Value SuperScreen Deployed

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Includes: AFL, CBAN, CNC, DFS, DQ, DXC, ED, EE, ESRX, IX, KLIC, KRA, MATX, MPC, MTUM, MU, PAA, PBF, RCL, TOL, TPH, WD, WLKP
by: Michael J. Bernard
Summary

After a lengthy and multi-faceted analysis, a final composition of the Value SuperScreen Portfolio has been reached.

Back-testing versus the Rest-of-Universe (excluding S&P 500) provided more encouraging results.

Moving forward, portfolio rules are established and deployment options presented.

Introduction

In the conclusion of my most recent article, "Value SuperScreen Vs. The S&P 500", I discuss a bit of my reservations with the composition of the VSS Portfolio as it sat at that moment, namely, that a few stocks were included which I felt would ultimately not make the cut.

One challenge I have with fully committing to the VSS 22 is the reluctance to throw my lot in with a few companies or industries that I otherwise would avoid in almost all circumstances - Automotive Manufacturers such as GM or TM, airlines like DAL - or that I know very little to nothing about yet. Very certainly, the final step prior to deployment of the VSS 22 will be a final deep dive on every component to determine, despite what confidence and hope the back-testing "proves", whether each holding does not present a danger reminiscent to my three previous failed screening methodologies.

It is not lost on me that GM, TM, and DAL had become members of my universe of coverage, not because I fully expected that they would one day challenge to become a member of the Pretty 30, but that each would eventually be proven to be, despite initial metric passing, inadequate.

In fact, the entire Value SuperScreen began as a methodology I had hoped would narrow down my Universe of Coverage to a more manageable size - I had spent a few months adding in everything I came across with a PEG Ratio of less than 2, an Analyst Recommendation Score of less than 3.0, and in most cases, a dividend yield. The universe of potential stocks soon grew in size to the point that there were a number of ticker symbols contained I no longer recognized, and some such as the above mentioned three which had been added with the expectation of removal on closer examination.

For those who have followed along with the previous two articles thus far, the Value SuperScreen has obviously morphed into something entirely different.

The potential of the Value SuperScreen [VSS] was established in the prior article where a back-test from January 1, 2017 through May 4, 2018 shows the VSS convincingly beating the S&P over that time period - producing a Compound Annual Growth Rate [CAGR] of 23.28% compared to the S&P 500 (SPY) CAGR of 15.45% in the same time frame.


Also included in the above graph was an isolated portfolio of S&P 500 components that also met the VSS criteria (blue line) and my other stock selection strategy represented by my Pretty 30 Portfolio (yellow line). Both of my strategies handily beat the SPY over that time period.

It is worth noting as well that despite their very similar performance, there is absolutely no component overlap between the Pretty 30 and the VSS portfolio.

It is the goal today to finish back-testing the VSS portfolio versus the Rest of the Universe (excluding S&P 500) stocks traded in the United States major exchanges, then finalize the composition of the portfolio and establish the re-balancing rules moving forward.

A Few More Components...

One of the topics I have mentioned a few times over the course of the VSS articles has been constraint - as in, the number of holdings that can be included in a portfolio. Based on the broker service one uses, there may be specific optimal numbers available - for example, on Motif Investing, 30 holdings is the most that can be included in any specific "Motif", while on Folio Investing, a "Folio" can include up to 100 holdings. I use both services and each has upsides and downsides.

It was not my intention at the beginning of the VSS to end up with a number of portfolio holdings to be constrained by any number less than 100; however, as it has turned out, the VSS has come in with room to spare on the Motif model.

Incidentally, I came across the below graphic the other day, and while I previously used the Zweig Screen, IBD 50 (FFTY), iShares Edge MSCI USA Momentum Factor ETF (MTUM) and Fidelity Momentum Factor ETF (FDMO), this presented a few other options that I looked at.

Out of the above, I found four additional holdings that met the selection criteria and will be considered for final inclusion:

Centene Corporation (CNC) {sourced from Guggenheim S&P 500 Pure Growth ETF (RPG)}

Kulicke and Soffa Industries, Inc. (KLIC) {sourced from Guggenheim S&P SmallCap 600 Pure Growth ETF (RZG)}

TRI Pointe Group, Inc. (TPH) {sourced from Guggenheim S&P MidCap 400 Pure Growth ETF (RFG)}

Walker & Dunlop, Inc. (WD) {RZG}

VSS original 22 components:

