Last week, the Chicago Quantitative Alliance (CQA) held its
annual fall conference. As a member, I was able to attend this
interesting two-day event. The presentation I enjoyed the most was
a psychology-based talk centered around the reasons why we don't
perform our best and how to move toward optimal performance. It
reminded me of a book I recently finished titled
The Inner Game of Tennis.
It's one of those books that have applications that reach much
further than the title suggests. So it could have easily been
called
The Inner Game of Preparing for Surgery, Stock Investing or
Anything Else in Life.
The basic premise of these psychological performance themes is that
we tend to over-think what we're doing and would be better off
simply doing. That is, of course, doing only after we've spent
hours preparing or practicing to hone our game. Once you are
skilled at doing something, just do it. Don't over-think.
Over-analysis can cause paralysis. Certain thought processes during
analysis could also lead to confirmation bias. Studies have shown
that both over-analysis and confirmation bias do impede
performance.
While it's highly important to
do your due diligence on stocks
, I do believe too many investors buy into the story and become
emotionally tied or mentally committed to a stock. It's fairly
clear that one should sell if conditions change, and that's harder
to do if you're committed to a stock. You've got to be able to let
go of a stock that's struggling or avoid it to begin with if
something just isn't right.
People also make the mistake of forming initial viewpoints and then
only "see" things that confirm their first opinion and ignore items
that don't match that preliminary thought. This confirmation bias
affects us in all aspects of life, including stock investing. If
you bought a stock, you clearly have a favorable viewpoint and will
tend to ignore negative aspects that should be heeded.
Avoid Potential Mistakes
That's why I take pleasure in investing in quantitative strategies.
After I've built a strategy that I am confident has a good economic
rationale and superior performance, I follow it even if it tells me
to sell a stock that I'd rather hold onto. I remove emotion from
the process and allow the strategy to drive returns by indicating
when to buy and sell. I feel that's one thing that gives me an edge
in the market. I don't buy a "story" and am not committed to any
specific stock. I simply see them as interchangeable vehicles
useful for making money. I believe there are times when investors
miss out on profitable opportunities because they're tied to a
"story" stock whose price remains stagnant versus buying stocks
with true return potential. Remember, a good company is not always
a good investment.
Also, I don't mind if a strategy tells me to
short a well-known company
or buy a company I've never heard of before. So quantitative
strategies also help remove familiarity bias, which is when one
purchases only stocks he of she has heard of and avoids ones that
are unfamiliar. In fact, one of the things I like best about
quantitative strategies is that they often unearth unfamiliar
stocks. These little-known stocks might provide great opportunities
for profits because fewer eyes are watching them.
How To Just Do It
One of the easiest ways to implement a quantitative strategy is
though a screen. A screen is a great way to find stocks based on
indicators that matter. There is so much information available to
investors that it's best to focus your stock-picking on proven
ideas.
The
Zacks Research Wizard
allows one to shift through hundreds of different data items to
determine which are the most important, and then develop a screen
that will identify stocks that meet the desired criteria. Once the
screen has been tested to determine profitability, just save it and
run it as often as you like to generate your list of stocks.
Since the Research Wizard contains a number of pre-built
strategies, we'll take a look at Growth and Income Winners as an
example. Here's how that strategy compared to the S&P 500 on a
historical test from August 2002- August 2012:
Those results show that, over time, the strategy significantly
outperformed the S&P 500 over the last ten years. The
annualized rate of return for Growth & Income Winners was 15%
higher with a maximum loss of about half as much as the S&P
500. Now that's impressive!
Here's how to find Growth & Income Winners:
- First, create a liquid, investible set of the stocks whose
price is greater than $5
and
average daily trading volume greater than or equal to
100,000 shares
(if there's not enough liquidity, it'll be hard for you to
trade).
- Select only those stocks with a current
Zacks Rank
less than or equal to 3.
(You want stocks rated at least a buy or hold.)
- Select companies with an
ROE higher than the S&P 500 median.
(You want higher than average profitability.)
- Next, pick those stocks with a
P/E less than the S&P 500 median.
(You don't want to overpay for a stock.)
- Then, choose only those with a
Debt/Equity Ratio less than 1.
