Surprise, Surprise: No Strategy Works All The Time

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Includes: CO, GBNK, MGPI, THO
by: John P. Reese

Summary

Very few, if any, would have predicted our Momentum model's 55%+ return so far in 2017.

14+ years of running systematic strategies has taught me one key thing -- it's impossible to predict the top performing guru methodologies in any given year.

Blending strategies and taking a long term view is your best bet in leveraging focused factor-based approaches.

I've found four interesting smaller cap stocks using the Momentum and Small Cap Growth models that may be worth taking a closer look at.

Since 2003, I’ve been running a series of investing models on Validea inspired by great investors and successful strategies. One of the most prominent lessons I’ve learned over the years is that these models can surprise me, both on the upside and the downside. Since their performance in any given year also reflects investors' appetite for certain types of stocks and styles, I thought it might be both an interesting and enlightening exercise to review these models – which cover a vast set of investing approaches –and see what we might glean from their track records.

Coming into this year, we had started to see a reversion of value stocks and models, but that has proven to be fairly short-lived. As of this writing, the top performing model on Validea, one that is up nearly 55% for the year, is a momentum-based model that looks for stocks with quarterly and annual EPS growth of at least 18%, share price within 15% of the 52-week high, strong share price performance (relative strength of at least 80) and a minimum return-on-equity of 17%.

The strong performance shown by momentum stocks reflects investors' willingness to pay up for growth and for price performance strength. In a recent interview with Barron's, BlackRock’s head of factor-investing strategies said, "The global economy is in expansion mode now, when growth is accelerating and trends persist, so we expect momentum and other risk-seeking factors to perform well."

If you were lucky enough to assume that momentum would be on top, you may have also gravitated toward Validea’s Small Cap Growth model—far and away our best performer. Since 2003, this portfolio has returned 554% (13.9% annually) vs. 164% for the S&P 500 (7% annually). Until this year it has been one of the most consistent outperformers, beating the market in 80% of all calendar years, including a partial year in 2003. This year, however, has proved difficult for the portfolio, which is lagging the market by nearly 17%.

What do these observations tell us?

  1. Even within a style of investing (i.e. value or momentum), you can see big differences in performance. Factors, says Ang, tend to perform differently depending on what phase of the economic cycle is underway. For this reason, he says, diversified exposure across factors is the key to long term success.
  2. Like trying to time the market, trying to predict which models will be on top in any given year is nearly impossible.
  3. No one strategy will prove successful all the time. If that's your goal, you might end up jumping from strategy to strategy chasing returns or the hottest stocks--a recipe for buying high and selling low. Investors that focus on the long-term (over a time horizon of at least five years) will be better equipped to endure short-term underperformance and reap the rewards of a good strategy.

A key takeaway for investors is the importance of finding a strategy that fits their particular risk profile and long-term goals, and sticking with that strategy through the inevitable periods of underperformance. This may sound easier than it is --particularly as we continue to experience a seemingly steadfast bull market. But it is a recurring theme of my articles and the cornerstone of our investing strategy here at Validea. This is what works in the long-run, if investors can remain level-headed and disciplined. One way to accomplish this is to identify companies that reflect strong underlying fundamentals that will support their operations despite inevitable market downturns.

Using the above-referenced stock screening models, I have identified two high-scoring picks from each of our Momentum and Small-Cap Growth portfolios. All of these names have strong momentum and are smaller cap names - these two things mean the stocks are very risky and should probably only be held in the context of a well diversified investment portfolio. Often times with high momentum names, once the momentum starts to fade the downside pressure on the stocks can be quite severe, so just tread carefully in any of these names.

Momentum:

MGP Ingredients Inc. (MGPI) is a producer and supplier of distilled spirits, specialty wheat protein and starch food ingredients. The company earns a perfect score from our Momentum screening model based on both quarterly and annual earnings growth as well as the stock's price performance and return-on-equity which, at 24.5%, well exceeds the minimum requirement of 17%.

Thor Industries Inc. (THO) manufactures a range of recreational vehicles (RVs) in the United States and sells those vehicles primarily in the United States and Canada. The company earns high marks from the Validea Momentum stock screening model based on earnings growth and consistency as well as the stock's price performance—at $151.49, it is within 15% of its 52-week high, a requirement under this model. ROE of 28.2% is well above the 17% minimum required.

Small Cap Growth:

Guaranty Bancorp (GBNK) is a bank holding company for Guaranty Bank and Trust Company, which provides banking and other financial services, including commercial and industrial loans, real estate loans, construction loans, consumer loans and agriculture loans across its targeted Colorado markets. The company earns high marks for its after-tax profit margin of 26.61%, which far exceeds the model's required minimum (7%) as well as its liquidity (cash holdings totaling $50 million).

China Cord Blood Corp. (CO) and its subsidiaries are engaged in the provision of umbilical cord blood storage and ancillary services in the People's Republic of China. The company earns high marks from our Small Cap Growth screening model based on the stock's price performance (relative strength of 95), profit margins, and level of insider holdings (12.75% versus the minimum requirement of 10%). The company's debt-free balance sheet adds appeal.

Disclosure: I am/we are long MGPI, THO, GBNK, CO.

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