'10-Minute System' Beats Market By 17% In 17-Year Backtest

|
Includes: BLX, MHLD, NGG, STWD, TCAP-OLD
by: Lino Patti

Summary

My “10 Minute Stock Rating System” performs well in backtest.

My investment strategy is slightly different than the backtest investment strategy.

It is worth performing a backtest to test your own investment strategy.

A few weeks ago I exposed the "10 Minute Stock Rating System” in the article written here. The article got a lot of positive feedback, influenced many dividend growth investors, and caused a lot of intelligent discussion. The goal of the system is to rate a stock’s financials, value, dividend strength, and risk. Stocks that rate high in the system should be considered for purchase with the expectation of outperforming the market and providing a growing dividend stream over the long term. I have only been using this system for less than 3 years so I don’t have much when it comes to historical results. However, InvestorsEdge, an investing strategy analysis company, changed that when they performed a 17 year backtest on the “10 Minute System” and provided me the results.

In this article I will show you the results of the backtest, discuss what is different about my investment strategy and the investment strategy used in the backtest, and discuss the benefits of testing your own investment strategy.

Backtest

InvestorsEdge is a website that performs backtests on investor’s strategies. Their goal is to provide you with a tool that shows you if your trading strategies worked in the past and to help you stick to your plan in the future. They give you a global database of in depth price, fundamental and analyst estimate data and a simple yet powerful interface to manipulate it with, and you get the ability to run profitable trading strategies that you trust are reliable and robust. I was unaware of InvestorsEdge until one of their Seeking Alpha contributors commented on my "10 Minute System" and provided me with a link to a backtest.

The release of my investing strategy piqued InvestorsEdge’s interest, and they were nice enough to run a 17 year backtest on my strategy. I knew my strategy was backed by strong fundamentals influenced by investor greats like Benjamin Graham, but I had no idea how successful my strategy could have performed in the last 17 years. Below is the total return curve they outputted from their backtest:

Source: InvestorsEdge

The chart above shows that the “10 Minute System” (blue line) returned 2,458% over the last 17 years when the S&P 500 (grey line) only returned 65.65% over the same period! My CAGR was 20.42% and the S&P 500 CAGR was 2.93%. The “System” beat the market by over 17%! I understand past results don’t predict future results but how can you not love these results? This test legitimizes the “System” and gives me confidence that the “System” can perform well in the future.

The backtest invested a $10,000 portfolio and had the following defined rules:

  1. Max number of positions in portfolio = 30 (I also follow the rule of never owning more than 30 stocks)
  2. Max weighting of position =30% of total portfolio (my largest holding is 25% of my portfolio)
  3. Buy only companies within S&P 500
  4. Initiate a position when a stock rates a 100% on the “10 Minute System”
  5. Close a position when a stock no longer rates a 100% on the “System”.
  6. Initiate/Close positions once a month on the 1st of each month (rebalance).
  7. Flat fee trade commissions (I pay a flat fee as well)

10 Minute Stock Rating System

The following list shows the 13 metrics a stock must pass to rate a 100% in the “System” and is explained in depth in the link provided in the beginning of this article:

  1. Is Current Ratio >= 1.5?
  2. Is Long Term Debt not more than 110% of Net Current Assets?
  3. Positive Earnings for Each of the Past 5 Years?
  4. 1 Year of Uninterrupted Dividends?
  5. Is EPS[ttm] > EPS from 5 years ago?
  6. Is P/B <= 1.2?
  7. Is P/E[ttm] less than 10?
  8. 5+ Years of higher dividends?
  9. Is Current Yield >= 3%?
  10. Is Payout Ratio <50%?
  11. Does FCF cover the Dividend Payout?
  12. Is 5 Year Dividend Growth Rate (DGR) >= 10%
  13. Is 3 Year DGR divided by 5 Year DGR >= 1?

