10Jun 2016

Creating An Investment Universe by Stock Whittler (@dosh100)


Creating An Investment Universe

As a private investor, we aren’t unlike the crew of the Starship Enterprise. We are permitted to roam within the investment universe as we seek new gems that we may add to our investment portfolio. Unfortunately, that universe is a vastly big place and we are not naturally gifted at birth with the emotionless logic of Mr Spock that may enable him to find those investment gems more readily than a mere earthling. All too frequently investors latch onto some of the space-junk that drifts in the vacuum of space. Many private investors that journey in the investment universe take a random journey as they bounce from one idea to another, from hot tip to hot tip, from chaotic bulletin board “in the know tart” to the next hot thing suggested by part-time journalists.

Now that universe is a difficult place to travel, so how can we make that journey a little less random and improve our chances of beating the FTSE index? I suspect that the majority of private investors, especially inexperienced investors, invest to some degree with a random approach, selecting stocks that sound the real thing! Sometimes this random approach works, sometimes it fails as I found out many years ago in my early days as a PI. The approach I adopted some years ago is to shrink that universe greatly; in fact creating my own universe of stocks; hopefully, a universe that I may continue to feel comfortable with and understand. A good number of investors take this universe approach by becoming specialised in such sectors as utilities, oil stocks etc and carry out the bulk of their trading within their chosen specialist area. Others may develop an understanding of value stocks, growth stocks or hitch a ride on momentum etc. The common thread is that they understood their universe and severely limited their diversions to random space walks that invariably lost them money.

My Approach: The Whittler Universe:

Well, firstly absolutely no jam tomorrow stocks, bulletin board stocks or following of tipsters in any way: been there, done that many years ago and learnt the lessons. My investment universe is very heavily biased to stocks that are already displaying the characteristics of winners. I screen entire listing of LSE stocks for shares that includes AIM, to come up with a relatively small number of stocks that meet the rather demanding criteria that I apply for universe membership. The criteria I apply are all linked to returns on capital (ROCE & CROCI) & cash-flow, particularly free cash-flow; I also treat debt with real caution. I don’t like to overpay for stocks but have more faith in cash-flow valuations, cash profits valuations than I have on the PE ratio although I do tend to set an upper limit on the PE when screening.

After each screening, I tend to end up with about 20-25 stocks and it’s surprising that over a given period the numbers of stocks that reappear month after month. In fact looking back over the past five years, only a total of ninety five stocks have entered my universe via my screening.

Do I invest in all of these stocks? No, firstly I keep a very close eye on the recent and current company RNS particularly outlook statements. I look to see if there is anything obvious lurking in the numbers that may suggest that the story I originally perceive is not the true one. I then take a view on the strength/current favourability of the sector; then I apply some very simple TA; where does the price sit to the 200 day MA, recent trends etc. Finally, if I am still comfortable and I see the stock as being available at a fair value, I buy.

My approach will never identify the Gulf Keystones of this world, thankfully, it will also miss many, many high flyers but it is a universe approach that I feel comfortable with and certainly gives me the edge over beating the FTSE All Share index.

Do all of these stocks go on to increase in value? Well, no, of course, they don’t otherwise an infinite way of legally printing money could be claimed. The majority do go on to increase in share price but some are inevitably the victims of changes in market sentiment, sector downturn or falling behind market expectations.

My particular application of screening tends to create a universe of fairly boring stocks. Over the past 5 years the unexciting large caps such as GVC, SMWH, NXT, ITV along with smaller caps stocks such as XPP, NFC, ZYT, CCT & DTG. I have mentioned that over the last five years that ninety-five shares have entered the universe for further appraisal and roughly one-third of that number have then been bought/sold or continue to hold.

There are another couple of parts to my universe but these are a touch smaller and close to Jim Slater’s Zulu principle followed by a splattering on stocks that I see as undervalued.

The real point I am trying to get over in this article is that to improve one’s chances of success, in my experience, it helps greatly if you have a fairly large portion of your investment portfolio made up from a universe of shares that meet your criteria. A universe of shares whose fundamentals you both understand and whose degree of risk you feel comfortable with.

The sources of data I use for screening for my universe are:

I then seek data for confirmation from Stockopedia and RNS data from Investegate or the company’s web site.

Happy Investing!

Article written by @dosh100

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