment of cash flow. Third, long/short managers exploiting the value premium should focus on non-dividend-paying stocks. The return difference between non-dividend-paying, small-cap value versus small-cap growth stocks exceeds 1% per month.


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Howard Adams 3rd Oct 19 of 30
2

In reply to post #518721

Hi Ed

I like these points (re-iterating your comments from the recent Webinar) and follow most them through slightly differing lenses of analyses (Wyckoff for the institutional volumes in relation to prices, RS values, QM and so on).

A question I have though is this.

Do you have any guidances about ceilings to your examinations of 200 MA, RS 6m or 1yr? As stocks could easily fit these and be in the top 10% of the market. But in they have become over-stretched and about to fall back (possibly dramatically).

Do you suggest any risk-reward guides (i.e. volatility maximums perhaps) to steer clear of these 'stocks which cannot rise for ever'?

Your thoughts are always welcome.

Regards
Howard

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pka 3rd Oct 20 of 30
1

In reply to post #518721

Ed wrote: "I like to use Relative Strength and the 200d MA as indicators. I look for positive 6m or 1y RS (ideally in the top 10% of the market) and a stock above its 200d MA."

I wrote: "One of my criteria for buying a stock, investment trust or fund is that the value of its % 50dMA / 200dMA is significantly greater than 100."

I have noticed that if a stock has a value of % 50dMA / 200dMA significantly greater than 100, e.g. 110, then it is likely to satisfy all three of Ed's momentum criteria as well. Make of that what you will!

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pka 3rd Oct 21 of 30
1

Sorry, what I should have written in my previous post is:

I have noticed that if a stock has a value of % 50dMA / 200dMA significantly greater than 100, and if it is in the top 10% of the market for that criterion, then it is likely to satisfy all three of Ed's momentum criteria as well.

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Nick Ray 3rd Oct 22 of 30
3

In reply to post #518756

Do you have any guidances about ceilings to your examinations of 200 MA, RS 6m or 1yr?

For what it's worth I had a quick look at this for my own reasons a few days ago.

Of the Momentum metrics where "big is better", the following ones do seem to have a limit above which bad things are more likely to happen as shown in the table below.

Metric Limit Rank in Market
% Price Chg 5y <= 608 98
RS 1y <= 257 99.3
% 50dMA / 200dMA <= 136 98
% Price Chg 1y <= 281 99
% vs. 52w Low <= 307 98.6
Altman Z Score (2) <= 53.4 94

They all seem to occur at about rank 98 to 99, so somewhere in the top 1-2% in terms of percentiles. They might not be red flags but definitely "be careful" flags.

I've included the Altman Z score (2) in the table too because I was rather amused to discover that very high Altman scores can happen (usually they are about 0-5) and that they are an indicator of possible trouble. Very high Altman scores happen when the T4 argument ("Market Value of Equity/Book Value of Total Liabilities") in the Altman formula blows up, and indicates an oddity in the balance sheet which needs checking out.

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abtan 3rd Oct 23 of 30
4

A fantastic post, thank you for initiating!

For what it's worth I have a few criteria of my own, which I would say I follow for 80-90% of my equity holdings (I don't buy funds). 

These are as follows:

  1. Unbroken increase in revenues over a several year period, I might miss some gems where revenues may have fallen one year for a valid reason (eg sale of part of the business), but as a screener I have found this to be a good starting point.
  2. Maintaining or increasing gross margins. This is a must for me. There is no point having rising revenue unless margins are maintained.
  3. Operating cash flow (before working capital movements) less maintenance/"normal levels of" CAPEX is <=10-12 times EV of the company. 
  4. Little or no debt
  5. I never look at broker forecasts any more (having lost money doing this before deciding to take things into my own hands), but I do now keep an eye out for positive changes in forecasts (thanks to Ed for emphasising this in a couple of his webinars).
  6. I generally try to target companies in the £80m-£100m market cap range (though I do of course have a few much bigger companies). My understanding from a comment by Paul (Scott) a long time ago, and from speaking with a friend who manages his own fund, was that many institutions won't  (can't?) invest in a company until a Market Cap exceeds £100m, so that's the point at which I would hope one of my holdings is picked up and takes off.
  7. International exposure.  60% of my holdings are listed in the UK, with the rest based in Europe and one in the USA.
  8. Pays a dividend, however small, to re-assure me that cash flows are probably real.
  9. I generally sell on:
    1. bad news,
    2. spotting something I don't like or understand in company reports
    3. thinking that management are lying/exaggerating
    4. the share price reaches a point where point 3. above (OCF-CAPEX/EV) makes the share price look too high. I would say it has been a 50/50 split with regards to a share price subsequently completely tanking/rising beyond my expectations after I have sold


The above is not a conclusive list, but covers most things I check before buying.

