I have been reviewing the performance of various models I've developed over the past few years. I use these to help screen for undervalued stocks and track what is working under current market conditions. I have spent a lot of time working with stock-picking models in the past year and have learned a lot in the process. I was interested, but not surprised, when I noticed that the top-performing stock-selection model this year has been what I call the Enterprise Value Growth and Income stock-picking model. Although it is designed to be a relatively conservative stock-picking methodology, it has been the most consistent approach to investing that I turned up in my studies of what works in the stock market.
The model simply screens for profitable dividend-paying companies with an EV/EBIT ratios of less than 6. I eliminate those with market caps less than $100 million, so there is adequate liquidity and then add a margin of safety by restricting the purchase to companies with Piotroski F-scores of 5 or higher. As I mentioned in my first article on this approach in January after some heated discussions with Wesley Gray and Tobias Carlisle, I did not exclude financials from the screen. They wrote the book on using EV/EBIT as a stock-selection tool, so I went with their advice. I then selected the 50 highest-yielding stocks for the portfolio and rebalanced every six months.
This portfolio has outperformed the market over all the time periods I tested and once again this year is easily beating the market. The Enterprise Value Growth and Income portfolio is up 23% since I published the first article on this method in January and rebalanced in July. I sat down this morning and ran the screen again to see what stocks would qualify for an Enterprise Value and Growth and Income portfolio as we move close to the new year.
One thing I noticed right away is that I did not find enough stocks to become fully invested in a 50-stock portfolio. The only other times this happened during the test periods were 2001 and 2006 when markets were elevated and about to move down. Even then the portfolio cash level was right around 30%. Today I only find 25 stocks that fit the criteria to be included in the portfolio so a new Growth and Income portfolio would be about 50% cash. I am a huge fan of cash this year, but the fact that so few stocks qualify should also serve as a bit of a long-term red flag about market levels.
The average EV/EBIT ratio of the stocks in the portfolio is 4.7 right now, and the average yield is 2.3%. There is an adequate margin of safety as the average company in the new portfolio has an F-score of 6, so fundamentals are strong and improving. The average market cap of the companies that qualify is $8.5 billion.
The largest stock is biotech bellwether Gilead Sciences (GILD) , and the smallest is Citizens Holding (CIZN) , a community bank in Mississippi. The highest-yielding stock is Westlake Chemical Partners (WLKP) with a 6.3% yield. The cheapest stock is vitamin-and-supplements company Natural Health Trends (NHTC) with an EV/EBIT ratio of just 2.7.
It is a good thing I did not exclude financials as they make up a substantial percentage of the current Enterprise Value Growth and Income portfolio. Community banks make up five of the 25 stocks so the Trade of the Decade is well represented. There are four insurance companies, including long-time large-cap favorite Prudential (PRU) . There are only two oil-and-gas names, Rowan (RDC) and Atwood Oceanics (ATW) , this time around as energy-related stocks have rallied somewhat in 2016.
The Enterprise Value Growth and Income portfolio is meant to be a purely quantitative approach to investing. You have to resist the urge to tinker. As an example, I would never buy Natural Health Trends on my own and might be tempted to take it out of the portfolio. Using that type of thinking is a mistake. I am not a huge fan of the for-profit education stocks, and that might have led me to exempt Cappella Education (CPLA) from the portfolio in January. Yet that has been one of the best-performing stock in 2016. This is a set-and-forget-for-six-months approach to investing that has worked very well over the year and should continue to do so in the future.