Not the Perfect Backtest

I must note that there are a few differences between my investing strategy and the strategy used in the backtest. The first difference is that the backtest only invests in stocks that rate 100% in the “System”. I consider investing in any stock rating an 80% or above. In this current bull market it is hard to find stocks that rate a 100%. For instance, the following table shows the only two stocks I have invested in that rated a 100% at time of initiation:

Stock

Date[s] Purchased

Rating

Maiden Holdings (MHLD)

8/22/2016

100%

Banco Latinoamericano de Comercio Exterior (BLX)

8/6/2015, 7/27/2015

100%


This change in investing strategy would mean that I would have to have extreme patience and wait for a stock to hit a 100% rating. I don’t like keeping my cash on the sideline so I invest in whatever is rating the highest at the moment. Could I make better gains by only investing in 100% stocks, it seems probable looking at the results, but because my other goal is to build an income stream, I am more inclined to pick up dividends than “time the market” and wait. However, the good news is that the results of only investing in 100% rated stocks gives the “10 Minute System” legitimacy and proves that the System produces alpha long term and is working.

The second problem is that the backtest rebalances every month by selling any holding rating less than 100% and buying any holding rating 100%. I rarely sell a holding. I only really sell when a dividend gets cut or suspended and ends their dividend raise streak. Because I am a buy-and-hold investor, when one of my holdings no longer rates favorably, I just hold on. I am happy at the price I got in at and don’t have a concern if the P/E ratio raised above 10 or that the yield dropped below 3%. I can see this change in strategy having a drastic difference in results. But does it really benefit the investor long term by selling often? What about all those trade fees? Also, stock prices tend to rise when yields are shrinking, and P/E’s are getting too high; is that really a good reason to sell? The following chart shows how long stocks were held in the backtest portfolio:

Source: InvestorsEdge

As you can see from the chart above the average holding period of a position ranges from 3 months to 6 months. It is evident that the backtest is a short term trading strategy when my strategy is long term as almost all of my positions have been held for at least a year or more. In fact, out of the total 31 positions I’ve owned using the “10 Minute System”, I have only closed out of 4 of them, National Grid Transco (NGG), Starwood Properties Trust (STWD), Triangle Capital (TCAP-OLD), and BLX after they ruined their dividend raise streaks. You can’t argue with the backtest’s results, but you can wonder which strategy produces more gain. I will request that InvestorsEdge re-run the backtest using the dividend raise streak as the only reason to sell out of a position instead of the monthly rebalances due to a less-than 100% rating.

I also have purchased a couple stocks outside of the S&P500 but I don’t think it has a big effect on the backtest. I also favor some diversification and never buy two stocks within the same industry.

The final reason my strategy is different than the backtest’s strategy is that I use low-risk put and call options to buy shares below market price and sell shares above market price while picking up option premium. If you don’t understand how these options work and how they can benefit you, please read about them here and here respectively.

My portfolio has gained substantial option premium income from my investing strategy. I have earned $1,971.96 in premiums and $5,297.53 in dividends in the few years I have used my “10 Minute System”. That option premium is income that is not accounted for in the backtest strategy. Furthermore, all that premium was reinvested into other stock, and is a result from buying stock below market and selling stock above market. My options strategies have benefited my portfolio results greatly, so this is one area where I outperform the backtest, income.

The Importance of a Backtest

A backtest is not necessary for everyone. If you have been following the same strategy for 30 years, you already have enough historical data to see if you are beating the overall market or not. But if you are like me, a young inspiring investor who just started an investing strategy a few years ago, it is imminent that you perform a backtest to see if your strategy would have worked in the past so that you can have confidence that it will work in the future. Investing strategies are great, but if they don't outperform the market than one should consider buying a broad base stock market index fund, which could save the inspiring investor a lot of time and money.

To perform a backtest you need access to many data points and have the ability to use a platform that will screen a large batch of stocks. I encourage all young investors to run backtest to make sure their strategy is sound and can produce alpha. InvestorsEdge is a company that provides this service.

Conclusion

InvestorsEdge’s 17 year backtest has proved that the “10 Minute Stock Rating System” is an effective strategy that should beat the market by a wide margin over the long term. Although, the backtest strategy is different than my investment strategy, the results still give me large amount of confidence and enthusiasm that I am following a market-beating strategy.

Backtests are effective ways to measure the performance of any investing strategy. All young and inspiring investors should run their strategy through a backtest to at least know if they should think about continuing or changing the way they invest.

Disclosure: I am/we are long MHLD.

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.