El Paso Electric Company (EE) {Tiingo}

Plains All American Pipeline, L.P. (PAA) {Tiingo}

Royal Caribbean Cruises Ltd. (RCL) {Tiingo}

Westlake Chemical Partners LP (WLKP) {Tiingo}

Colony Bankcorp, Inc. (CBAN) {Zweig}

DAQO New Energy Corp. (DQ) {IBD 50}

Kraton Corporation (KRA) {IBD 50}

Micron Technology, Inc. (MU) {IBD 50, MTUM/FDMO}

Aflac Incorporated (AFL) {Universe, MTUM/FDMO}

Comcast Corporation (CMCSA) {Universe}

Delta Air Lines, Inc. (DAL) {Universe}

Express Scripts Inc. (ESRX) {Universe}

General Motors Company (GM) {Universe}

ORIX Corporation (IX) {Universe}

Matson, Inc. (MATX) {Universe}

Toyota Motor Corporation (TM) {Universe}

Toll Brothers, Inc. (TOL) {Universe}

Discover Financial Services (DFS) {MTUM/FDMO}

DXC Technology Company (DXC) {MTUM/FDMO}

Consolidated Edison, Inc. (ED) {MTUM/FDMO}

Marathon Petroleum Corporation (MPC) {MTUM/FDMO}

PBF Energy Inc. (PBF) {MTUM/FDMO}

Back Testing vs. Rest of the Universe

There are 7,419 possible components of the universe of USA stocks, and when screened by the VSS 4 hurdles - PEG Ratio of less than 2, Price to Book of less than 3, Price to Sales of less than 3, and Price to Free Cash Flow of less than 15 - this number is narrowed down to 191. Removing components of the S&P 500 (back tested previously here) or of the VSS Portfolio itself left 144 individual stocks.

It was my original intention to find some novel way to break these 144 up into more easily manageable numbers, but every method I tried came up with at least one super-large jumbled group and maybe a few other smaller more refined groupings. So I went ahead and attempted the VSS vs. All of Them At Once.

Unfortunately, I ran into one technical hurdle - the tool I use for back testing, Portfolio Visualizer, limits the number of absolute holdings per test to 150 - so there was no way to actually do it the exact way I wanted to so I had to go through a few iterations which I will detail below.

The above is broken down as follows:

Portfolio 1: The VSS 22 as originally constructed.

Portfolio 2: The Rest-of-Universe of VSS passing stocks (excluding S&P 500 and VSS 22) missing the final 16 holdings of the RoU that exceeded the 150 available slots in Portfolio Visualizer.

Portfolio 3: The VSS 22 removing DAL, GM, TM, and CMCSA and replacing with CNC, KLIC, TPH and WD.

SPDR S&P 500 ETF (SPY)

Portfolio 4: The entire Rest of Universe of VSS passing stocks in its entirety

Portfolio 4 was run by itself, but on the graph would be between the green and red lines representing Portfolio 2 and the SPY, closer to the red though.

Again, Portfolio 4 is not here, but its stand-in performed just slightly worse in both time periods.

Something I had not utilized before - the ability to see the portfolio income from dividends and disbursements. This will come up again later. Unfortunately, the income for the SPY is not included but should be around $180 per year (based on today's price/dividend per share). Portfolio 1 slightly outperforms in this regard and Portfolio 3 slightly underperforms relative to the SPY.

This second run was broken down as follows:

Portfolio 1 : The VSS 22 as originally constructed.

Portfolio 2: The Rest of Universe of VSS passing stocks (excluding S&P 500 and VSS 22) minus the last 16 + the VSS 22 original + CNC, KLIC, TPH, WD.

Portfolio 3: The VSS 22 removing Delta Airlines, General Motors, Toyota Motors and Comcast Cable and replacing with CNC, KLIC, TPH and WD.

SPDR S&P 500 ETF (SPY)

I think this second exercise serves as a good example of the mechanics of the portfolio efficient frontier, at least in relation to the gross number of holdings. Adding in the VSS 22/22 alternative to the 144-16 does increase the portfolio return by about 3% but still fails to match the return of the SPY.

22, 22, or 26?

As I previously mentioned, I am hesitant on DAL, GM, TM, and CMCSA. There are drawbacks to removing all 4 - they do have the highest dividend yields within the portfolio - however, I also fear the risk that automaker, airline, and cable company exposure brings to the portfolio as a whole.

I think the cable industry is in a secular decline. I think the automotive industry has headwinds that could come sooner rather than later - rising oil prices and a consumer economic downturn - and I think that airlines would have the exact same headwinds faced by the automotive industry.

