I highly encourage individual investors to take advantage of screening technology and I will be writing about this frequently. Here is a sample of what I mean.
If you haven’t heard of Joel Greenblatt’s magic formula, go look it up. It’s a simple quantitative formula that ranks companies based on quality and cheapness. It is just one of many formulas that can be used to eliminate emotion, increase discipline, and choose an average of stocks that are highly likely to outperform the market averages.
I have a few quantitative screens that I like to use. Let me show you the results of one that I have been testing recently. I exclude industries in the same way Greenblatt does because some of my metrics are similar to Greenblatt’s (earnings before interest isn’t a great way to look at financial companies, for example).
The model uses 26 ranking metrics. This first graph shows a backtest covering over 13.5 years. 30 stocks are held for a year and then rebalanced.
The blue line at the bottom is the S&P 500. Notice that $100 dollars becomes $4244 (annualized return of 32%) with the formula and $111 with the S&P. There are no OTC companies included in the backtest.
If the screen’s rankings are broken into deciles, here is how each of the deciles perform.
Each of these deciles holds about 400 companies. It’s facsinating to see that the screen works in order. As in, we can know how a group of stocks will perform relative to others. If you don’t think that is amazing then you are hopeless.
The above is rebalanced every year. For non-taxable accounts a more frequent re-balancing may be an option depending on brokerage costs. Here is the same screen above backtested over the same time period but with three month re-balancing.
That’s 46% per year in a nearly flat market.
Here is the 3 month rebalancing broken into 50 rank buckets.
All of these are run on the Compustat Point in Time Database.
My question is… why doesn’t everybody use a screen like this?
We will discuss some of what goes into making a screen like this, how it might be improved upon, and why the individual investor might do well if they ditched their mutual funds and tried a similar approach to the one above.