The New Year is both a time for reflection and for looking ahead. Reflection on the highs and lows of the previous year; those stocks that performed beyond your wildest dreams and those that let you down. It’s a time to note down any lessons learnt and to resolve to apply them in future. In my case, all too often it is to become a better 'cutter' of losing positions. By better, I mean quicker.
On looking ahead to what the year has in store, there are plenty of publications predicting what might happen on the political front and to the economy. For private investors, studying the ‘Tips of the Year’ can be both entertaining and provide some food for thought. Private investors can join in the fun with many competitions for them to enter their winning stocks for the year ahead – one of the most popular is the UK Stock Challenge www.stockchallenge.co.uk but more on that later.
As a full-time private investor, I acquire my information from a number of sources. I read a lot including this website, I attend company seminars such as those arranged by ShareSoc (www.sharesoc.org ) and Equity Development (www.equitydevelopment.co.uk ) and I attend larger investment events such as those organised by Mello Events (www.melloevents.com), the next one scheduled for mid-May. In addition, I subscribe to two providers of data and analysis, ShareScope and Stockopedia. I have used ShareScope for many years to manage my portfolios and, among other things, for its excellent charting. I first came across Stockopedia in 2012 and find it extremely useful for generating new ideas and for doing further research.
One of the features of Stockopedia that I particularly like is its StockRank system. Its approach is inspired by James O’Shaughnessy’s book What works on Wall Street. It calculates value, quality and momentum ranks for stocks based on a number of factors that have been proved to have the greatest bearing on future stock market returns. For example, factors included in the value score include price to book, price to earnings, price to free cash flow, dividend yield and price to sales. Quality includes measures aimed at assessing whether it is a good company, an improving company and a safe company, such as return on capital, margin stability, sales growth consistency and net debt to assets.
The overall stock rank is an equally weighted combination of the quality, value and momentum scores. For the remainder of this piece I will be ignoring momentum and focusing on quality and value. Stockopedia’s research shows that, over time, they are the two most important variables when it comes to predicting future performance.
Stockopedia can demonstrate that stocks with the highest combined quality and value scores significantly outperform those with the lowest. The bar chart below separates UK stocks into five baskets, each containing a fifth of the stocks in the universe. The column on the right comprises the 20 per cent with the lowest combined quality/value scores, and the one on the right the highest. The annualised returns since April 2013 (when Stockopedia launched its rankings) shows that cheap high-quality stocks, on average, do better than expensive low-quality ones. The lowest quality/value basket, 'expensive, junk', has achieved an annualised return of -8.2 per cent, while at the other extreme the 'good, cheap' basket has produced an annualised return of +9.2 per cent. The portfolio is rebalanced annually. Over the same period the FTSE All-Share has achieved an annualised return of just +2.3 per cent.
This second chart shows the cumulative performance of the five quality + value quintiles
This prompted me to explore if any lessons could be gleaned from the UK Stock Challenge. The administrators run monthly competitions, but for this exercise I focused on the annual contest. Each entrant enters five stocks which are put into an equally weighted portfolio, 20 per cent each. It uses bid to offer pricing, which is closer to real life dealing than using the mid-price. Larger-cap stocks usually suffer less bid/offer spread loss but don't have the potential gains of smaller caps, so this adds to the stockpicking challenge. It also takes account of dividends and corporate adjustments which can be significant. It has 412 entrants in the 2019 competition. On the website one can, helpfully, rank all the stocks entered by popularity. The most popular, entered 58 times, is Hurricane Energy, followed by RockRose Energy, (38 times) and Burford Capital, (29 times). I thought it might be instructive to see where the most popular stocks stood on Stockopedia’s quality/value rank spectrum.
The scatter chart below shows the 96 stocks that were entered six times or more.
