Stock screen 2019 review: Brexit bonanza!

During the past 12 months, my Top Five Best of British stock screen has beaten all of the other strategies I monitor by a considerable margin. The screen has delivered a 55 per cent total return compared with 8.6 per cent from the FTSE All-Share Index. A truly storming run that follows a number of dismal years. 

The year that was

Buying British can hardly be defined as an investment style, but buying quality shares can – the Best of British screen tries to identify quality business that generate three-quarters of sales from the UK. While there has recently been much talk about a resurgence in the 'value' investment style, it is my 'quality' focused screens that have produced most outperformance during the 12 months. Collectively, my 'growth' focused screens have come second with 'value' taking third and last place.

Overall, it has been a very strong period for the screens (the timing of this piece means the 12 months under review runs to 5 December rather than the 2019 calendar year). Exactly three-quarters of the screens have outperformed the indices that stocks were selected from. The average screen has delivered a 16.8 per cent total return over the last year compared with 7.3 per cent from the average index. Meanwhile, average index outperformance stands at a beefy 8.9 per cent. 

Long-term thinking

I continue to be rather staggered by the strength of the long-term returns from the screens. On an annualised basis, the average screen has delivered a 13.1 per cent total return during its life compared with 6.7 per cent from relevant indices. The average life of the screens stands at 7.2 years while average annual outperformance comes in at 6.1 per cent.  

Returns since inception

While these performance numbers are impressive, it’s worth pointing out that stock screens should definitely not be regarded as some kind of silver bullet. For one thing, it is worth bearing in mind that the performance of the screens reviewed relates exclusively to a very long bull market. Also, many years have been less impressive than 2019 and many of the individual stocks highlighted every year prove very disappointing. Frequent single-stock disappointments are an inevitability with investing, but especially so with screens. This is because the relatively simple criteria needed to create a screen that produces a decent number of results lacks the nuance to provide a rounded judgement. For this reason, the screens monitored in the column should generally be regarded as a source of ideas for further research rather than off-the-shelf portfolios (a couple of the guru screens followed are actually designed to produce portfolios). 

Lessons from 2019

Over the last year, I’ve tried to give over more space to analysis of individual companies. This reflects a desire to put more focus on the stock-specific considerations that screens can miss. There are three 2019 screens that come to mind that illustrate why further research is such a good idea. 

One case in point was the 2019 picks from my Great Expectations screen, which focuses on broker upgrades and share price momentum. The screen has become one of my personal favourites over the eight years I’ve followed it – subscribers to our Alpha service get monthly updates from the screen. The screen has had a very good 12 months, having identified two particularly strong performing stocks (Spirent and JD Sports) from the seven highlighted. However, at the time I ran the screen, two of the shares highlighted were among the 10 most shorted on the market. One of these, Anglo American, has actually performed well to date, generating a 21 per cent total return, but the other, Plus500, has bombed, with a negative 43 per cent return. Simply excluding these two heavily-shorted shares based on the red flag provided by the short interest would have lifted the screen’s 12-month total return from an already impressive 22.1 per cent to 34.7 per cent.

My Contrarian Value screen often finds itself flirting with value traps, so looking for red flags in the stocks it selects is a very good idea. From a contrarian perspective, former stock market darling Ted Baker (TED) looked like an interesting pick by this year’s screen when I ran it in late July. Factors in favour of the fashion retailer include its relatively limited exposure to fixed shop rents, a strong brand, and its historical record for growth and margins. However, the thing that really stood out when delving deeper into Ted’s accounts was its “astronomical” stock levels compared with sales. Worse still, this ratio had been rising for several years, racing up from an acceptable 20 per cent to 37 per cent. This is a classic red flag; especially for a retailer experiencing trading problems. 

The screen itself does not dig down into this level of financial analysis, though. Ted is currently contributing a 54 per cent negative return to the screen’s Contrarian Top Five selection. The share price drop reflects news of an investigation into overstated stock values as well as ongoing trading difficulties and suspension of the dividend. The Contrarian Top Five shares are still managing to beat a negative 1.5 per cent from the FTSE All-Share, with a 4.2 per cent average return, but Ted has significantly dampened an average 19 per cent return from the other four picks.

All these issues were clear to see at the time the screens highlighted the shares, and were mentioned in my write-ups. Subsequent events help illustrate why screens are best used to guide the research process rather than as an end in themselves. That said, screens can play an immensely valuable role in an investment process, which is reflected in the raw performance numbers. 

A welcome change

As well as research, another way to add value to screens is by selectively changing criteria. I try to avoid tinkering with the screens unless I see a really good reason to. In the coming year, the High Quality Small Cap screen that highlighted Character could be a case in point given the benefit derived from recent changes I made to its sister screen: the High Quality Large Cap screen. 

The change in question was to move from looking for cheap, quality, large-cap shares (a strategy that worked well in earlier years of the bull market despite being somewhat counterintuitive) to looking for reassuringly expensive quality shares. My review of High Quality Large Cap screen during the year looked at two portfolios of 'high quality' shares selected in 2018. One portfolio was based on the old criteria (in my opinion a criteria that has become defective) and the other portfolio was based on the new reassuringly expensive criteria. The new criteria won a decisive victory, delivering a 24 per cent total return compared with 2.4 per cent form the old criteria and 3.0 per cent from the FTSE All-Share. More importantly, the shares selected using the new criteria generally fit the 'quality' billing were as the old criteria continues to tend towards low-quality cyclicals.  

The change to the High Quality Large Cap screen was made in 2018, but a big screen criteria overhaul I made during 2019 was to my Free Cash Flow Kings screen. Using free cash flow (FCF) to assess valuation and performance has many theoretical advantages. Sadly, results from my screen focused on FCF have been poor since I began monitoring it in autumn 2013. However, since making some substantial changes in early September, the stocks selected are producing impressive returns, with the overall total return currently standing at 11.0 per cent compared with 1.1 per cent from the FTSE All-Share. It is far too early to say whether the changes really are well founded, but so far so good.

Hands down the most impressive change to a screen that I’ve made while writing this column was on someone else’s advice: the late, great Jim Slater. He wrote to me in 2015 to suggest I was getting things wrong with my screen based on the approach he set out in his classic investment book, The Zulu Principle. While I was attempting to bulk up the screen’s output by loosening its quality criteria while sticking rigidly to its value criteria, he said any easing of the screen’s criteria should be done quite the other way around; loosening the value criteria and doubling down on quality. Naturally, I put his advice into effect the next time I had the chance. Since then the screen’s performance has been truly phenomenal. In the last year the screen has managed a 22 per cent total return compared with 3.9 from a 50:50 split between the FTSE Small Cap and Aim indices. Had I been as wise as Mr Slater from the outset (one can but dream!), this screen could well be the best performing of all those that I monitor on an annualised basis.