Jack o'Clubs
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I know that the majority of T2W members trade intra-day and therefore this may only be of interest to a minority, but a few people ask about EOD strategies and as not everyone has the time (or patience) to trade short time frames, this post might be of some interest.
I've used this method for equities in my own portfolios for some time and it works for me. The 'complete' in the title refers to the fact that it combines fundamental and technical analysis and I make no apology for that. Die-hard technical or equity analysts may choose to go elsewhere although I have more sympathy with the chartists' view that everything is discounted in the price action, than the fundamentalist refrain that 'charts are for sailors', but in my experience the two methods work very well together in longer time-frames. The fundamental element has got me into stocks far earlier than a study of the chart alone would have done, while bearish charts have kept me out of value-trap companies where the analysis lags a deteriorating reality (particularly in recent times). But charts alone would never have triggered an interest in some stocks I’ve owned which have bumbled along for a while not doing much before being spotted elsewhere for their attractions and being taken out by a bidder. I also make no apology for lack of originality either, my fundamental approach will be immediately recognised by anyone who has read Jim Slater’s Zulu Principle books.
Finally I use this approach for a portfolio of long-only UK stocks. However there is no reason why it shouldn't work in other regions, or with a bit of crafty inversion, in identifying stocks for shorts.
So onto the strategy. The first thing is to screen for prospective companies. There are lots of screening programs available, some at great cost, but to be honest the data in the free sources isn't that much worse than the paid-for providers that the price difference can be justified. I would use the customisable screens on the Digital Look website – the data is sourced from Factset which I use at work, so know and trust. What I'm looking for is fast growing companies at reasonable valuations that are cash generating with unstressed balance sheets. There are various ways of looking for these, but I tend to choose low-PEG (ie PE to EPS growth ratio), a sensible PE (to screen outliers), cashflow per share equal to or greater than earnings per share, and a dividend. In Digital Look this is set as a PEG and 12-mth forward PEG of <0.6 (relaxed to <0.75 for FTSE100 large-caps), a PE and forward PE of between 5 and 20, a dividend yield and operating cash flow >0. A quirk of the Digital Look screen is that if you don’t put in zeroes as minimum values in the filters it will also include ‘NAs’ so you need to watch for that. Also it can't directly identify FCF/share>EPS so I have to do that manually as part of the shortlist process below.
This will return a long-list of stocks (20 or so at the time of writing) which is where the hard-work starts. But to me this next stage is interesting and not particularly time critical so easily done as part of an EOD strategy (in fact I do mine weekly).
The process for the long-listed stocks is then:
i)check the screening data is accurate. For smaller cap stocks anything with only one broker forecast is omitted – there need to be at least two forecasts to give a consensus (and preferably more). In particular I manually check the PEG calculation and that CFPS > EPS (or cash flow > net income) which the screen can’t handle (this is buried in the ‘fundamentals/financials’ tab of the Digital Look companies page, but it is there). I also want the company to have reported EPS and revenue growth over the last three years, and gearing of less than 50% (although less worried about this if cash flow growth is particularly strong).
ii)Director selling over the last six months? I don’t worry too much if just one has off-loaded shares, but if there have been several selling in size then that is a clear warning signal.
iii)I then go into a range of ‘softer’ factors, such as the last outlook statement (is it positively or cautiously worded?), have they given guidance and are broker estimates above or below, I read through the last results statement looking for anything that might be concerning (big working capital swings, etc). This is the most difficult part to describe as its essentially an intuitive process – basically does everything look right?
This then gives you a shortlist, with which I use TA to define entry and stops. This is not particularly sophisticated and anyone with their own favourite set-ups should probably use those (although remember we’re fundamentally buying stocks to hold for weeks / months rather than days). I'm not very sophisticated here - 50 and 200 daily MAs, obvious support and resistance lines. To be clear, I'm looking more at whether the chart is showing a warning signal, and to set a stop level than to finesse an entry. If there is no obvious technical position for a stop within a reasonable distance (relative to perceived risk/reward, but usually about 10%) I will usually scratch the trade. This strict criteria for exits is absolutely critical for any longer term strategy if it is not to end up as a buy, hold and hope plan which is as good a method as any to lose money.
Exiting a position. First, into my diary go all key dates - results, analyst meetings, trading updates etc. On the day of one of these I will always check that i) the fundamentals haven't changed or ii) that the price action isn’t warning me about something. Otherwise each week I check that the metrics for the stock have not materially changed, and that the chart based stop is still relevant. If nothing has changed fundamentally, but strong performance means it falls outside the valuation parameters (ie PE>20 or PEG>1.2 (my warning level)), then I don't sell as momentum may carry the stock much further in defiance of gravity, but instead pay close attention to the charts and sell on any technical weakness – I’ll generally move the stop closer at this stage.
What you should end up with is a reasonably well diversified portfolio of 15-25 stocks which have the various ingredients (value, growth, momentum) to increase steadily in value over time. Most important, and probably where most long-term investors go wrong, is to be strict about exits - not just buy and hold. It’s not the only approach I take in my EOD trading, but is the longest lived and most successful of my portfolio approaches.
