Seeking Alpha
Profile| Send Message| ()  

Equities have performed very well this year. That's no secret. As of this writing, the S&P 500 (SPY) is up over 23% YTD and the Dow Jones Industrial Average (DIA) is up around 20% YTD. My 50-equity portfolio, however, has significantly outperformed both.

Some time ago, I read James P. O'Shaughnessy's book, What Works on Wall Street: A Guide to the Best-Performing Investment Strategies of All Time. It's a good read; informative but a bit dated and the findings have been debated by many. But I have adapted the findings of this book to my own long term strategy and have achieved exceptional results this year.

For those who have not read What Works on Wall Street: A Guide to the Best-Performing Investment Strategies of All Time, O'Shaughnessy used a systematic, fundamental approach, compiling 45 years of S&P Compustat market data to research the performance of many different long term investment strategies. As expected, he concluded that some produced significantly greater returns than the S&P 500 while others produced less.

One of these strategies includes, at the end of each calendar year, using screens derived from the two best performing strategies in O'Shaughnessy's book to find potential value and growth opportunities for the coming year.

The two top performing strategies in his book are O'Shaughnessy's Cornerstone Growth and Cornerstone Value strategies. In his research, these two strategies yielded the strongest and most consistent long term returns and, since the publications of his book, have continually been used by investment firms, mutual funds, and portfolio managers. The marriage and adaptation of these two strategies have been my focus since reading the book.

O'Shaughnessy also found that December is the best month to rebalance a long term portfolio and, as such, I continually use this month to rebalance my portfolio as well. I won't go into any more detail about his work in this article, but for those interested in this kind of research, I strongly recommend the read.

So, here's how my adapted strategy works: Derived from O'Shaughnessy's combined Cornerstone Value and Cornerstone Growth strategies, I comprise my portfolio with 25 value equities and 25 growth equities, using screens I have adapted from his findings. These equities are rebalanced (sold and purchased/repurchased) in December.

Here is a look at the screens I use for this long term portfolio:

My long term value strategy includes some of the fundamental parameters below. I select the top 25 equities from this screen:

  1. Market cap > Market mean
  2. Cash flow growth rate (TTM vs. Prior TTM) > Market mean
  3. Exclude utilities stocks
  4. Rank by highest dividend yield

My long term growth strategy includes some of the fundamental parameters below. I select the top 25 equities from this screen:

  1. Market cap > $150 million
  2. EPS growth (TTM vs. Prior TTM) > Market mean
  3. 5 years consistent EPS growth
  4. Price to sales ratio < 1.5
  5. Rank by EPS growth

As mentioned in the opening paragraph of this article, this combined strategy has significantly outperformed both the S&P 500 and Dow Jones Industrial Average in 2013. The results of this strategy are as follows:

  1. Value strategy return = 31.54% (from 12/1/12 to 12/1/13)
  2. Growth strategy return = 45.03% (from 12/1/12 to 12/1/13)
  3. Total combined return = 38.29% (from 12/1/12 to 12/1/13)

The full details of the returns of the value and growth strategies can be found at the end of this article.

So, as the S&P 500 return stands at 27.63% for the time period mentioned above, this strategy, with a 38.29% return, outperformed the S&P 500 by over 10% in 2013.

As I have always been more of a value investor, it was interesting to find that the value strategy was outpaced by the growth strategy by over 13%. I would expect any growth strategy to perform better than value in 2013, what with investors continuing to pour into higher risk, growth equities throughout the year, but 13% is a very significant difference; one that surprised me.

It should also be noted that the dividends of the value strategy equities were the strategy's saving grace in 2013. Before accounting for average annual dividend yields, the value strategy's return was a mere 21.20%; more than 6% below the S&P 500 return.

But let's get back to the point. Will my strategy work as well in 2014 as it did in 2013? That depends how you look at it.

First of all, I, as well as most, believe the S&P 500 is not going to have as spectacular of a year in 2014 as it did this year. Depending on time frame and reinvested dividends, the S&P 500 generally returns around 7% to 10% annually (not adjusted for inflation). As mentioned, the S&P 500 returned 27.63% (from 12/1/12 to 12/1/13) in 2013, about 18% to 20% above its average annual return.

I believe that, at best, in 2014 we will see the S&P 500 return back to its 7% to 10% annual average. At worst, I believe that we will see a much lower return from the S&P 500 in 2014, due to possible quantitative easing pressures and/or natural market corrections.

In summation, I am confident that my combined value and growth strategy will outperform the S&P 500 in 2014. As the strategy outperformed the index by 10% in 2013, I see no reason why it would not do the same in 2014. So, if the S&P 500 returns to its 7% to 10% average annual return, I would expect a 17% to 20% annual return from my strategy.

I would think, however, that in 2014 the value side of the strategy may show stronger returns than the growth side as investors move into safer, dividend-yielding investments for protection from possible market doom mentioned above.

For those interested in this strategy, listed below are the top 20 equities from the above-mentioned screens (ten from each screen, value and growth) for your 2014 portfolio:

The full 2014 portfolio, including all equities from the above-mentioned screens can be downloaded here.

