The Intelligence List: What It Is, What It Should Do

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Includes: SPY
by: Peter F. Way, CFA

Summary

Intelligence has several dictionary dimensions: Reason, Intellect, Shrewdness, Understanding, Comprehension. Educators kidnapped the IQ notion to identify smarties. For investors, NEWS is the important definition dimension.

In combat, Intelligence is “information concerning an enemy or possible enemy or an area, also an agency engaged in obtaining such information.”.

Equity investing is mankind’s second most serious combat, next to war. Investors need to have information intelligence to play the game competitively.

This article illustrates how one form of intelligence report is being used to make rational decisions under uncertainty (“the fog of war” ) in choosing among portfolio candidates.

The article is intended to urge investor thinking about the game’s dimensions, rather than as a sales pitch.

What is this information?

It is the forecasts of coming prices for thousands of equity securities, judged to be likely over the next few weeks and months. They have been made daily and retained for several decades.

Where is it coming from?

It comes from private actions taken by market professionals to protect their at-risk capital in hedging transactions made in public, partly restricted markets of derivative securities.

What form(s) does it present?

This illustration lists for each security a daily-updated range of likely prices, in comparison to the present price. There are measures of the balance between extreme change prospects between upside and downside are provided. It also looks back in history to see how prior forecasts of similar proportions were subsequently followed by market transactions.

What advantage may it provide?

This illustration is a recent Intelligence List of 20 stocks (ranked best by a combination of factors). It was chosen because this was the most recent time when the stocks contained were capable of being completely measured under a portfolio risk management discipline that limits holdings to a maximum period of 3 months (91 calendar days or 63 market days). Please see Figure 1:

Figure 1

source: blockdesk.com

The first advantage is TIME

No, not timing, the advantage is of conserving the most precious resource you have, your personal time, how you spend it.

We all are given an indeterminate allocation of time at birth. None of us knows for sure how long it will last; we all hope for the best. Youngsters often behave like it will be infinite. The medical community tries, but they may not make it soon enough for you and me.

Investors have this problem: Their capital is limited, but choices for its application seem infinite. Decisions need to be made.

Actually there may only be 40-50,000 equities. And then there is information about each one of them; 4-5,000 stocks and ETFs may make the needed information accessible by practical means. But for each candidate there are years of financial report histories, not just annually but quarterly or sometimes even more frequent.

Like daily market price data. How far back do you want to go? To what end? (no pun intended.)

It all takes time; your time?

The next advantage is organization

If there was only one savings institution in the world where you could employ capital you wouldn't have to choose among alternatives. But there are several potentially productive asset types to which capital can be assigned. And as in the equity category, noted above, there are thousands of them. To make rational, deliberate choices, COMPARISONS must be made.

So what to compare? How to do it without consuming a lifetime - on just one choice?

First, we need to identify what we want to do. That seems so obvious that many investors storm right by it and plunge into the morass of details pushed at our attention by an endless number of purveyors.

This illustration is designed to help investors who are intent on building their capital resources to meet needs and desires which are important to them. Just what those may be do not matter, but how much liquefied capital, and when it may be needed does matter.

Sorting that out can be helped by competent financial planners who know the actuarial sciences, the laws of succession and probate (among others), and probable taxation laws.

But don't count on them also being skilled investment advisors. The other activities, particularly that of keeping up with changes in tax regulations is an intense, full-time activity.

This illustration focuses on the possible and probable changes in price likely to occur within the ability of competent, peculiarly advantaged, participating observers to make such useful forecasts.

That is why the illustration presents itself the way it does.

You don't see any of the usual "value" measures in Figure 1. That is because, following a basic of information technology, they have been performed by "massively parallel" supporting participants helping the forecasters to enrich their own special sources of information inputs in making their likely extreme price forecasts, the ones seen in columns (2) and (3).

Reflect on this notion for a moment. Your role in using this intelligence is like that of the forecasters. You are using the forecasters as your "massively parallel" evaluative resources in deciding which capital investment choices to make, based on their forecasts.

They bring special information into the process because, as facilitators of volume transactions in shares for managers of huge investment portfolios, they see, minute by minute during each trading day, they see just what the evolving "order flow" of such transactions suggests for price changes in coming days, and shortly beyond.

You bring to your challenge, the understanding of your personal preferences in what best satisfies your needs, ambitions, and goals. Only you can provide that, and if you really care, you should not assign it to someone else. W. Buffet doesn't.