(Some debt is good. Too much is a problem.)
-
Beta should be less than or equal to 1.00.
(Low volatility stocks reduce risk.)
- Finally, select the
2 stocks in each sector with the highest Dividend
Yield.
(You should be looking for a good dividend as well.)
Here are five of the ten stocks that passed the screen this week
(9/21/12):
EC
- Ecopetrol S.A.
Ecopetrol, based in Bogota, Colombia, is an integrated oil company
that engages in the exploration, development and production of
crude oil and natural gas. This company has a better than average
valuation (P/E of 13), good profitability (ROE of 32%) and has a
5.9% dividend yield. Ecopetrol also has manageable debt levels
(Debt/Equity of 20%) and a low volatility in its stock price.
AZN
- AstraZeneca PLC
AstraZeneca engages in the discovery, development and
commercialization of prescription medicines for gastrointestinal,
cardiovascular, neuroscience, respiratory, inflammation, oncology
and infectious diseases worldwide. This company, which is one of
the top pharmaceutical companies in the world, has a very
attractive valuation based on a P/E of 7. This company also has
good profitability measures and a lower than average debt level.
The dividend yield of 6.1% is also very appealing.
RAI
- Reynolds American Inc.
Reynolds American, through its subsidiaries, manufactures and sells
cigarette and other tobacco products in the United States. This
company has a mildly attractive valuation, but is highly stable and
profitable and offers a nice dividend for the price. What I also
like about this company is that they beat earnings expectations in
the most recent quarter, which leads to its Buy rating on the Zacks
Rank.
RNF
- Rentech Nitrogen Partners, L.P.
Rentech engages in the production of natural gas-based nitrogen
fertilizer and industrial products for agricultural uses. This
highly profitable company, which is one you've probably never heard
of, pays a nice dividend and its stock price is up 124% YTD. Even
considering the price appreciation, its P/E is still below the
S&P 500's. Earnings projections for the company have been
revised upward many times, leading to its Zacks Rank #1 rating.
HRB
- H&R Block, Inc.
H&R Block, through its subsidiaries, engages in the provision
of tax preparation and related services to the general public in
the United States. It's interesting that this stock passed the
screen this week because it was mentioned at the CQA conference as
a stock that would perform better with a Democrat in the Oval
Office. H&R Block's valuation is just a little better than
average, but has a strong ROE (38%), high dividend yield (4.8%) and
low debt. It has also seen earnings projections for the next couple
of years improve--perhaps in anticipation of an incumbent victory
in November.
Buy Results, Not a Story
Since not all analysis is good, you obviously need to focus on
avoiding the bad analysis and concentrate on the good. One of the
easiest ways to do that is to implement a quantitative screen. Once
you have developed a screen that works; follow it! It's good to
confirm the numbers and ensure everything makes sense, but don't
over-think the picks and get committed to a specific stock. Get
committed to the strategy and the complete portfolio!
The strategy highlighted in this article picks stocks that have low
volatility and pay a high dividend. These are also perfect stocks
for a retracting market because there's usually a flight to quality
and stability when the market's having an identity crisis. Want to
see other picks in the same genre? Or perhaps you have other ideas
on how to pick winning stocks? No problem. The
Zacks Research Wizard
can be used to develop a screen to uncover outperforming stocks for
any investing style.
Starting today, you are invited to use it free of charge. You'll
have 14 days to create, tweak and backtest your strategies. At the
same time, you can see the latest picks from pre-loaded winning
strategies with average gains of up to +67.4% per year.
Learn more about your
Research Wizard
free trial >>
Let's make some money!
Kip
Kip Robbins is a Quantitative Analyst with Zacks.com. He
analyzes screens and strategies for Zacks customers and for use in
Zacks Research Wizard
, which empowers individual investors to use market-beating
screens, build their own and backtest their results.
ASTRAZENECA PLC (AZN): Free Stock Analysis
Report
ECOPETROL- ADR (EC): Free Stock Analysis Report
BLOCK H & R (HRB): Free Stock Analysis
Report
REYNOLDS AMER (RAI): Free Stock Analysis Report
RENTECH NITROGN (RNF): Free Stock Analysis
Report
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