No. of Recommendations: 33
I was reading an interview with Sir John Templeton recently, and he
mentions in passing that he usually had a lot of luck over the years
buying companies trading below a P/E ratio of 12.

One of the simplest screens we have here is LOWPE, which looks for a low
price/earnings ratio (no surprise, Sherlock) and a bit of momentum.
So, I thought, can I make it simpler?
This is the same thing put just a little tiny bit differently.
But, it's about the simplest screen that I would put real money in with confidence.

Earnings positive
P/E ratio < 11.8
Total return 26 week top 20

Why 11.8?
I was using 12, then tried the same screen in the GTR backtester, and
11.8 seemed about best. So I tried it back at the monthly-start
backtester and it was a bit better there too. To me, this falls
into the category of "harmless overtuning". Provided you don't *expect*
the results of the best tuning, I figure there is no harm in *using*
the best tuning, so long as it's very close the the same neighbourhood.

1986-2007, 20 stocks deep monthly
CAGR 26.5 to end 2007, or 25.4 to end-March 2008.
GSD 23.2 to end 2007
Sharpe 1.04

So far, I hear you yawning. But this looks nice, with 91% of rolling years positive up to end March 2008:
Year   Screen   S&P
1986 25.9 23.9
1987 -10.0 5.8
1988 31.4 10.4
1989 45.0 35.2
1990 -0.9 -4.8
1991 64.6 30.8
1992 14.6 7.1
1993 22.2 10.2
1994 9.1 1.5
1995 52.2 38.7
1996 10.1 23.2
1997 54.5 27.9
1998 4.9 34.5
1999 0.5 18.4
2000 24.6 -10.8
2001 33.1 -9.3
2002 9.9 -22.1
2003 72.3 28.5
2004 45.5 10.2
2005 36.5 7.5
2006 14.7 13.8
2007 25.2 5.6
TTM 4.1 -4.9 to March 2008

Here are the returns from one run of the GTR version.
The only thing I changed was adding bit of lag (6 days) to the RS26 sort.
Year   GTR ret
1986 25.4
1987 -6.0
1988 26.4
1989 37.6
1990 -7.1
1991 62.2
1992 15.5
1993 12.9
1994 -3.0
1995 36.6
1996 14.2
1997 54.1
1998 0.2
1999 2.1
2000 35.9
2001 59.2
2002 9.7
2003 48.9
2004 68.1
2005 25.3
2006 21.7
(CAGR 23.8)

For those who like tuning (overtuning?) things with the GTR backtester,
it gets better with:
- using RRS with no lag instead of RS with lag
- much longer lookback
- a small factor on poor recent short-term performance in the final sort, e.g. 6-9 days
- skip value line stocks with very low safety ranks
- very short hold (since it's mainly a long term RRS momentum final sort,
this doesn't increase the annual turnover all that much)

These approaches will get you to over 30% CAGR even with 0.5% friction 20 stocks deep.
Whether it's all trustworthy becomes less certain with each step, of course.

Philosophically, it's kind of interesting. You can think of it as getting
at least 8.5% return from the earnings yield (at purchase day) and the
rest, up to 17.5% according to the backtest, from some mix of the
momentum effect and "bounce" on stocks that are only temporarily undervalued.
A more subtle effect is that, by requiring strong momentum, either the
stock had an even lower P/E ratio a while back and is already recovering,
or it has earnings that are rising even faster than the stock price is.
But, the main appeal for me is to find something so very simple.
Adding Timeliness hurts, and this is without any of the usual balance
sheet or safety criteria that I would normally include. Simplicity itself.
Nothing really new, just a pretty rock on the MI beach.

Print the post  


What was Your Dumbest Investment?
Share it with us -- and learn from others' stories of flubs.
When Life Gives You Lemons
We all have had hardships and made poor decisions. The important thing is how we respond and grow. Read the story of a Fool who started from nothing, and looks to gain everything.
Community Home
Speak Your Mind, Start Your Blog, Rate Your Stocks

Community Team Fools - who are those TMF's?
Contact Us
Contact Customer Service and other Fool departments here.
Work for Fools?
Winner of the Washingtonian great places to work, and Glassdoor #1 Company to Work For 2015! Have access to all of TMF's online and email products for FREE, and be paid for your contributions to TMF! Click the link and start your Fool career.