Achieving 16.7% Returns with the Value Score
The Quality Score produces 16.8% CAGR in the tests that I’ve performed for the upcoming “Action Score” that I’m implementing into Old School Value.
Next is the Value Score.
Here is the full table of results again.
- stocks are bought at the beginning of the year
- held for one year
- rebalanced after 1 year
- commissions and fees are not included into these results
If you followed this strategy, the 16.74% is the max return. After fees, it likely comes down to 13-14% range annualized.
Here’s How I Created the Value Score
When you create a ranking system (or even a screener) the higher the number of criteria, the worse the performance becomes.
When picking individual stocks, making sure a stock passes lots of checks is a good strategy because you allocate based on your conviction. However, when you try to employ any sort of quantitative strategy, it is not a good idea to list 20 different criteria that must be passed.
Of all the tests I’ve performed, a strategy with lots of checks consistently lose to the market by a wide margin.
I mention this because people ask me whether I’ve tried combining several of the best performing value screeners on display.
And the results are pathetic.
It severely handcuffs the number of stocks that pass and the screen ultimately fails.
When you pick stocks individually, you have to be precise and picky.
For anything quant based, it needs to be looser as you are buying a bunch.
As I mentioned in the Quality Score article, instead of blindly coming up with metrics for each Q, V and G, I already had a list of metrics for each methodology based on previous research papers and proven results.
Then the theory was tested and confirmed via backtesting.
In it’s purest form, the Value Score is based on the following 3 factors:
- P/FCF – best range is less than P/FCF of 10
- EV/EBIT – best range is less than 11
- P/B ratio – preference for P/B to be less than 3
Here’s the initial backtest to confirm the theory for a 20 stock holding portfolio.
Eliminating OTC stocks, financials, energy, mining or utilities and the results continue the outperformance.
Backtest works with the selected metrics.
It now comes down to how well the same idea can be applied when creating a ranked database.
To further clean up the results, additional weightings were applied to each of the above ratios. Then all the stocks are further ranked with the Piotroski score again to eliminate low quality stocks.
- P/FCF has the biggest impact on the results and receives the highest weighting
- EV/EBIT does a great job of identifying cheap stocks and receives the second highest weighting
- P/B acts as a “cleaning” filter to remove stocks where you overpay for assets. Also a way to remove bad stocks you wouldn’t want to own no matter how cheap it looks
- The Piotroski score is assigned a fairly high weighting so that the list removes “lotto” stocks and potential black swan stocks
The Value Score Rank Results
Even if I did follow this strategy, it’s not an easy one to follow. There is a LOT of volatility. If you can’t stomach big moves and have faith in the process, you are doomed.
If you focus too much on beating the market each year instead of an absolute long term return, you are doomed.
When buying and holding the top 20 ranked Value stocks each year for the entire universe of stocks, the scoring system achieves 16.74% CAGR.
If you start with $10k, you’d end up with $138k after 16.5 years.
Eliminate OTC, financials, miners, utilities and energy again and the results are shockingly great at 19.4% CAGR.
$10k becomes $203.6K after 16.5 years.
But what I don’t like about the Value Rank on its own is the lack of downside protection in 2008.
Cheap stocks and growth stocks get hammered the most during severe bear years. But a -40% return is a huge blow and a can easily shatter your faith in the system and process.
Something to think about.
Top 20 Value Stocks from 2015
Here is the list of top 20 stocks that make up the Value Score portfolio starting from Jan 1, 2015 so that you get a sense of what type of stocks the Value Rating is selecting.
When Will the OSV Ratings Be Officially Released?
This rating system along with a screener is being developed and the tentative release date is 2016 Q1 for existing members.
The idea is to have all current members grandfathered into their plan and be the first group to test the beta. The spreadsheet analyzer will continue to operate as usual, but you’ll also gain access to the online version when complete.
The free value stock screeners will remain available to everyone but the ratings will be only within the web app itself.
Next up is the Growth Score followed by the final Action Score.
No positions in any stocks mentioned.