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High-yielding market leaders

Sometimes it can be worth giving up a bit of performance for a smoother ride, and the reason why is all in your head… something the original Cornerstone Value screen has a solution for
March 12, 2019

While this column covers screens primarily to highlight ideas worthy of further research, some investors use screens as an end in themselves. Indeed, last week’s screen and the one in this week’s column were designed by top investors as ways to come up with fully investable, off-the-shelf stock portfolios. What’s more, there is a large and fast-growing industry that adopts this fully automated approach to stockpicking and portfolio construction. Such fund managers go by a number of names, including 'smart beta', 'factor' or 'quant' investors.

The stock screen-based strategies these fund managers follow are usually the product of huge amounts of back-testing using historical data. One of the first people to champion this approach was Jim O’Shaughnessy, whose classic Cornerstone Value screen I’m revisiting this week.

Mr O’Shaughnessy’s progressive thinking was not confined to data analysis. The original edition of his seminal book, What Works on Wall Street, also paid a lot of attention to the field of behavioural finance and the Cornerstone Value screen addresses one of the greatest 'behavioural' issues that can upend an individual’s returns from a sound screening strategy.

Rather than designing the Cornerstone Value screen for maximum outperformance of the market (the Cornerstone Growth screen I will review separately soon covers that ground) Mr O’Shaughnessy designed it to outperform without deviating from the index too much. In doing so, Mr O’Shaughnessy acknowledged one of the key impediments to investors looking to back a screening strategy wholesale.

The problem with the performance of screens is that, even if the long-term results are good, over any given year they can be expected to underperform the market and sometimes by a drastic amount. For an investor with a long-term time horizon, it is easy to argue that short-term volatility should not really make much difference, but that is only true in a theoretical world that does not take account of real-world human behaviour.

The trouble is, regardless of the strength of historical evidence that exists about a strategy, underperformance has massive psychological impact because we all have a tendency to put excessive weight on recent events (so-called recency bias) and have far greater sensitivity to losses than gains (about double). These widely observed behavioural influences are compounded by the fact that no one can be entirely sure that what worked for investors in the past will work for investors in the future.

Sadly, fears about strategies having shelf-lives cannot be dismissed as mere behavioural quirks, despite our propensity to think irrationally on such subjects. For example, a recent study into factor momentum, titled 'Factor Momentum Everywhere' by AQR researchers Tarun Gupta and Bryan Kelly, found that of 65 historically identified factors tested, 25 showed performance relative to the market that was statistically indistinguishable from zero, while three had negative returns. In other words, from the time the factors were originally identified to the time Mr Gupta and Mr Kelly carried out their assessment, many had seemingly conked out. More reassuringly, the best-known factors examined, such as value and momentum, continued to pack a punch.

All of this means it is extremely easy for investors to give up on screening strategies when the going gets tough. While this could sometimes be justified, often it will be a case of jumping ship at precisely the wrong time. Indeed, the ample evidence that has emerged from the field of behavioural finance over the last half century suggests the brain is pretty much hardwired to tell us to run for the hills around points of maximum pessimism.

So viewed in the light of what we know of human behaviour, the risk of volatility is less about the ups and downs for investors that stay the course and more about the fact that ups and downs encourage investors not to stay the course – and bail out at precisely the wrong time. The focus on returns that are close to that of the market allows the Cornerstone Value screen to help investors cope with this psychological obstacle.

The version of the screen I run for this column has had to be anglicised (it focuses on only 25 stocks rather than the 50 stocks suggested by Mr O’Shaughnessy) and it is also based on the original version of the screen, which has since been updated. Mr O’Shaughnessy’s value focus switched to a value composite that takes account of a range of valuation factors. The original screen, though, has the advantage of being clear and straightforward and has performed pretty well since I began monitoring it in early 2011. That said, there was modest underperformance last year when the 25 shares put in a negative 0.7 per cent total return compared with a positive 2.2 per cent from the FTSE 350.

 

Last year's Cornerstone Value performance

NameTIDMTotal return (28 Feb 2018 - 8 Mar 2019)
PersimmonPSN66%
GlaxoSmithKlineGSK35%
Royal MailRMG29%
IG GroupIGG22%
PetrofacPFC21%
Aberdeen Asset ManagementADN20%
Marks & SpencerMKS17%
AstraZenecaAZN16%
SSESSE8.9%
PhoenixPHNX8.7%
InmarsatISAT0.7%
AdmiralADM0.2%
CentaminCEY-0.2%
Crest NicholsonCRST-1.2%
HSBCHSBA-3.9%
Amec Foster WheelerAMFW-5.0%
ITVITV-6.3%
StagecoachSGC-12%
CentricaCNA-26%
Barratt DevelopmentsBDEV-28%
Direct LineDLG-29%
CapitaCPI-31%
Greene KingGNK-34%
MitieMTO-34%
British LandBLND-52%
FTSE 350-2.2%
O'Shaughnessy Value--0.7%

Source: Thomson Datastream

 

Over the past eight years the screen has produced a total return of 99 per cent, compared with 66 per cent from the index. After taking the vital step of factoring in a 1 per cent annual charge for dealing costs, the total return drops back to 84 per cent. The annual returns from the screen compared with returns from the FTSE 350 can also be seen in the table below.

