By David Stevenson, 30 March 2010
Stock screens
As I survey the steady progress of the FTSE All Share index I have to admit to having mixed feelings. I find myself with current cash levels well below 10 per cent across the entire portfolio, which equates to over 90 per cent exposure to the markets. Those high equity levels have meant that I’ve participated in much of the recent rally and my portfolio is also making steady progress, albeit not quite at the same rate as the benchmark. That lag is because I’ve positioned my portfolio fairly defensively with heavy exposure to boring sectors like utilities which will tend to underperform super cyclical sectors.
But I can’t help but think that we’re all acting a bit like Wil E Coyote, the fictional cartoon character, constantly racing along in thin air unaware that he’s lunged off the cliff and is heading to his demise. Earnings momentum is not showing any signs of falling away rapidly and the US economy will pick up enthusiastically but I still can’t quite shake the feeling that this is all one longish bullish leg of a long bear market. This pessimistic world view can be summarised as follows – equities have had a dreadful decade and in 2008 they got totally pummelled. The 2009/ 2010 H1 rally is to be expected but it simply takes us back to the 2007 position yet most of the structural issues to do with global imbalances, debt levels and emerging resource restraints have not gone away. Add in the need to yank up taxes and you have the makings of a sharp reversal at some stage as risky equity assets over-reach themselves by bidding up prices beyond a sensible level. Cue another leg of the 10 year plus bear market…..
I freely admit that my portfolio doesn’t reflect this bearish scenario and I have to say that I think the markets will probably muddle along but my pessimistic side is beginning to push for heavier cash holdings. Ranged against this my investments are nevertheless proceeding to plan with only a few upsets – and there are more and more opportunities presenting themselves on a daily basis. My biggest losses so far have been in Russian closed end fund Aurora which is down a nasty 38 per cent - part of this is (justified) concern over Russia as well as a worry that Aurora will struggle to get its core private equity investments off its books and into trade buyers hands or IPOs on the local market. I think this pessimism is at odds with the reality on the ground which suggests that Aurora and its stable of financial services and consumer retail companies will have a successful 12 months as consumer spending picks up in Russia.
I’m also a little surprised that my investment in property developer Quintain has already taken a 10 per cent hit – this was always a risky recovery play on a highly geared operator that has had a terrible few years. The market is clearly discounting the management team’s ability to turn the company around and again I’m tempted to increase my holdings.
Intriguingly I also see plenty of new opportunities, especially in defensive stocks with decent valuations. In the Investors Chronicle we constantly reference a number of strategies designed to screen through the stock market using quantitative criteria to pick solid companies with a substantial margin of safety. A couple of weeks ago Simon Thompson checked on the progress of the classic Dogs of the Dow strategy but I’m more partial to a system devised by a Chicago accounting professor called Joseph Piotroski. His F score system aims to identify companies with strong balance sheets using a number of “points” – the aim is to get at least seven out of nine points to make the grade. I’ve put the scoring system in a box below to remind you of the measures used, but it's worth noting that the F Score system has been rigorously checked and double checked over the last decade, has been very successful, and is widely used by big fund managers and quantitative strategists as a robust stock selection system.
In particular Andrew Lapthorne at SG uses the Piotroski strategy but with a few additions – he also looks at debt levels (using a bond s analysis system called the Merton model) and dividends paid. He moulds these measures into his own ‘quality’ at a decent price screen and regularly publishes the latest candidates.
The F Score points system
1.One point is awarded for a positive return on assets- this is defined as net profits before exceptional items divided by the total assets of the firm
2.One point is awarded for a positive cash flow
3.One point is awarded for an improvement on return on assets over the last year
4.One point awarded for a company where cash flow from operations exceed net income. This should be the case as depreciation and non cash expenses normally reduce the net profits but have no impact on cashflow.
5.One point is awarded if the measure of financial leverage, ratio of total debt to total assets, declined in the past year
6.One point is also given if the current ratio (working assets or current assets divided by current liabilities) increased over the year
7.One point comes with companies that have not issued any new shares in the current financial year – firms that issue too much debt might be struggling to manage liquidity and running short of funds.
8.One point for an increase in gross margin
9.One point if asset turnover (total sales divided by total assets at the start of the financial year) has increased during the year
In the table below I’ve listed the UK list of stocks that currently pass the SG test – it’s an impressively defensive bunch of quality stocks, all of whom are churning out cash which is used to pay a generous dividend.
But this form of ‘stock screening’ is only meant to be suggestive – I’m not about to go out and buy these stocks en masse if only because you absolutely need to run your own due diligence process and investigate each stock in great detail. But I have to say that a portfolio with the likes of Cineworld, Halfords, Braemar, Astra Zeneca and Britvic looks pretty appealing to me at the moment with an average yield of over 5 per cent and average dividend cover of well over 2 plus rock solid balance sheets.
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