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In this Mini-Book: Why most investors lose in the stock market How you can take advantage of the weakness of others Step by step example of a systematic investing strategy Building screening strategy using Stockopedia How to think about screening results How many stocks should you buy relative to portfolio size How to think about position size, rebalancing and diversification
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FACT
Over the long term, value stocks outperform glamour stocks. Investors tend to overpay for glamour stocks, but underpay for value stocks.
Its only when the tide goes out that you find out who has been swimming naked Warren Buffett
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Buy quality The record of Warren Buffett is stellar a record that he built on the back of buying cheap, safe, high quality stocks. It shouldnt be a surprise that high quality stocks (based on profits, cashflows, margins etc) outperform low quality stocks (think blue sky stocks) by a big margin.
Buy improvement companies with recently rising share prices continue to rise. Companies with improving fundamentals continue to improve. Companies with rising broker forecasts continue to rise. Momentum is possibly the strongest market anomaly. It works. Learn to use it.
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1.
Our first filter relates to market capitalisation as a precaution against small-cap disasters and to focus on more established names we dont want anything valued at less than 100m (lower or higher if you prefer). Once you have entered your requirement, hit the Add a Screening Rule button to create another one.
2.
Our second group of filters relates to removing companies that have a high risk of permanent capital loss. Firstly, we want to remove the companies that have the highest risk of bankruptcy, using something called the Altman Z-Score created by Professor Edward Altman in the 1970s for this purpose. Its a blunt tool, but quite effective - companies with a Z-Score < 1.8 are high risk.
We also want to remove stocks that may have aggressive accounting practices as they tend to suffer in future. We have several ways of doing this at Stockopedia, but well focus on using the Beneish M-Score (M stands for Manipulation) which has predicted trouble at Cupid and Supergroup. This time we choose a cut off of an M-Score less than -1.78 for the safest companies.
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3.
Given that companies scoring 8 or 9 on the F-Score significantly outperform their peers it makes sense to restrict our universe to focus on them. It should be noted that the F-Score finds companies whose fundamentals are improving not whose fundamentals are good. 6 out of 9 of the criteria focus on the trend in the fundamentals rather than on the companys current state.
Please note that all these ratios are described on this page may seem intimidating by their labels, but really they are designed to do something very simple filter out weak companies. You can read up further on all the Stockopedia Screening Ratios at the Glossary. http://www.stockopedia.co.uk/ratios/
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Return on capital is a measure of how effective a company is at making a profit from its assets while the earnings yield takes the operating profit and divides it by value of the companys entire enterprise. The screen ranks the market from high to low for each indicator and adds the two ranks together to get an overall Magic Formula. In his book he maintains an astonishing record for the Magic Formula its a brilliant read that we highly recommend and only about 150 pages long!
4.
We use the Magic Formula as a percentile rank to sort the market in descending order from the highest ranking stocks to the lowest ranking stocks. The sort will act on our filtered universe, clear of all the distressed, low quality, fundamentally deteriorating stocks that we have diligently cleared out in the first three steps.
If youve been following these steps you will end up with a set of criteria that look like this:
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If you do intend to buy stocks that qualify for a personal system you should ensure that you have a complete understanding and have researched the risks involved. Equity investment is a volatile business and drawdowns during market routs can be very extreme it is best to perform extra research into the candidate stocks on any list.
Handling Outliers
When searching for the cheapest stocks in the market, one can occasionally find companies with anomalous data qualify for example stocks that have a P/E Ratio of less than 0.5. To avoid the extremes that may be due to data anomalies it can be a good idea to add some extra criteria that remove the tails of the distribution.
Liquidity Issues
Many shares (even large caps) can be tightly held, illiquid and have very wide bid-ask spreads adding significantly to trading costs. Its best to conservatively estimate trading costs by adding a slippage factor to the overall portfolio spread, while reducing risks by removing extremely illiquid shares and those with low free floats.