Year-by-year returns

Year to Feb/MarFTSE 350O'Shaughnessy ValueOut/under- performanceFTSE 350O'Shaughnessy ValueO'Shaughnessy Value with 1% charge
2011---100100100
2012-2.9%-5.0%-2.2%979594
201318%20%1.7%114114112
201412%20%6.7%128136132
20155.9%12%5.6%136152146
2016-9.2%-2.0%7.9%123149142
201726%36%8.5%155204192
20184.9%-1.3%-6.0%163201187
20192.2%-0.7%-2.9%166199184

Source: Thomson Datastream

 

The screen works by looking for the UK’s highest yielding market leaders. Due to the diminutive nature of the UK market compared with the US, the choice of companies that are big enough to qualify as market leaders is reduced, which is why my screen focuses on half the number of shares compared with the original screen highlighted by Mr O’Shaughnessy. This means my anglicised version of the screen can be expected to be more erratic in performance due to lower diversification, although it has tracked the market relatively faithfully. The following characteristics make a market leader (again I’ve had to anglicise some of Mr O’Shaughnessy’s specific criteria):

  • Market cap of at least £500m.
  • Greater than average number of shares outstanding.
  • Higher than average cash flow per share.
  • Turnover of more than 1.5 times average.

The 25 picks for 2019 along with some fundamental data can be found in the table below.

 

NameTIDMMkt CapPriceFwd NTM PEDYDiv CoverFwd EPS grth FY+1Fwd EPS grth FY+23-mth Fwd EPS upgrade/downgrade3-mth MomentumNet Cash/Debt (-)
EVRAZ plcLSE:EVR£8.4bn581p716%1.5-36%-9.6%10%19%-$3.5bn
Standard Life Aberdeen plcLSE:SLA£5.9bn241p1110%1.0-37%-8.9%-11%0.3%-£974m
Vodafone Group PlcLSE:VOD£37bn136p169.9%--20%18%-8.3%-16%-€32bn
Centrica plcLSE:CNA£7.0bn123p129.8%0.3-11%20%-23%-13%-£3.4bn
Royal Mail plcLSE:RMG£2.6bn257p109.5%0.4-41%-17%-5.3%-16%-£490m
Cineworld Group plcLSE:CINE£3.9bn286p138.8%9.020%17%0.6%5.4%-$3.7bn
Aviva plcLSE:AV.£16bn419p77.2%1.31.3%8.2%-2.9%8.6%£37bn
Imperial Brands PLCLSE:IMB£25bn2,637p97.1%0.84.9%4.2%1.4%12%-£11bn
WPP plcLSE:WPP£11bn867p96.9%1.4-8.5%3.3%-2.5%5.2%-£4.0bn
Marks and Spencer Group plcLSE:MKS£4.4bn270p116.9%0.1-11%-3.4%-3.1%-6.1%-£1.6bn
Man Group plcLSE:EMG£2.1bn138p116.7%1.415%27%-20%-2.7%$543m
HSBC Holdings plcLSE:HSBA£125bn624p116.4%1.43.3%4.2%-5.2%-3.2%$275bn
British American Tobacco p.l.c.LSE:BATS£65bn3,077p106.3%1.45.7%7.3%-0.7%15%-£45bn
Direct Line Insurance Group plcLSE:DLG£4.8bn352p126.0%1.6---0.1%14%£833m
BP p.l.c.LSE:BP.£109bn541p135.9%1.4-15%17%-16%3.5%-$43bn
Rio Tinto plcLSE:RIO£61bn4,145p105.6%2.55.7%-11%22%14%$625m
GlaxoSmithKline plcLSE:GSK£74bn1,509p145.3%0.9---3.3%5.3%-£22bn
Glencore PlcLSE:GLEN£42bn303p115.2%1.2-7.6%8.6%-20%5.4%-$33bn
British Land Company PlcLSE:BLND£5.7bn598p175.1%0.7-8.1%1.1%-2.0%6.6%-£2.8bn
International Consolidated Airlines Group, S.A.LSE:IAG£11bn554p65.0%5.0-3.0%11%1.3%-10%-€1.3bn
G4S plcLSE:GFS£3.2bn206p124.7%1.3-5.8%11%-2.0%7.5%-£1.6bn
BAE Systems plcLSE:BA.£15bn472p114.7%1.4---4.6%3.6%-£901m
BBA Aviation plcLSE:BBA£2.4bn235p144.7%1.0-5.6%16%-9.0%4.9%-$1.3bn
Barratt Developments PLCLSE:BDEV£6.1bn605p94.5%2.75.0%2.6%-30%£379m
J Sainsbury plcLSE:SBRY£5.0bn227p114.5%1.30.2%2.7%-1.0%-25%-£1.9bn

Source: S&P CapitalIQ