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Issue No. 50 – October 31, 2005 Prescott, Arizona Systems@WiserTrader.com
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1.0 Trading
This week looks at the effectiveness of a stock filter based on year ago value metrics consisting of price to earnings ratio (PE), price to book ratio (PB), price to sales ratio (PS), return on equity (ROE) and price to free cash flow (P-FCF).
1.1 Value Filter
A filter based on a recent study of five stock valuation metrics is given in Table 1. Column 2 provides year ago values that had the lowest probability of loss over the past year. Column three contains year ago values that had the highest probability of a 25% or greater price gain. The last column contains values used in the filter with emphasis on minimizing losses.
Table 1
A Value Stock Filter to Minimize the Probability of Loss
|
Year Ago Metric |
Value for Minimum Risk of Loss |
Value for Likelihood of 25% or Greater Gain |
Value Used in Filter |
|
Price to Earnings (PE) |
<10 |
< 10 |
< 10 |
|
Price to Book (PB) |
< 1 |
< 1 |
< 1 |
|
Price to Sales (PS) |
< 0.5 |
< 0.5 |
< 0.5 |
|
Return on Equity (ROE) |
10 to 20 |
50 to 100 |
10 to 20 |
|
Price to Free Cash Flow (P-FCF) |
< 5 |
< 5 |
< 5 |
The filter sharply reduced the number of stocks from about 2,000 down to four. Year ago stock prices ranged from $12 to $54. The resulting average gain over the past year was 22%. The maximum gain was 33% and the minimum gain was 7%. There was never a draw down and the maximum decline for any single stock was less than 3% for a one month period. For this group of stocks, using or not using a stop loss would have resulted in identical results. Details on each of the 5 value metric studies can be found in recent newsletters beginning with the 9/12/05 issue.
© 2005 Desert Mountain Systems, LLC. Members of wisertrader.com are neither licensed brokers nor licensed advisors. Trades discussed represent recommendations made by the editor for the wisertrader.com portfolio. The newsletter and web site are for information only and should not be considered as personal advice. While it is believed that the posted information is factual, mistakes can be made in transcription. Investors should trade stocks only after verifying all information and consulting with a licensed broker or adviser. Desert Mountain Systems markets third party trading systems but has no other affiliation with trading system companies.
2.0 Market Analysis
Choppiness continues as investors switch between concerns over inflation, relatively good earnings reports and the occasional earnings warnings that appear to be consistent with historical norms. About 70% of S&P500 companies have reported that earnings are likely to reflect a 15% gain over the same quarter last year. However, higher 10 year bond yields reduce the relative value of stocks and are a major reason stocks have been flat this year despite good profit growth and GDP values above the long-term trend of 3.1%.
Key industry ETF’s in Table 2A are Biotech and Semiconductors which confirm the NASDAQ. Transportation confirms the Dow Jones Industrial Average according to Dow Theory. Banking and Financials are confirming indicators for the S&P 500. Gold and Real Estate are respective indicators for the inverse health of the currency and the capacity for consumer spending.
Table 2A
Index Tracking Stocks, Key Industry ETF’s and Sector SPDR’s
|
|
1 month |
1 wk ago |
2 wks ago |
3 wks ago |
4 wks ago |
|
DIA (DOW) |
-1.8% |
1.7% |
-0.7% |
-0.1% |
-2.6% |
|
QQQQ (NASDAQ 100) |
-2.9% |
-0.6% |
1.3% |
-0.7% |
-2.8% |
|
SPY (S&P 500) |
-2.6% |
1.4% |
-0.5% |
-0.8% |
-2.8% |
|
IWM (Russell 2000) |
-5.0% |
0.1% |
0.2% |
-1.9% |
-3.4% |
|
GLD, GOLD |
1.1% |
1.5% |
-0.6% |
-1.2% |
1.4% |
|
RKH, Banking |
4.2% |
2.6% |
2.0% |
0.4% |
-0.9% |
|
IYT, Transportation |
0.4% |
3.0% |
-0.3% |
-0.8% |
-1.5% |
|
SMH, Semiconductors |
-9.8% |
-4.1% |
0.8% |
-2.8% |
-4.0% |
|
BBH, Biotechnology |
-0.5% |
2.6% |
-0.8% |
1.2% |
-3.5% |
|
IYR, Real Estate |
-3.5% |
2.5% |
-0.1% |
-1.3% |
-4.4% |
|
OIH, Oil |
-6.2% |
6.5% |
-2.5% |
-1.8% |
-8.0% |
|
XLE, Energy |
-10.1% |
4.9% |
-4.8% |
-2.4% |
-7.7% |
|
XLU, Utilities |
-7.6% |
2.3% |
-1.7% |
-4.4% |
-4.0% |
|
XLB, Materials |
-0.1% |
3.6% |
0.8% |
-1.0% |
-3.3% |
|
XLI, Industrial |
-1.7% |
1.2% |
-1.1% |
-0.6% |
-1.2% |
|
XLK, Technology |
-3.3% |
0.2% |
0.8% |
-1.0% |
-3.3% |
|
XLV, Healthcare |
-3.5% |
0.1% |
-1.9% |
0.2% |
-1.9% |
|
XLF, Financials |
2.7% |
3.2% |
1.0% |
-0.2% |
-1.3% |
|
XLP, Consumer Staples |
-0.9% |
0.9% |
0.5% |
-0.4% |
-1.9% |
|
XLY, Consumer Discretionary |
-3.6% |
0.1% |
-0.4% |
-1.0% |
-2.4% |