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#Stocks 1 5 10 15 25 50
Portfolio Size (assuming 80% annual turnover and the above costs) 5,000 10,000 25,000 50,000 100,000 250,000 1,000,000 4.72% 2.76% 1.58% 1.19% 1.00% 0.88% 0.82% 6.00% 3.40% 1.84% 1.32% 1.06% 0.90% 0.83% 7.60% 4.20% 2.16% 1.48% 1.14% 0.94% 0.83% 9.20% 5.00% 2.48% 1.64% 1.22% 0.97% 0.84% 12.40% 6.60% 3.12% 1.96% 1.38% 1.03% 0.86% 20.40% 10.60% 4.72% 2.76% 1.78% 1.19% 0.90% NB - 'Red' limit is > 4% costs annually NB - 'Green' limit is < 2.5% annually
Based on these costs and assumptions, our analysis at Stockopedia shows that the optimum starting investment pot for a DIY investment strategy should be 30,000+. At that level the costs of investing and managing a portfolio of 25 shares should be less than 2.5%. That assumes that you rebalance 80% of the portfolio annually which may be rather high, but is the average portfolio turnover rate of a typical investment fund. By comparison, the same portfolio with 5,000 to invest would attract charges of 12.40% - at this level of portfolio size, you may be better off either investing in a fund or ETF or picking your spots by owning many less shares. While the costs may be higher the education will be priceless !
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Diversification
One of the biggest mistakes that novice investors make when using screens to build portfolios is to ignore sector weightings. Dividend strategies became heavily overweight banks in 2008 just before they collapsed so setting a 20% cap to any single sector weighting can be a very prudent approach to minimising downside. Stockopedia provides a plethora of portfolio analysis tools that can help to manage risk, keeping position sizes and sector exposures from drifting too far from target allocations. Subscribers can analyse their portfolio style, overall portfolio valuation, risk and exposures.
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We have been tracking the performance of these GuruModel strategies since December 2011. As reported in the FT, 85% of our long only strategies have beaten the market some by very large margin. Its very important to recognize though that we are not factoring in transaction costs, and some value stocks do suffer from wide spreads. In spite of this, the evidence from all sources is that smart contrarian value investing, especially in smaller cap stocks that institutions cannot invest in does work and is a persistently profitable strategy over medium term timeframes.
Does this stuff really work? This Bottom Up: using screens as checklists
describe all of these ideas in much greater detail. We have summarized the history and philosophy of value
Taking it further read our ebooks This Bottom Up: using screens as checklists
investing for over 10,000 readers since publication, and our summary of dividend strategies has also been extremely well received.
www.stockopedia.co.uk/courses/books/
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Recent Press & Subscriber Buzz This Bottom Up: using screens as checklists
Still thrilled with your system ! Read many of the books before, but never dreamed I would see such in action. **Michael B** Ive been using Sharescope since 1999 but you really trump them on the data/screening side and also I really loved little things like being able to add important dates to my calendar. **C E** As a novice investor this site is absolutely brilliant. The screens and ability to create your own are fantastic. What a simplification of all the bull one sees in the market. Keep up the great work. **Jerry** Already very impressed and have just sent an email cancelling my Sharescope subscription which I have held for the last 7 years as I plan to use Stockopedia as my data source going forward. **Chris S** I actually fell in love with your product... I have to give you guys great credit for the software design - really sharp. **David B** I am absolutely delighted with the program (and the support)! **Jon M** You guys are probably the most passionate, involved, engaged and intelligent business leaders/entrepreneurs Ive worked with over the years. **Diego C** Hats off, what a fantastic website, hands down the best standalone resource website available. Phenomenal resource and an amazing effort. **Andrew B** I'm in love! Great, great job you guys did. Stockopedia is fine art. Thank you! **Marcelo T** Its really good to deal with someone genuinely interested in providing such a good service **David S** From what I have seen so far I think Stockopedia is probably the best information source we have in the UK, so well done to you chaps! **Miserly Investor** Your support is probably the best in the business and I love the enthusiasm that you and Dave display and Im sure that the product has the makings of something very special. **David S**
http://www.stockopedia.co.uk/buzz/
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Take a free trial to Stockopedia Premium This Bottom Up: using screens as Stockopedia is the UK's highest quality checklists stock analysis service on the web where
you can put everything discussed into practice. We build investment models that apply the lessons of the world's greatest investors to the finest database sourced from Thomson Reuters. If you are a serious self-directed investor looking to improve your investment returns through stock picking, Stockopedia has the toolkit you need. Take a free trial and discover how our 65 GuruModel stock screens and 2000+ UK StockReports can improve your stock selection process.
Stockopedia Ltd. Stockopedia is a fundamental data & stock screening toolkit for self-directed individuals who have an adviser and/or are comfortable making their own decisions. We do not provide investment advice or recommendations as to whether an investment or strategy is suited to the investment needs of a specific individual. The figures quoted in the above stock report are for illustrative purposes only and should not be relied upon as they are subject to change as well as specific site terms of use. Please note that quantitative screening helps to narrow a search based on pre-defined criteria and is not a substitute for independent analysis. In addition, past performance is not necessarily a guide to the future