With just a quick glance one can see there are many more stocks in the bottom left red area, (40 in or on the line) than the top right, (12 in or on the line). There are a number of conclusions that one could come to. First, that private investors are easily suckered into get-rich-quick stories – blue-sky companies that aren’t making money yet but it is hoped will soon, and lots of it. Examples might be mining stocks drilling for gold, oil companies with a sure-fire exploration well, a biotech company with a drug that, if successful, will cure cancer, or a technology company that has a new battery technology that will replace all before it.
Sometimes these come off, but more often than not, they end in disappointment. I have been guilty of investing in some of these types of stock where the excitement of the upside was too much to resist: Clyde Petroleum in 2012 with its Namibia drilling programme, Fox Marble in 2013 with its marble quarry in Kosovo, and Flow Group in 2015 with its revolutionary combined heat and power boiler. The promised millions evaded me, losing money in all of them. The only comfort is that they were small positions and did not dent my overall performance too much.
A criticism might be that looking at baskets of stocks gives an average result and that there will be stocks in the top right that do not perform well, while not all the stocks in the bottom left are doomed to failure. There will be stocks where positive transformation is occurring which is not apparent in the historical figures, which could easily lead to a quality/value score that is too low. That is almost certainly true but to pick the right ones you either have to be a tremendous stockpicker or else lucky.
The main reason I plotted the chart was to see which stocks were the most popular with my fellow private investors and which I should take a closer look at. The stocks in the green area are: Somero, IG, Plus 500, easyJet, Taptica, Superdry, Scientific Digital Imaging, Amerisur, Kaz Minerals, Anglo Asian Mining, Centamin and H&T. I hold a couple of those and perhaps should take a look at the others. Of the 96 stocks in total, I currently hold nine, three of which I have bought this month. More on those in next month's Private Investor’s Diary.
Another conclusion might be that to win a stock competition like this, you have got to shoot the lights out – ie, pick the stocks that go ‘from zero to hero’. I think there is some validity to that argument as I doubt most private investors would hold just five stocks.
Looking at last year’s results, the top three contestants held 14 different stocks between them. The top three positives, with Stockopedia’s QV scores at the start of the year, were Regal Petroleum (+661 per cent, QV score of 86), Tern (+445 per cent, QV score of 73) and Sopheon (+240 per cent, QV score of 90). The three biggest fallers were Physiomics (-56 per cent, QV score of 4), Vast Resources (-47 per cent, QV score of 27), Hardide (-33 per cent, QV score of 22). It’s pretty clear to me the big successes all had decent QV scores and conversely the losers had low scores.
Last year’s winner, up 131.6 per cent, was 'Share Money', with his five-stock portfolio of Regal, Serica, Parkmead, Seeing Machines and Vast Resources. A result that anyone would be happy with! 'Share Money' first entered the competition four years ago and has an impressive record; first out of 516 entrants last year, ninth out of 312 in 2017, third out of 283 in 2016 and in 2015, 40th out of 260, with a return of +19.0 per cent. Compounding his returns over the four years would have quadrupled your money.
Using an average annual participation rate of 350, the chances of being in the Top 10 three out of the four times is, I believe, one in 11,000; perhaps more than just luck! He describes his approach: “My focus is on commodity stocks that are aligned with shareholders, have low-cost production and limited debt, focusing on free cash flow, increasing production and a strategy to deliver near-term growth.” He clearly does his homework and given his approach, it’s not surprising that his entries this year are RockRose Energy (QV 30), Kaz Minerals (81), Ophir Energy (37), Newmark Security (58) and JKX Oil & Gas (58). Food for thought.
One should never blindly follow anyone else’s strategy, though, and should do one’s own research before buying a stock. Only an individual can know their risk appetite and how any position fits into the overall risk profile of their portfolio. It is essential that a private investor accepts that they ‘own’ their investment decisions. In that context, stock tips can throw up ideas for further research using the likes of this magazine and its website, ShareScope or Stockopedia, and where better to start than some of the stocks mentioned above.
