What You’ll Learn
- Why You Should Try Adopt Some Sort of Mechanical Strategy
- Does the OSV Rating System Really Work as it Claims?
- Analyzing the Performance by Grade
- How You Can Apply This On Your Own
Many portfolio managers act like investors, but they behave like traders
– Aswath Damodaran
So much truth to this quote.
Mostly because we are humans and emotions play a huge role in who we are, no matter how disciplined or “emotionless” you are.
My first boss in the biz says “its usually the right thing to buy when you feel like puking but the hard hard thing is you feel like puking”
— Kyle Mowery (@kylemowery) February 11, 2016
So what do you do?
First, we are not the next Warren Buffett with nerves of steel constantly on the hunt for elephants.
Nope, we are not the next Ben Graham or Walter Schloss, because we can’t properly stick with the core disciplines and skills needed to be as successful in the stock market.
That’s why most investors fail.
But there are methods in putting up guardrails to make better and objective decisions instead of constantly falling for the story or buying something because you feel like you’re going to miss out.
It’s all about controlling your emotions. Not getting rid of them. There’s no way you can get rid of emotions. Otherwise, what’s the difference between you and a robo advisor?
Here are some things you can think about applying.
- allocating a portion of your portfolio to a mechanical strategy
- creating rules for selling and sticking to it
- once you buy a stock, let someone else handle the selling or notify a fellow investor of your exit strategy to keep yourself accountable
- use simple checklists
- don’t read the news
For the sake of this article, I’m focusing on #1 because I also want to answer whether the new OSV rating system actually works and give you a behind the scenes look at the data I’m looking at.
A lot of sites, actually all the ones I’ve looked at, hide their methodology of how their scores or ratings are calculated.
I understand why, but I prefer to open mine up as much as possible.
Because if you decide to use Old School Value one day, you deserve to know what type of companies the algorithm is recommending, how it works and why it works.
Building an Emotionless Portfolio with Backtested Data
When following any investment strategy it’s pivotal that you trust the system.
Once doubt creeps in, it’s game over.
Here are the results I’m seeing based on the new OSV Scoring system for a filtered universe which excludes OTC stocks, financials, miners, energy, and utilities.
The results are based on buying the top 20 stocks with the highest Action Score and then holding it one year.
It doesn’t consider liquidity, stock prices, fees or slippage. Expect real life results to be lower.
But a reader, Ben, left some good comments about breaking down the data to get a better feel for how the scores perform and whether it’s really capable of identifying winners.
This also came up again while I was talking with a member who mentioned that he had come across some really good strategies in the past, but after further review, the 2nd quintile outperformed the first – which is not good.
In other words, for the new OSV ratings, do the B stocks outperform the A’s?
That’s an uncomfortable question for me, because if the B stocks do outperform the A’s, what does that mean for the new OSV rating system?
Does that mean all the time, effort and data from over the years I’ve analyzed was for nothing?
Well here goes.
Breaking Down the OSV Ratings Score by Grade
Drilling down on the data, here’s what I came up with when I looked at the performance of each Action Grade across the full universe of stocks.
In the OSV Online app, the scores are arranged into grades to make it easier to understand.
- “A” Grade stocks have an Action score of 85+
- “B” Grade stocks score between 75 and 85
- “C” Grade stocks are between 65 and 75
- “D” Grade stocks fall inside 50 and 65
- “F” stocks are below 50
- (Action Score methodology outlined here)
In the data breakdown I didn’t include F grade results because the OSV rating is not for shorting.
F grade stocks make up the majority of the stock universe so that goes to show you how horrible the majority of public companies are.
Seriously, I don’t want to go long or short on a stock like Cardica (CRDC) where:
- FCF/S is -584.2
- CROIC is -67%
- Pio score of 3
- EV/EBIT of -1
- P/FCF of -1
- and Gross Profit to Asset of -0.04
No need to waste time looking at how the F grades performed.
The D stocks outperformance over 10 years is definitely surprising and why I say that the OSV rating is not for shorting. Over the years, I have yet to create a winning mechanical shorting strategy.
Back to the results.
Here’s my first *gasp* in trying to answer the question “Do the B’s outperform the A’s”?
Although the A stocks returned 21.64% annualized compared to the B annualized rate of 24.45%, the difference was due to the staggering 146% return for B in 2002 where a lot of OTC stocks produced mind blowing returns.
But when you compare the 3, 5 and 10 year returns, the A stocks outperform the B stocks easily so there is no immediate conclusion.
What I did realize was that getting the performance for ALL the stocks in each grade is not the best choice.
My goal (and yours) is to profit in the stock market to build wealth.
I won’t be able to do that by buying and selling 1,000 stocks. These types of results are good for research reports, white papers, university theses, but I’m after a realistic portfolio and results that can be modeled in real life.
Realistic to me is owning and following a 20 stock portfolio which is what I do in the next part.
20 Stock Portfolio Breakdown of Each OSV Grade
Here are the real results where only the top 20 stocks of each grade is tracked for the full universe of stocks. i.e. includes OTC, financials, miners and other industries I don’t like.
The A grade performance is the same as what I’ve been publishing over the past couple of months as it’s just the top 20 Action score stocks.
But now you can see the drop offs between the A, B, C and D grades.
In this analysis, since the focus in on the difference between the A and B, here’s a closer look at at the two.
Filtered Universe of Top 20 Stocks per Grade
Here is the last set of results where the universe of stocks has been filtered to exclude OTC, ADR’s, Financials, Miners, Utilities.
Only the top 20 stocks were taken, but with the reduction of stocks to choose from, the A grade was not fully invested for 4 out of the 17 years. Seeing as how the end result is still very close to the original 20.73% return I posted, I’m confident that the A’s will outperform the B’s, C’s and D’s.
Looking at this data, I can conclude that the A’s are the best performers of the group with better downside protection than the other grades.
So What? How Do I Make This Data Useful?
If you’re a numbers geek like me, then this is useful.
For the rest, you’re probably like “ugh.. so what? Just tell me how I’m supposed to make use of this.”
Here’s a simple idea of how you can apply something similar.
- set aside a small portion of your portfolio that you can afford to test with
- identify your own Quality, Value and Growth metrics
- assign a score to the metric
- find stocks that pass your criteria and meet other specs like market cap, volume etc
- buy and hold
- sell once it reaches your definition of fair value or sell after 1 year
If you need some help with this, you can use my existing investment scorecard as a template and modify it to fit your needs. I created it based on analyzing the financials statements so it looks something like this.
Whether you like or dislike this mechanical investment approach, always be searching and thirsting for better practices and processes.
Your portfolio will thank you for it.