The Austrian business cycle theory suggest that
investors buy stocks in the capital goods sector, or cyclical stocks, in the
early years of an expansion and switch to consumer goods makers in the later
years. Investors can do that easily with exchange traded funds (ETF) which
cluster stocks in a dizzying array of industries, commodities and countries.
For example, one of the better known tech stock ETFs is QQQ, which contains the
stocks of a lot of capital goods companies.
But as happens with any grouping of large numbers of
companies, most will be dogs. Only a few will be excellent companies whose
profits grow well and whose stock prices reflect that growth. Most of the
members of the ETF will act like an anchor on the value of the ETF. The only solution
is to buy individual stocks, but analyzing thousands of individual companies
takes more time than most part time investors enjoy.
Hundreds of web sites have sprung up to help investors by
providing expert analysis and promotion of individual companies. Most of the
investment advice on the web contains experts pontificating on the prospects of
individual companies. However, the experts get it wrong most of the time.
Bloomberg.com published a story in January titled “Almost All of Wall Street
Got 2012 Market Calls Wrong” in which the author wrote, “From John Paulson’s
call for a collapse in Europe to Morgan Stanley (MS)’s warning that U.S. stocks
would decline, Wall Street got little right in its prognosis for the year just
ended.”[1]
In other articles on the site, the authors suggested that investors would do
better shorting the stocks recommended by the pros and buying the ones they
snubbed.
That shouldn’t be surprising. Many studies have shown that
experts, from doctors to investment pros, tend to be biased. Ian Ayers in his book SuperCrunchers gives many examples, one
of the funniest being the biases of wine experts. He shows that simple
regression models beat the pros at forecasting just about anything. The main
advantage of the models is objectivity.
Investors can take a similar approach by using objective
criteria for choosing stocks and most of the work is already done for you. A
lot of academics and professionals have used statistical analysis and other
techniques to distill the myriad of features of successful companies to produce manageable
models that predict which stocks will see an increase in value in the near
future.
The American Association of Individual Investors, AAII, has
automated over 60 such models on its web site and without subscribing visitors
can read about the stock screening criteria of each approach. With a
subscription the web site will tell you which stocks the method recommends.
AAII runs the models once a month.
For example, recently the AAII featured in a newsletter the
Cash Rich Firms screen. This approach is value-oriented that screens for
companies with a high level of cash compared to its current share price. It
passes over companies with a lower market capitalization and has a monthly
turnover of around 25%.
The screen filters companies according to these criteria:
• Those
companies that are in the financial and utilities sectors and real estate
operations industry are excluded.
• Earnings
per share from continuing operations over the last 12 months and for the last
fiscal year (Y1) is positive.
• Market
capitalization for the last fiscal quarter (Q1) is greater than $50 million.
• The stock
price is higher than $5 per share.
• The total
liabilities to total assets ratio for the last fiscal quarter (Q1) is less than
the industry’s median total liabilities to total assets ratio for the same
period.
• The ratio
of long-term debt to total capital for the last fiscal quarter (Q1) is less than
the industry's median long-term debt to total capital ratio for the same
period.
• The cash
to price ratio is greater than 20.• The cash per share is at least 20% of the stock price per share.
• The net cash to price ratio is greater than 20.
• The net cash (cash minus current liabilities) per share level is at least 20% of the stock price per share.
Investors should be able to find several methods in the AAII list that allows them to combine the ABCT, their level of risk tolerance and need for diversification. I have had great success with the Piotroski: High F-Score screen in the past, but I am sitting in cash right now.
[1]
http://www.bloomberg.com/news/print/2013-01-04/almost-all-of-wall-street-got-2012-market-calls-wrong.html.
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