Selecting Workshop Stocks
Workshop strategies use fundamental stock valuation criteria, but apply them differently. Running stock screens may sound easier than reading annual reports, but to invest responsibly, you need to put in a lot of time understanding the process. Running the somewhat simple Investor's Business Daily screens is a good place to start.
By Ann Coleman (TMF AnnC)
October 12, 2000
[Every Thursday, the Fool Four and the Workshop will become one column, discussing topics applicable to all mechanical investing strategies.]
Mechanical investing can be deceptively simple. As Todd Beaird points out: You run a screen, you buy some stocks.
I admit I got hooked on mechanical investing after my first attempt to follow the Fool's advice about picking a stock resulted in my mistaking growth in revenue for growth in earnings. I found a stock with the most unbelievable(!) Fool Ratio. That beauty fell 40% during the year I held it. (Ask me if I sold it when I realized my mistake a few days after buying. No, of course not. It was down a buck, and I was waiting for it to recover.)
Compared to 50 pages of computer printouts all over my living room floor, and no idea at all when I should sell, the idea of using a few simple criteria to screen for a basket of stocks that were bought and sold according to a set schedule sounded like the answer to my prayers.
Ever read Anne Tyler's The Accidental Tourist? After his wife leaves, Macon decides to put some thought into housework. He loves clean sheets, but he doesn't want to waste time changing the bed every day. So, he folds seven sheets in half and sews each one across the bottom and up one side making a kind of sleeping bag, one for each night of the week.
My idea that mechanical investing would be easier than doing fundamental stock research is rather like that plan. Perhaps one day Macon would have saved enough time not remaking the bed every day to justify the hours spent sewing up those sheets, but before he gets there, Muriel moves in.
Just like fundamental research, mechanical investing takes a lot of time up front, and new developments just can't be ignored. You have to study, and learn, and keep track of new lines of thought.
So, it comes down to -- what's more fun? Reading annual reports or running Value Line spreadsheets? Thinking about competitive pressures or thinking about statistical validity? P/E ratios or Sharpe Ratios? Personally, I find spreadsheets more interesting, and have greater faith in my ability to handle them than in my ability to correctly assess a company's competitive positioning. That makes a better rationale for being a mechanical investor than the futile hope that it would be easier.
Of course, after getting up to speed, one can coast for a while. Once you understand how a strategy works, you can use our Current Rankings to either check your own numbers or to identify stocks when renewal time comes around. If you do that, a good way to double check our list (which Elan Caspi runs perfectly every week) is to check the Mechanical Investing board. The tireless Jack Cade runs the numbers with superhuman speed and posts them every Friday.
But don't even think for a moment that those lists get you off the hook for understanding why the stocks are picked and how to run the numbers yourself. That's following blindly -- when the truck slows for a turn, you're liable to get a tail pipe through your radiator.
Here's how we run the numbers for the three screens that are easiest and cheapest to run on your own. It won't cost you anything but a trip to the library and a legal pad. Note: This is the low-tech version.
You start with the latest issue of Value Line. Your library will have a long row of very thick black binders. That's Value Line. Find the most recent edition of the "Summary and Index" and turn to page 27 where Value Line lists "Timely Stocks, Stocks Ranked 1 (Highest) For Relative Performance (Next 12 Months)." That's your starting universe. Before you start with this universe, though, you might want to review Value Line's credentials and the credentials of their Timeliness rankings.
Now, grab the most recent issue of Investor's Business Daily. This part is something of a pain, but it gets easier after you do it a few times. You need to look up each of Value Line's 100 Timely stocks in the IBD stock tables. Then you write down IBD's RS (Relative Strength) and EPS (earnings per share) rating for each one.
The RS-IBD strategy buys the five or 10 stocks with the highest RS rating. Since the RS rating is a percentile score (an RS of 97 tells you that the stock had a higher Relative Strength than 97% of the stocks ranked), and since Value Line picks stocks with good Relative Strength to begin with, you will have a lot of stocks ranked 99 or 98. That's where the EPS rating comes in. To determine the exact order, break the ties in favor of the higher EPS ranking. (You will still have a few ties most weeks.)
That's how you run the numbers. When you finish, what do you have? You have a list of five or 10 stocks that Value Line's proprietary Timeliness formula predicts will do well over the next six to 12 months, and that have been rising rapidly over the last year. (See Workshop Criteria for more details on Relative Strength and EPS ratings.)
A variation on the RS-IBD strategy reasons that any stock with a low EPS rating probably isn't a good investment, no matter how strong its recent performance. Formula 90 eliminates any stock with an EPS rating lower than 90, then ranks them by RS rating, again breaking ties using the EPS rating. Note for the lazy: This one is easier to run by hand, since you don't have to bother to write down any RS or EPS ratings below 90. It's also an awesome performer.
The old Unemotional Growth strategy (the first one developed using the Value Line and IBD data) is more volatile than RS-IBD or Formula 90. It ranks stocks by EPS first, and breaks ties using RS.
Think you can handle that? Value Line comes out on Friday, and is usually in most large libraries by Friday afternoon or Saturday morning. You didn't have anything else planned, did you?
The Value Line versions of the Relative Strength strategies have one huge advantage over the IBD versions. Once you fork out $600 for the software, they can be run in seconds. Pull up the Timeliness 1 stocks and sort by Total Return-26 weeks. Zap. I confess to a fondness for Value Line.
Fool on and prosper!
