Wiser Trader Stock Advisory
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February 2006 Prescott, Arizona Systems@WiserTrader.com
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The approach to stock investing is different from that used earlier. The frequency of trading is reduced significantly to prevent excessive brokerage fees from consuming profits. The portfolio is reviewed once a month with the investment timeframe of several months to a year. The number of stocks held in the portfolio ranges from 8 to 20. Equal weight is given to all positions. The rate of adding stocks to the portfolio is about one per month so that by the end of 2006, the portfolio should contain about 19 or 20 stocks.
Stock Filters
Stocks are selected using value and growth-momentum filters. Each filter is used independently.
Value stocks are selected based on five valuation metrics that are defined in terms of two filter categories listed in Table 1. The absolute value category lists metrics for each stock. The industry relative category lists metric defined as ratios to their industry value. A stock must satisfy all five metric ranges in a single category in order to be selected. The two value stock selection filters look for NYSE, NASDAQ and AMEX stocks that are priced above $4. Since company information must be updated in a timely manner, and applicable to all five metrics in a category, the filter eliminates Advanced Depository Receipts, Over the Counter Stocks and Exchange Traded Funds, making about 2,000 stocks potentially eligible for the portfolio.
Table 1
Valuation Metrics
|
Valuation Metric |
Absolute Value |
Relative to Industry |
|
Price to Earnings (PE) |
(7) 10 to 15 |
0.5 to 0.75 (1) |
|
Price to Book (PB) |
< 1 |
0.5 to 0.75 (1) |
|
Price to Sales (PS) |
< 0.5 (1) |
0.5 to 0.75 (1) |
|
Return on Equity (ROE) |
10 to 20 |
2 to 3 |
|
Price to Free Cash Flow (P-FCF) |
< 5 (10) |
(0.5) 0.75 to 1 |
Values chosen in Table 1 are designed to minimize the probability of loss based on recent and ongoing studies of their effects on one-year price performance. Values currently listed in the table have resulted in gains of 24 to 31%. The S&P 500 gained about 8% over the same period, by comparison. Metric values change slightly as the character of the market changes. Periodically, usually once a quarter, the study is repeated to determine the best values to use based on the character of the markets over the past year.
Growth-momentum stocks are selected based on three filters described in Table 2. The Growth-15 and Growth 40 categories are slight modifications of Dr. Stephen Cooper’s stock candidate filter. The only difference between the two is the price range of stocks that are chosen.
The Growth-15 is used to select stocks priced from $15 to $40 while the Growth-40 is used to select stocks price above $40. Both are used to take long positions in up and sideways markets. The third filter is newly developed and is used to take short positions in sideways and down markets
Table 2
Growth-Momentum Metrics
|
Description |
Growth-15 |
Growth-40 |
Down-market |
|
Market & Position |
Up, Sideways - Long |
Up, Sideways - Long |
Down, Sideways - Short |
|
Price |
$15 to $40 |
> $40 |
> $30 |
|
12 month EPS growth |
> 80% |
> 80% |
< 20% |
|
Relative Strength |
26 wk > 90% |
26 wk > 90% |
26 wk < 20% |
|
Price within |
5% of 52wk high |
5% of 52wk high |
5% of 52 wk low |
|
Exchanges |
NASDAQ, NYSE |
NASDAQ, NYSE |
NASDAQ, NYSE |
Stocks selected by the growth-momentum filters may include ADR’s and ETF’s. Over the counter stocks are excluded.
Money Management
There are many approaches to money management. In one case, trailing stops are used with a maximum percentage of capital per trade to limit draw-downs to less than 1 or 2% of investment capital. This method of money management is needed when a trader does not have access to a well characterized trading system. Over the past year, it was found that any stop loss settings narrower than -35 to -40% would have reduced total profits. Hence, we are open-minded when it comes to stop loss settings and endeavor to continuously test the market in that regard. Currently, trailing stop loss settings are assigned to each stock individually based on the stock’s performance.
As for position sizing, we recommend an equal weighting for each position. For example, let us say there is $20,000 to invest over the course of the year. The model we use assumes that $1,000 is allocated to each position. If there were only eight stocks in the current portfolio, you would only have $8,000 invested. Interest bearing cash is a valid position, too. This keeps performance measurement and allocation simple and avoids excessive broker fees associated with having to reallocate to stay fully invested.