At this point, your job really starts

There is a presumed job definition embedded in the organization of the illustrated Intelligence List. It is one of making rational, best-efforts (as "perfect" as can be, by your standards) trade-offs between reward and risk prospects among stocks and ETFs of high-quality (for the performance of building capital).

The Intelligence List cannot tell you what to do, because only you know that. So it presents a number of potential candidates for your (in the eye of the beholder) beauty contest.

How many winners in the contest there may be is up to you. It could be all of them, any one or more, or "none, see me again tomorrow". You are the King or Queen of your investing realm.

But the task is making comparisons - among one another of the candidates, or individually against the entire identified and evaluated population of ~2500 issues, or just against a market index average bogey like the SPDR S&P500 Index (NYSEARCA:SPY) ETF.

What are the comparison tools?

A first order consideration often is: What is the reward potential? Column (5) calculates the price change distance between the current price (4) and the forecast range high (2).

Then what is the risk? For prior forecasts like today's, (6) tells how bad a fright might be encountered on the way to (5). That emotional risk may cause abortion of a position prematurely, despite a capacity to accomplish its target.

Those prior forecasts are of Range Indexes [RIs] (7) like today. RIs which tell what percentage of the whole (2) minus (3) range lies below (4). In the past 5 years there has been a sample of them (12) to use as averages in your considerations.

Column (8) tells what proportion of that (12) sample recovered from their (6)s to have ending prices higher than their day-after (4) closing price costs. Column (9) tells how big was the net % payoff on all of the (12) sample, including the losses.

(10) shows how long the average required holding periods were, if winners were closed out at or above the (2) price as soon as they were encountered at end of market days. (11) turns the (9) payoff results and (10) time investments into CAGRs.

A measure of credibility in the forecast upside of (5) is a comparison with (9), found in (13). The ratio of risk to reward, (6) with (7), is presented in (14).

To attempt putting most of this together in one Figure of Merit [FOM], we have combined (5)*(8) minus 1-(8)*(6) all conditioned by (13) with a few "secret sauce" elements. This FOM is the qualifier by which the population has been ranked, and the "best" 20 have been identified.

Parallel averages to all those tools are present for the group of 20, the whole forecastable population, and an investable "market average" of SPY.

So, how did these 20 work out?

We chose this forecast day because it was the most recent one that would have all 20 of its candidates coming to a portfolio management discipline conclusion currently. The fact that it was pleasing to experience did not deter us, but was not the principal reason.

Other forecast days results have been much stronger, and some less so.

Instead, of bragging about success, what has been principal in our mind is the need for investors to appreciate the value of having an active, organized, and disciplined conduct of their equity investment decision process affairs. The old saying "you catch more flies with honey than you do with vinegar" still holds. The intent here is to illustrate that productive, accelerated capital building is being done.

Here is the follow-on to Figure 1:

Figure 2

The portfolio risk-management discipline being followed here is TERMD, which initiates a position with a buy at the cost per share of the closing price the day after the forecast. For record-keeping purposes that number is always possible to achieve, and is well-recorded and available.

TERMD positions are all closed out no later than 63 market days or 91 calendar days after the forecast date, unless they reach or exceed their sell targets earlier, when they are liquidated for reinvestment at that time.

The red CAGRs indicate that 5 of these 20 stocks reached their 91st day with prices below their costs, taking a loss. In one case while a -16% absolute loss is recognized, it was at an annual rate of -50%. But the other 15 positions earned profits of up to +18%, with correspondingly higher annual rates..

The properly averaged geometric mean of 1 plus the price change in each case shows an average of about +5 ½%. When that average is annualized to consider the time that the capital was committed the annual rate is +31%.

Please note that the results between the first-ranked ten stocks and the second ten are markedly different. The first ten earned at an 8% gain rate, and the second at a +77% annual rate. The top 3 ranked stocks did all right with CAGR gains of 18%, 48%, and the over +15% in only 25 days, earning at an annual rate of +750%.

But four of the five losers were in that first ten, and they pretty much destroyed a couple of gigantic CAGRs. It all goes to emphasize the importance of diversification in a portfolio.

In these days with transaction costs of as little as $1 and brokers quite willing to deal in fractional shares (not like the "old days" when shares were sold only in fractions of dollar points per whole share) it is easy to put round-dollar amounts into any share, regardless of its market price of the moment. So with 20 stocks and $20,020, you could establish and build a 20 stock portfolio from $1,000 positions each.

