Those that follow my articles know that I am a big fan of strategic investing. Developing new investment portfolio models is a hobby for my spare time. As of December 2011 I decided to make public many of my investment models as an accountable record for you to follow.
One of my more favorite defensive plays, in addition to MLPs and the utility sector, is small healthcare stocks. What is the strategy, and how well has it performed?
Healthcare Stock Strategy
This strategy is a mash up of a few different ideals. First we look to the healthcare sector for its general defensive properties. Next, we target smaller companies of less than 3 billion market cap. The two main profit drivers of this strategy are value and upgraded earnings.
- Current fiscal year EPS estimate must be higher than it was 8 weeks ago to buy
- Value ranking must be above 85 (a quantitative ranking system by Portfolio123 that targets stocks with low current and forward PE, low PEG, low price to sales and price to free cash flow, and low price to book ratios)
I only have one criteria to sell: if the current fiscal year estimate drops below what is was 8 weeks ago.
Can such a simple quantitative system with one selling rule which doesn't even use market timing, price action or any selling criteria be sound? My reasoning is that I already have strict buying rules that consider valuation. As long as earnings don't drop going forward I stay invested. Thus, if prices drop I get exceedingly deep value and if prices go up - well that's the plan. If earnings drop then my valuation support is weakening and I bail.
What are the current picks with this strategy? How has it held up since December and over the past few years with backtesting?
Current Healthcare Picks
Est. EPS 8 Wks Ago
Community Health Systems
Five Star Quality Care, Inc.
Sun Healthcare Group Inc
Almost Family, Inc.
Select Medical Holdings Corporation
Medical Action Industries
Gentiva Health Services, Inc.
Magellan Health Services Inc
Health Management Associates, Inc.
Hanger Orthopedic Group, Inc.
I won't spend time on individual stock ratios, as this is a basket-trading method based on screening criteria. If I was to select only 10 stocks I would either pick those with higher value ranks or look for stocks bouncing off support levels, breaking past resistance or some other technical trading trigger. In general I recommend buying the entire basket and selling according to the estimated EPS rule listed above.
I submitted this strategy as an automatically rebalanced portfolio as of December 16th, 2011. Over the past 91 days it generated the following statistics:
- Max portfolio loss was greater than the market. The model fell 5.63% at one point while the market only dipped 2%
- 12 trades (realized) have been made with 9 winners and 3 losers
- The average return (realized) of the winning trades is 16% while the average loss of the losing trades is 4%
- In the current holdings (unrealized) we have 9 winners and 4 losers
- The winners are up 24% on average while the losers are down 4% on average (unrealized)
- In three months we have a total of 25 buy orders and 12 sell orders
- Total portfolio performance is up 26.87% in 3 months which is 11.74% higher than the market
This has been a strong-performing strategy over the past 3 months. It should be noted that the smaller cap stocks has created additional portfolio volatility over the most recent 3 months, but the excess gains have more than compensated for that. What about trading statistics over the past 5 years?
Backtesting for Health
This has been an incredible system over the past 5 years.
The maximum portfolio loss is under 30% versus the market of more than 50%. The 5 year total return is over 600% versus the market of -0.17%. The turnover is moderately high at 371%. Average 5 year compound annual growth rate is a whopping 47.42%.
Will this strategy continue to be a strong contender going forward? Well, if there wasn't risk, then it wouldn't be investing. I'll continue to investigate numerous models for my clients and followers, but the healthcare strategy is one that I would recommend investigating right now.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.