Monday, October 14, 1996
The Unemotional Growth Approach
by MF DowMan
A couple of weeks ago, I wrote a Fribble outlining a variation on the Dow Dividend Approach which we've begun calling the Unemotional Value approach, simply because it's a completely mechanical investment model which allows one to ignore emotions (primarily fear and greed) and invest strictly "by the numbers." The forced discipline of the approach turns out to be the investor's biggest ally in hard times.
In this Fribble I'll outline a companion approach called the Unemotional Growth approach. Like the UV approach, UG is completely mechanical and the two can be used together to develop a balanced and powerful portfolio that allows you to minimize your time spent on research and maximize your long-term returns.
How Does It Work?
Like my older Investing For Growth model, the Unemotional Growth approach begins with Value Line Investment Survey's rankings. On page 27 of Value Line's weekly Summary & Index, you'll find a list of the 100 stocks Value Line ranks the best for Timeliness. We start with those 100.
With that list in hand, get the current copy of Investor's Business Daily and write down the EPS (earnings per share) and RS (relative strength) rankings for each stock. Sort the list by EPS ranking, highest to lowest. Break ties with the RS ranking.
Buy the top stocks on the list (as many stocks as you would like for the growth portion of your portfolio) and update monthly or quarterly. Updating monthly improves the performance of the model a few percentage points per year, but it also increases the number of trades, so determine how often you can update your portfolio based upon what you pay in commissions and how large your portfolio is.
This model departs from my earlier model (IFG) in that I rebalance the holdings every period (whether that's quarterly or monthly). By not re-balancing in IFG, the portfolio was left open to a single stock or industry growing to a large proportion and dominating the portfolio. When the hot stock eventually collapses (remember Micron Technology last year as an example, or Iomega and America Online this year), it's such a large percentage of the total that it drags the entire portfolio down dramatically. By spreading out those winnings on the way up, you may sacrifice a few points of compounded growth as it goes up, but when it comes down, you'll have spread those gains out among all the stocks and those points may well be "saved" when the hot stock falls down.
How often you re-balance your portfolio is again a function of portfolio size and trading costs. Ideally you would re-balance every time you update, but a compromise is possible to keep trading costs lower. You may find that updating the holdings monthly and re-balancing quarterly works for you.
Approach Summary Step One: Get the 100 stocks ranked #1 for Timeliness from Value Line.
Step Two: Get the EPS and RS rankings for out of IBD for those 100 stocks.
Step Three: Rank the 100 stocks by EPS ranking, from highest to lowest.
Step Four: Break any ties with the RS ranking. (If a tie can't be broken, I take both.)
Step Five: Buy the top stocks in equal dollar amounts.
Step Six: Update and re-balance positions every month or quarter.
How Well Does it Work?
We now have just over ten years of data for the UG approach, beginning with August of 1986. Ideally we'd like many more years but since the model is tied to Investor's Business Daily's rankings, we're limited by that publication. The newspaper only began publication in 1984, so at most we can add another two years to the history if and when we find a complete newspaper archive. Suffice it to say that we recognize the limitations of only having a decade of data, but we'll have to live with it for this model.
From August 1986 through September 1996 (ten years and two months), the Unemotional Growth five-stock model had a compound annual growth rate of 40.63%. The ten-stock model had a growth rate of 31.73%. (Results exclude dividends, taxes, and trading costs.) Compare these returns to those of Investing For Growth over the same period (approximately 22% per year).
To report these returns like mutual fund companies would, here are the returns over the last 3, 5, and 10 years (using the October - September period just completed) for the five-stock model:
3 Years 45.0% 5 Years 49.3% 10 Years 41.9% Life of model 40.6%
And finally, here are the year-by-year returns for the five-stock model:
1986 0.61% (5 months) 1987 21.32% 1988 6.25% 1989 86.53% 1990 -3.06% 1991 150.23% 1992 38.44% 1993 35.52% 1994 4.14% 1995 53.43% 1996 82.08% (9 months)
I'm currently running the numbers over the same period for the Relative Strength variation of Investing For Growth and will report those numbers as soon as possible.
Transmitted: 10/14/9