Top ten value equities:

Symbol

Company Name

Market Capitalization

Dividend Yield

ARR

ARMOUR RESIDENTIAL REIT INC

$1.5B

15.35%

PDH

PETROLOGISTICS LP

$1.6B

14.53%

RSO

RESOURCE CAPITAL CORP

$760.1M

13.45%

AI

ARLINGTON ASSET INVESTMENT CORP

$441.6M

13.16%

TWO

TWO HARBORS INVESTMENT CORP

$3.4B

12.06%

LRE

LRR ENERGY LP

$428.0M

11.93%

NRZ

NEW RESIDENTIAL INVESTMENT CORP

$1.5B

11.67%

TICC

TICC CAPITAL CORP

$571.1M

10.83%

STRA

STRAYER EDUCATION INC

$400.4M

10.81%

BKCC

BLACKROCK KELSO CAPITAL CORP

$729.1M

10.61%

Top ten growth equities:

Symbol

Company Name

Market Capitalization

EPS Growth (TTM vs Prior TTM)

XL

XL GROUP PLC

$9.1B

1252%

CSRE

CSR PLC

$1.4B

1207%

TUC

MAC-GRAY CORP

$314.2M

308%

EIG

EMPLOYERS HOLDINGS INC

$1.0B

271%

KVHI

KVH INDUSTRIES INC

$221.2M

194%

KR

KROGER CO.

$21.8B

178%

ORBK

ORBOTECH LTD

$590.0M

163%

TPC

TUTOR PERINI CORP

$1.2B

133%

OTCQX:DTEGY

DEUTSCHE TELEKOM AG

$70.2B

133%

OTCQX:AKZOY

AKZO NOBEL NV

$18.1B

128%

For reference, full details of 2013 value strategy returns (12/1/12 to 12/1/13):

Symbol

Company Name

Performance 12/1/12 - 12/1/2013

Average Dividend Yield

NTI

NORTHERN TIER ENERGY LP

7.60%

21.51%

XRS

TAL EDUCATION GROUP

119.53%

12.36%

OTCPK:KKPNY

KONINKLIJKE KPN NV

-44.48%

7.92%

CYS

CYS INVESTMENTS INC

-37.13%

15.49%

NMM

NAVIOS MARITIME PARTNERS LP

22.49%

12.01%

EFC

ELLINGTON FINANCIAL LLC

6.15%

12.74%

MITT

AG MORTGAGE INVESTMENT TRUST INC

-35.07%

13.81%

HCLP

HI-CRUSH PARTNERS LP

108.00%

9.36%

IRS

IRSA INVERSIONES Y REPRESENTACIONES SA

67.22%

11.20%

NRP

NATURAL RESOURCE PARTNERS LP

5.65%

11.46%

PSEC

PROSPECT CAPITAL CORP

7.26%

11.55%

KCAP

KCAP FINANCIAL INC

-4.49%

11.54%

QRE

QR ENERGY LP

-10.67%

11.22%

MCC

MEDLEY CAPITAL CORP

4.18%

10.59%

NCT

NEWCASTLE INVESTMENT CORP.

40.75%

8.90%

PNNT

PENNANTPARK INVESTMENT CORP

11.90%

5.20%

BKCC

BLACKROCK KELSO CAPITAL CORP

-3.35%

10.50%

TEF

TELEFONICA SA

25.57%

7.99%

SFUN

SOUFUN HOLDINGS LTD

204.09%

6.14%

PMT

PENNYMAC MORTGAGE INVESTMENT TRUST

-8.53%

9.73%

GSJK

COMPRESSCO PARTNERS LP

15.19%

8.49%

HTGC

HERCULES TECHNOLOGY GROWTH CAPITAL INC

60.32%

8.12%

SDRL

SEADRILL LTD

10.96%

8.41%

RNF

RENTECH NITROGEN PARTNERS LP

-48.31%

6.76%

BWP

BOARDWALK PIPELINE PARTNERS LP

2.75%

8.03%

Average Return

21.10%

10.44%

Total Return (with dividends)

31.54%

For reference, full details of 2013 growth strategy returns (12/1/12 to 12/1/13):

Symbol

Company Name

Performance 12/1/12 - 12/1/2013

Dividend Yield

FSRV

FIRSTSERVICE CORP

45.87%

0.90%

EXTR

EXTREME NETWORKS INC

92.29%

0.00%

GPK

GRAPHIC PACKAGING HOLDING CO

40.28%

0.00%

TWI

TITAN INTERNATIONAL INC

-15.45%

0.10%

JBSS

JOHN B. SANFILIPPO & SON INC

47.21%

0.00%

REX

REX AMERICAN RESOURCES CORP

80.31%

0.00%

DENN

DENNYS CORP

53.49%

0.00%

BRCD

BROCADE COMMUNICATIONS SYSTEMS INC

51.57%

0.00%

CLUB

TOWN SPORTS INTERNATIONAL HOLDINGS INC

37.44%

4.60%

NATR

NATURE'S SUNSHINE PRODUCTS INC

28.82%

2.10%

URS

URS CORP

38.41%

1.60%

STFC

STATE AUTO FINANCIAL CORP

49.18%

2.00%

ACAT

ARCTIC CAT INC.

49.09%

0.70%

WDC

WESTERN DIGITAL CORP

124.62%

1.60%

DK

DELEK US HOLDINGS INC

16.27%

2.20%

ACET

ACETO CORP

119.73%

1.20%

SKH

SKILLED HEALTHCARE GROUP INC

-24.44%

0.00%

AMED

AMEDISYS INC

55.51%

0.00%

ITRI

ITRON INC

-2.10%

0.00%

DF

DEAN FOODS CO

18.15%

0.00%

GTIV

GENTIVA HEALTH SERVICES INC

20.17%

0.00%

KS

KAPSTONE PAPER & PACKAGING CORP

142.84%

0.00%

VMI

VALMONT INDUSTRIES INC

3.47%

0.70%

ZAGG

ZAGG INC

-43.16%

0.00%

SMP

STANDARD MOTOR PRODUCTS INC.

77.13%

1.30%

Average Return

44.27%

0.76%

Total Return (with dividends)

45.03%

Source: My Portfolio Returned 38.29% This Year, Here's What I'm Doing For 2014