Guest Post by Contributing Editor, Kip Robbins, CFA, Zacks.com.
This week, I bumped into a friend who remembered my article based on seasonal investing in which I suggested to buy around Halloween and sell in May (see “Goblins, Ghouls and the Halloween Effect“). He reminded me that May is soon approaching, and asked me whether I still felt that way. After I published the article in the Fall, I purchased one of the stocks I’d recommended. Its price is up a modest 1% since then, has a 3.6% dividend yield, and lately I’ve been reading a lot of positive prose about the stock, so I’m a little uncertain if it’s really time to sell.
My friend also asked me what I was going to write about next and I mentioned I sort of feel like my Muse is quiet. Suggesting I write about something from my core, he reminded me of the line from Shakespeare’s King Lear, “Speak what we feel, not what we ought to say.”
So you might expect me to now say that this time is different. However, I don’t feel that way. I get the feeling the stock market is going to limp along this summer then pick up again around Election Day. However, even though the market as a whole might tread water, there will be stocks noticeably outperforming others and bucking the sideways trend. It’s time for a longer-term perspective and buying now would enable you to lock-in a low purchase price. Because of this, I’m going use the Research Wizard to show you how to pick stocks to hold for at least 6-12 months.
How to Look for Long-Term Winners
This is perfect timing because for the past couple of months, I’ve been conducting research on which indicators or characteristics of a stock, or a company’s financials are correlated to future stock returns. Some of that work has had a short-term focus while some has had a long-term focus. The long-term analysis is complete and I have identified a few profitable metrics. There’s a peppering of Value, Momentum and Growth in these ideas including Earnings-Before-Interest-Taxes-Depreciation-and-Amortization (EBITDA) to Enterprise Value (EV), 1- and 12-Week Price Changes, Zack’s Rank, and 1-Year Earnings Growth. What’s great about these is that they offer a nice set of diverse factors and are complementary to one another.
I conducted tests on each of these five variables from 2001-2011 wherein I measured the average six month returns for the stocks in the top 10% of each variable. So let’s take a peek at the results.
|Average 6-Month Return:|
|1-Week Price Change:||7.42%|
|12-Week Price Change:||7.35%|
|1-Year EPS Growth:||5.95%|
After running these individual tests, I compiled a composite model using each of these factors in combination, and tested them over a longer time frame from 2000-2011. The results of the combination showed a 14.1% average annual compounded return versus 0% for the S&P 500. That’s 14.1% on average for each year, which results in a total compounded return of 385%. That means $10,000 invested in the S&P at the start of 2000 would have delivered $10,000 at the end of 2011, while this strategy would have produced over $48,500 on the same investment.
Due to the diverse factor set, the strategy was also less risky compared to the S&P 500. The maximum draw down for the strategy was -37.3% compared to -40.4% for the S&P 500. Also, the average losing period was -13.5% for this strategy, compared to the S&P 500’s -17.0%. These results are all the more surprising because the strategy only held at most 10 stocks in the portfolio, compared to the 500 in the S&P 500.
Here’s how to find good stocks for the long run:
- First, start with only U.S. common stocks.
- Next, create a liquid, investible set of the stocks with the largest 3000 market values and average daily trading volume ≥ 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 = 1. (You want current high-ranking stocks.)
- Select 60 stocks with the highest EBITDA/EV ratio. (You want high earnings compared to Enterprise Value.)
- Next, pick the 30 stocks with the highest 12 week price change. (You want stocks with solid price momentum over the last 12 weeks.)
- Then, choose the 15 stocks with the lowest 1 week price change. (Research shows it’s best to buy stocks on a recent pull back.)
- Finally, select the 10 stocks with the highest 1Q change in 4Q EPS. (You should be looking for good earnings growth too.)
Find More Long-Term Stocks
So do you feel like you need a longer term approach in this current market environment? Would you like to explore your own ideas and thoughts about what makes a great stock? I’m confident you’ll discover a strategy that conforms to your style of investing with the Zacks Research Wizard. Search your feelings and see if you have what it takes to be a better stock picker.
I bet you do. You just need a tool that facilitates and cultivates your ideas.
- 3 Stock-Picking Strategies for 2012
- The Biggest Unknown in Financial Planning
- Beyond VIX: The Outlook for Market Risk
(Disclosure: The views and opinions expressed here are those of the author(s) and do not necessarily reflect the views of the Portfolioist. Zack’s is unaffiliated with FOLIOfn Investments, Inc. but does use its services.)
Folio Investing The brokerage with a better way. Securities products and services offered through FOLIOfn Investments, Inc. Member FINRA/SIPC.