For anyone struggling with some of the fundamental metrics mentioned here I would strongly recommend the Jim Slater books which I don’t think are currently in print, but are easily available second-hand off the web.
I've used this method for equities in my own portfolios for some time and it works for me. The 'complete' in the title refers to the fact that it combines fundamental and technical analysis and I make no apology for that. Die-hard technical or equity analysts may choose to go elsewhere although I have more sympathy with the chartists' view that everything is discounted in the price action, than the fundamentalist refrain that 'charts are for sailors', but in my experience the two methods work very well together in longer time-frames. The fundamental element has got me into stocks far earlier than a study of the chart alone would have done, while bearish charts have kept me out of value-trap companies where the analysis lags a deteriorating reality (particularly in recent times). But charts alone would never have triggered an interest in some stocks I’ve owned which have bumbled along for a while not doing much before being spotted elsewhere for their attractions and being taken out by a bidder. I also make no apology for lack of originality either, my fundamental approach will be immediately recognised by anyone who has read Jim Slater’s Zulu Principle books.
Finally I use this approach for a portfolio of long-only UK stocks. However there is no reason why it shouldn't work in other regions, or with a bit of crafty inversion, in identifying stocks for shorts.
So onto the strategy. The first thing is to screen for prospective companies. There are lots of screening programs available, some at great cost, but to be honest the data in the free sources isn't that much worse than the paid-for providers that the price difference can be justified. I would use the customisable screens on the Digital Look website – the data is sourced from Factset which I use at work, so know and trust. What I'm looking for is fast growing companies at reasonable valuations that are cash generating with unstressed balance sheets. There are various ways of looking for these, but I tend to choose low-PEG (ie PE to EPS growth ratio), a sensible PE (to screen outliers), cashflow per share equal to or greater than earnings per share, and a dividend. In Digital Look this is set as a PEG and 12-mth forward PEG of <0.6 (relaxed to <0.75 for FTSE100 large-caps), a PE and forward PE of between 5 and 20, a dividend yield and operating cash flow >0. A quirk of the Digital Look screen is that if you don’t put in zeroes as minimum values in the filters it will also include ‘NAs’ so you need to watch for that. Also it can't directly identify FCF/share>EPS so I have to do that manually as part of the shortlist process below.
This will return a long-list of stocks (20 or so at the time of writing) which is where the hard-work starts. But to me this next stage is interesting and not particularly time critical so easily done as part of an EOD strategy (in fact I do mine weekly).
The process for the long-listed stocks is then:
i)check the screening data is accurate. For smaller cap stocks anything with only one broker forecast is omitted – there need to be at least two forecasts to give a consensus (and preferably more). In particular I manually check the PEG calculation and that CFPS > EPS (or cash flow > net income) which the screen can’t handle (this is buried in the ‘fundamentals/financials’ tab of the Digital Look companies page, but it is there). I also want the company to have reported EPS and revenue growth over the last three years, and gearing of less than 50% (although less worried about this if cash flow growth is particularly strong).
ii)Director selling over the last six months? I don’t worry too much if just one has off-loaded shares, but if there have been several selling in size then that is a clear warning signal.
iii)I then go into a range of ‘softer’ factors, such as the last outlook statement (is it positively or cautiously worded?), have they given guidance and are broker estimates above or below, I read through the last results statement looking for anything that might be concerning (big working capital swings, etc). This is the most difficult part to describe as its essentially an intuitive process – basically does everything look right?
This then gives you a shortlist, with which I use TA to define entry and stops. This is not particularly sophisticated and anyone with their own favourite set-ups should probably use those (although remember we’re fundamentally buying stocks to hold for weeks / months rather than days). I'm not very sophisticated here - 50 and 200 daily MAs, obvious support and resistance lines. To be clear, I'm looking more at whether the chart is showing a warning signal, and to set a stop level than to finesse an entry. If there is no obvious technical position for a stop within a reasonable distance (relative to perceived risk/reward, but usually about 10%) I will usually scratch the trade. This strict criteria for exits is absolutely critical for any longer term strategy if it is not to end up as a buy, hold and hope plan which is as good a method as any to lose money.
Exiting a position. First, into my diary go all key dates - results, analyst meetings, trading updates etc. On the day of one of these I will always check that i) the fundamentals haven't changed or ii) that the price action isn’t warning me about something. Otherwise each week I check that the metrics for the stock have not materially changed, and that the chart based stop is still relevant. If nothing has changed fundamentally, but strong performance means it falls outside the valuation parameters (ie PE>20 or PEG>1.2 (my warning level)), then I don't sell as momentum may carry the stock much further in defiance of gravity, but instead pay close attention to the charts and sell on any technical weakness – I’ll generally move the stop closer at this stage.
What you should end up with is a reasonably well diversified portfolio of 15-25 stocks which have the various ingredients (value, growth, momentum) to increase steadily in value over time. Most important, and probably where most long-term investors go wrong, is to be strict about exits - not just buy and hold. It’s not the only approach I take in my EOD trading, but is the longest lived and most successful of my portfolio approaches.
For anyone struggling with some of the fundamental metrics mentioned here I would strongly recommend the Jim Slater books which I don’t think are currently in print, but are easily available second-hand off the web.