An important word about measuring performance

The discussion about Figure 2's results points out how widely results can be claimed or calculated. Did the list produce a "performance" of +8%, +31%, or +77%? Was the list 75% profitable because 15 out of its 20 stocks earned a gain?

Could it be honestly claimed that the portfolio earned, net of losses, at a rate of +99%?

It could, and that might even be conservative.

Bankers finagling on the money borrowed from them want to be paid at some rate on every day the money is not in their pocket, or vault. So to be precise, they created the notion of a "basis point". It is one 100 th of one percent. To be sure that no interest-taking opportunity gets overlooked, their full unit of measurement is a "basis point per day".

When we look at the gains (or losses) made by each of the 20 stocks in the Intelligence List, and convert their results to "basis points per day", add 'em all up and take their average, what do we have? Nineteen basis points per day.

Now let's turn around and compound 1 plus the 19 bp/d for 365 days, subtract the 1 needed to do the compounding, and convert the remaining fraction to percent. You get 99%.

But wait! (as they say on TV) There's more! What if instead of averaging in the bp/d of the losses into the total, we made separate bp/d calculations for the wins and for the losses. Then we get instead of a 19 bp/d average for them all, -10 bp/d for the losers and +28 bp/d on the winners. Convert those to annual rates and while the losers lost at an annual rate of -31%, the winners won at an annual rate of 182%, nearly 6 times as large.

And remember, there were 3 times as many winners as losers!

We're not sending live human beings out into hazardous space missions here, so ultra-precision is really not needed. It's probable that in the 91 days taken by the losers, the winners would have put about half again as much capital to work further (perhaps in winner positions) from other Intelligence Lists that may perform as well as they did in the 64-day average of their now liquidated wins from this list.

It is these kinds of considerations that make active investment strategies like TERMD both productive and hard to compare with passive, index, buy&hold investment strategies. Conventional strategies are usually simply measured by CAGRs from a beginning date to an end date, ignoring the interim perturbations.

The best we have been able to do in making a comparable measure to the results we have is to force identically-timed intervals of entry and exit, without any transaction costs, on an acceptable market index instrument, exactly paralleling the active management strategy actions. Then the basis points collected by each strategy can be compared, showing which strategy is ahead, and by how much.

We have done this for over 95% of the 5,040 stock identifications made at 20 per day by Intelligence Lists in the 252 market days of the year 2016. The remaining ~5% have not yet met targets or been timed out, as they certainly will be by the end of March, this year. Figure 3 shows how that has been going.

Figure 3

source: blockdesk.com

Conclusion

Investment intelligence, as in any competitive activity, is an important resource. Figuring out how to keep informed about myriad operating, financial, planning, and corporate management on thousands of alternative investment candidates begs for assistance.

Yet many individual investors confront the problem largely by themselves, perhaps with some information services that mostly add to the volume of potential minutia inputs that already overwhelm them.

They need to find ways to cover more ground efficiently, in terms of their own personal time expenditures. More orderly ways of handling what is coming at them is one way. Being more selective in seeking out help is another way; a way where Seeking Alpha can be an important contributor.

On Seeking Alpha folks with recent direct experience in many areas of familiarity can be helpful in providing either the information needed directly, or guidance as to where the best places are to find it.

Advances in information technology have made it both possible and profitable to take different investment strategy approaches than ones that were widely used and found to be productive in the 20 th century. It is important to let go of outdated ideas and strategies if the investor is to be alert to his/her financial objectives be aware of the time remaining before goals must be met.

Some of those advances may be discussed more fully in additional SA articles.

Additional disclosure: Peter Way and generations of the Way Family are long-term providers of perspective information, earlier helping professional investors and now individual investors, discriminate between wealth-building opportunities in individual stocks and ETFs. We do not manage money for others outside of the family but do provide pro bono consulting for a limited number of not-for-profit organizations.

We firmly believe investors need to maintain skin in their game by actively initiating commitment choices of capital and time investments in their personal portfolios. So our information presents for D-I-Y investor guidance what the arguably best-informed professional investors are thinking. Their insights, revealed through their own self-protective hedging actions, tell what they believe is most likely to happen to the prices of specific issues in coming weeks and months. Evidences of how such prior forecasts have worked out are routinely provided. Our website, blockdesk.com has further information.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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