|
|
|
|
Staying Cool On The Hot Trends; A Disciplined Approach To Investment Success
oo many investors chase the strategy du jour, or the stock of the month, or the mutual fund of the quarter. Instead, they should care less! Investors should develop a disciplined approach with a constant philosophy that they implement over the long term.
That is difficult to do. Investors are barraged with market and economic information as well as a plethora of investment strategies. Yet most of this information relies upon anecdotal evidence or market research with rather short term time horizons. Few compelling studies exist.
With those shortcomings in mind, I recently read and examined the findings contained in What Works on Wall Street, by James O'Shaughnessy (1996). My opinion? The book earns this praise given by Barron's: "O'Shaughnessy's conclusion that some strategies do produce consistently strong results while others underperform could shake up the investment business".
The key to O'Shaughnessy's research is that, for the first time, Standard & Poors agreed to release its entire database to an outside researcher. The database, known as Compustat, is preeminent; it is the largest, most comprehensive database available, containing data since 1951. No less important, the computer allows one to dissect that data.
The specific findings include:
Buying Wall Street's current darlings with the highest price-to-earnings ratios is one of the worse investment strategies
Most small capitalization strategies owe their superior returns to micro-cap stocks with market capitalization below $25 million,
which means that these stocks are too small for virtually any investor to buy
You can do four times as well as the S&P 500 by concentrating on large, well known stocks with high dividend yields
Relative strength in price is the only growth variable that consistently beats the market
Using several factors dramatically improves long term performance
Particularly impressive are four strategies that Advocate Capital Management, Inc. may recommend to its clients. These strategies are:
Value 1: purchase stocks from the "All Stocks" universe with price-to-sales ratio less than 1 and with best 1 year relative strength
Value 2: purchase stocks from "All Stocks" universe with price-to-book ratio less than 1 and with best 1 year relative strength
Value 3: purchase stocks from "All Stocks" universe with price-to-earnings ratio less than 20 and with best 1 year relative strength
Growth 1: purchase stocks from "All Stocks" universe with return-on-equity greater than 15% and with best 1 year relative strength
Why are these four strategies so impressive? Consider a $10,000 investment in the S&P 500 on December 31, 1951. 43 years later, your investment is worth a handsome $1,027,828! Similarly, a $10,000 investment in the "All Stocks" universe (which are all companies with market capitalization of $150 million, adjusted for inflation) would be worth $1,782,174 in 1994!
Notably, the S&P 500 strategy and the All Stocks strategy carry Sharpe risk adjusted return ratios of 44 and 47, respectively (the higher the number, the better, as that shows better performance for each unit of risk assumed).
Before you rush to buy an S&P 500 index fund or a broader market index fund such as the Russell 2000, now consider the spectacular performance of the above four strategies:
Value 1: $10,000 becomes $14,149,980
Value 2: $10,000 becomes $10,645,437
Value 3: $10,000 becomes $8,613,730
Growth 1: $10,000 becomes $9,355, 638
Moreover, the Sharpe risk adjusted return ratios for the four strategies also are superior: 62, 61, 55 and 55, respectively.
Should you invest this way to gain such spectacular returns? Investors must consider three factors. First, identifying the stocks that qualify for the Value 1, Value 2, Value 3 and Growth 1 strategies is not easy. As a result, you must consult investment professionals. At Advocate Capital Management, Inc., we can identify the qualifying stocks on a daily basis through computer database screening.
Second, these strategies work best for long term holding periods given short term performance fluctuation. We recommend 5 to 10 year holds because 43 years of performance data reveals the following:
Value 1 Beats All Stock Universe:
77% of the 43 years based upon single year returns;
100% of the 43 years based upon rolling 5 year returns; and
100% of the 43 years based upon rolling 10 year returns.
Value 2 Beats All Stock Universe:
72% of the 43 years based upon single year returns;
87% of the 43 years based upon rolling 5 year returns; and
97% of the 43 years based upon rolling 10 year returns.
Value 3 Beats All Stock Universe:
65% of the 43 years based upon single year returns;
85% of the 43 years based upon rolling 5 year returns; and
91% of the 43 years based upon rolling 10 year returns.
Growth 1 Beats All Stock Universe:
63% of the 43 years based upon single year returns;
85% of the 43 years based upon rolling 5 year returns; and
100% of the 43 years based upon rolling 10 year returns.
Third, investors must be able to invest no less than $100,000 in the strategy, and preferably more, in order to obtain proper diversification. O'Shaughnessy used portfolios of 50 stocks, though he notes that researchers J. L. Evans and S. H. Archer found that most of the benefits of diversification accrue with from as few as 16 stocks, and that subsequent research confirms that finding.
Overall, we recommend that investors consider Value 1, Value 2, Value 3 and Growth 1 as part of their disciplined investment approach with a constant philosophy that they implement over the long term.
|
Sponsored by James J. Eccleston. This Web site contains material of general interest. It is neither intended to, nor constitutes, either legal advice or investment advice.
Always consult an attorney and/or investment adviser when building and protecting your wealth.
All content Copyright © 2010 Advocate Compliance Partners, Inc. except where noted. All rights reserved.
One North Franklin Street, Suite 2620, Chicago, IL 60606
Telephone 312-332-0000 | Fax 312-332-0003
|
|
|
|
|