I've been in the game for many years (since mid-2000s), but I have only taken it more seriously since signing up to Stockopedia at the end of 2016,  since when my returns have been:

+38% (2017)

+4% (2018)

+13% (2019 YTD)

I would say that my strategy has worked so far, but of course I've never really had much skin in the game through a serious recession, so this last few years could have been pure luck. Time will tell.

Thanks again to all other posters, your thoughts are much appreciated.

A



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Gromley 3rd Oct 24 of 30
2

In reply to post #518846

Fascinating Nick,

You've touched before on the very highest StockRanks providing extreme returns in both directions and the only glib explanation I could think of for the extreme negatives was things being "too good to be true".

I am intrigued therefore by your observation on the Z-Score as this is a much more focussed measure than the SRs.

Are you able to provide any examples of "high Z-Scores gone wrong"? I'd love to do a couple of case studies on this to see if there are lessons we can learn.

I believe back-testing is somewhere on the Stocko Road Map, but until this is delivered it's really hard to go back an identify candidates at source.

Edit : As soon as I posted this it occurred to me that there was probably one obvious example Patisserie Holdings (LON:CAKE) which I note in August 2018 had a top class Z-score of 81.5. That's really not was I was looking for though - PV's high Z-Score came about purely because it was calculated on fictitious numbers and I suspect it is such an outlier that there is not too much that can actually be learnt from it. (Although I am aware that some have peddled the idea that they "could have" spotted it.

Any more mundane cases?



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Nick Ray 3rd Oct 25 of 30
3

In reply to post #518876

Yes - here are a few examples to mull over.

Quick note: The warning about Altman Z scores applies specifically if you are also filtering for very high momentum.

And of course it does not mean that any stock with high momentum and Z score > 54 will perform badly - but that the probabilities tip the wrong way for that case.

Anyway, with my caveats out the way here are the examples. (BTW the "guide" is a fixed 25% p.a. line, so that when comparing price plots I get a quick visual alert if the scales are very different.)

IMM - (my records stop in 2018 when the Mkt Cap goes too small for me to track)

5d9675f23e04ealtimm.png

LOOP

5d9676555a3e6altloop.png

UKOG

5d96769e45c5faltukog.png

PURP

5d9677f222e52altpurp.png


Others include PLUS, PANR, FUM, DDDD, BPC, JAY.

There are quite a few small resource and mining stocks.

Looking at the plots above, it looks like a high Z score together with high momentum can be an indicator for the "frenzy" type of price behaviour where the froth suddenly goes away again.

So with that in mind, here are a couple of stocks where the froth has not yet blown away(!)

GAW

5d967860c8461altgaw.png

FEVR

5d96787a03dd2altfevr.png


And just for completeness, here is what CAKE looked like before its untimely demise. I don't know whether the particular Z score behaviour here is suspicious or not though. But in any case the stock did not have particularly high momentum during the 2016-2018 period so it doesn't meet the screening criteria.

CAKE

5d967936f214aaltcake.png


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Howard Adams 4th Oct 26 of 30
1

In reply to post #518846

Hi Nick

That's an interesting list and associated metrics (post #22), thank you.

Are your statistics derived from the market in 2019, or does your research go further back in time?

Edit: Oopps just seen your later post. That answers my question many thanks.

Regards
Howard

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Gromley 4th Oct 27 of 30
1

In reply to post #518891

Interesting mix of candidates there Nick. I think I can immediately see a potential cause of the anomaly.

Even today ImmuPharma (LON:IMM) has a reasonably good Z-Score of 11.2.

However when you look at what drives that 19.6 of the 11.2 is caused by the test "Does firm value compare favourably to its liabilities?" (Market Cap / Total liabilities)

IMM has a market cap of £17.6m and total liabilities of only £0.54m at the last balance sheet date. So that equals 32.6 weighted in the Z-Score at 0.6 => 19.6.

I understand (although maybe not accept) the logic of this test - How easy would it be for them issue new shares if they needed to cover all of their liabilities? At the very least it is having a disproportionate impact on the Z-Score (and much more so when the share price was 10x the current price). The rest of the Z-Score elements contribute negative 8.3 to the score.

Of course this does not explain why the very high z-score might be predictive of future price falls, but it does IMHO say that the very high Z-Score is dubious.

Z-Score is not a measure in which I have much faith in the first place, but for it to be capable of being so skewed is potentially problematic. To be fair the measure seeks to identify companies that may be at risk of bankruptcy not to implicitly comment on how great or not the rest of them are.

I can see that the fact of the share price being (too) high is obviously a risk factor, but the fact that it is high relative to total liabilities seems to me to be of less relevance and I'm not sure how it can be predictive.

Perhaps the giveaway might be if the contributions of the other 4 factors in the Z-Score are very low?

I guess I'm concluding that the effect you're seeing might just be co-incidental, although interested in thoughts to the contrary.

Anyway, just to get my regular drone in, with lots of IFRS16 liabilities heading towards balance sheets, the nature of this test will change

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Nick Ray 4th Oct 28 of 30
1

In reply to post #519021

However when you look at what drives that 19.6 of the 11.2 is caused by the test "Does firm value compare favourably to its liabilities?" (Market Cap / Total liabilities)

Yes - it is entirely driven by T4 (as I mentioned originally) and this goes for every case I have looked at where a stock has a very high Z score.

The Z score is not intended to be used like this of course. It consists of a calculation using a set of "magic" coefficients which were chosen by Altman using a linear regression - an early attempt at data mining really - and with the intent of separating stocks which will go bankrupt from those that will not. The cut-off for that is somewhere around 4;  so a long way away from stocks with values of 50 or 100 or even 1000 sometimes.

So the fact that these very high Z scores do seem to be a predictor of trouble for high-momentum stocks is entirely serendipitous and does seem to rely on the oddities of T4 by detecting stocks with very tiny liabilities.

I have a suspicion that tiny liabilities (relative to Market value) are working as a proxy for P/E and/or P/S somehow (i.e. insufficient business activity to justify price). For many of these stocks there is no P/E but the P/S is often very high (over 500). (Apart from a few stocks where P/S is large and negative (e.g. DDDD in 2016 had a P/S of -4000 and Z score of 270) which is a "trap" to be aware of when screening for low P/S. Negative P/S is a definite no-no.)

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Gromley 4th Oct 29 of 30

In reply to post #519036

Thanks Nick,

Sorry!  I had missed the fact that you had already diagnosed 'T4' as the reason for the anomaly. I did actually have a similar thought that is some strange way "total liabilities" might be an odd proxy for business scale, but mentally dismissed as being just too indirect.

It has been interesting to think about, but on reflection doing a detailed case study probably wouldn't be very helpful after all. I had hoped there might be something where I could examine how and why an extreme Z-Score indicated risk. In fact though I suspect you are right that it is mostly about businesses being valued at well beyond their historic "scale". Stocks that need extreme growth to justify their valuation being risky is hopefully not too profound a revelation.

Getting back to the reason you originally made the observation, it does seem that an extremely high Z-Score could be an indicator of a "false flag", which brings me back to your observations that Extremely high StockRanks are potential causes for concern.

I will ponder on that one elsewhere at some point as I think I have dragged WarrantStar's 'thread' a long way from its original purpose! (Sorry WS!)

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Epitychia Thu 2:02pm 30 of 30
1

Investing is for the long run, so you need to stay in long term. This means:

Do not over gear / borrow
You need a reasonable spread, e.g. 20 -30 shares
Focus on process over outcome
Focus on probabilities, even when you are right sometimes the market is wrong. Nothing is certain but if you have a wide enough portfolio then probability will eventually be rewarded

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