What separates the VSS from my Pretty 30 Portfolio, however, is one certain big thing - the Pretty 30 is primarily geared to be a buy-and-hold forever strategy, whereas the VSS is literally a more short-to-intermediate term strategy, only married to any one component so long as it meets the metric criteria and maintains membership in one of the selection universes (Zweig, FFTY, MTUM, FDMO, RPZ, RPG, RFG, Tiingo).

DAL, GM, TM and CMCSA made it in because they had been added to my universe of coverage for future consideration of the merits of their investment thesis - and ended up fitting a portfolio model that was not in existence at the time of their inclusion.

And even if I was wrong about my primary concerns with DAL, GM, TM and CMCSA - none of the 4 were a part of any of the recognized momentum or growth portfolios, unlike AFL or ESRX - which could have a drag effect on the portfolio.

Now it is time to look at all three back-testing scenarios - With or without DAL, GM, TM and CMCSA.

This run was broken down as follows:

Portfolio 1: CNC, KLIC, TPH, WD

Portfolio 2: DAL, GM, TM, CMCSA

Portfolio 3: DAL, GM, TM, CMCSA, CNC, KLIC, TPH, WD

SPDR S&P 500 ETF (SPY)

So looking at since January 1, 2017, the newer cohort of CNC, KLIC, TPH and WD absolutely demolish DAL, GM, TM and CMCSA even taking into account dividend re-investments.

What would be the effect on the entirety of the VSS over the same period?

This run was broken down as follows:

Portfolio 1: VSS 22 Portfolio w/ CNC, KLIC, TPH, WD.

Portfolio 2: VSS 22 Portfolio w/ DAL, GM, TM, CMCSA.

Portfolio 3: VSS 26 Portfolio w/ DAL, GM, TM, CMCSA, CNC, KLIC, TPH, WD.

SPDR S&P 500 ETF (SPY)

Both tests prove out that DAL, GM, TM and CMCSA would be a drag on performance vs. the cohorts derived purely from Growth/Momentum universes.

So CNC, KLIC, TPH and WD have won out and are now officially in the VSS Portfolio. I hesitate to officially designate it the "VSS 22" as it would probably be very soon that the number increases or decreases due to some unforeseen circumstance.

On To Deployment

Now that the VSS has been fully constructed and tested, it is time to set the portfolio balancing and sell rules moving forward.

Depending on the nature of the brokerage account used, some of these will be easier than others to actually put in place or may require manual tweaking on the part of the person running the portfolio.

As I have mentioned several times, I use both Motif and Folio and both have features which I like and dislike. On Folio, it is possible to use various settings to ensure that dividends are reinvested, that allocations into the portfolio are automatically distributed to bring the portfolio back to target weightings, and other really cool features that are not as easily done on Motif.

The flip side is that by using Motif I can create a public "motif" of the Value SuperScreen and persons wishing to invest in the same portfolio can do so. Purchasers would still have the final say in composition - for example, someone prefers to have all 26 rather than leaving out DAL, GM, TM and CMCSA - portfolio weighting and re-balancing.

One thing that I can do on Folio which I cannot do on Motif is if a component of the VSS falls out of the portfolio - but I do not necessarily want to sell it, take AFL for instance which still is a part of my accumulate-and-never-sell portfolio - I can simply move it from one folio to another without a sell transaction. That is not possible on Motif.

Absolute Sell Rule: A holding that no longer meets all 4 of the compositional hurdles.

Conditional Sell Rule: A value drop of more than 7% from entry point. The sharp eyed out there might say "KLIC dropped 7% on Friday!" and, indeed, this is correct. If that drop were to repeat next Friday or any other day for any holding of the portfolio, they will be reviewed for immediate removal.

The VSS components will be analyzed to ensure continued passing of the VSS SuperScreen on a monthly basis, and re-balancing of the portfolio to ensure a target balance as near to equal weighting as possible will be made at least quarterly but no more than once per month.

Conclusion

As much back-testing as can be done has been done at this point. I have reached the phase that only a live-action acid test on the portfolio can bring about tangible results.

To demonstrate the viability of the portfolio, I have created a public motif on Motif Investing for the Value SuperScreen. There is a small royalty ($1 per purchase or re-balance) that is paid to the creator of a motif if they have chosen to join the royalty program, which I have. Full Disclosure - because Motif limits the minimum investment into a motif at $300, I will be accumulating most of my VSS holdings via Folio (no minimum transaction limit) just as I do now with the Pretty 30 Portfolio.

For persons who are using a tax-advantaged account such as an IRA, caution is encouraged as there are components of all 3 of my public motifs that are K-1 producing investment vehicles. It is easy to exclude those holdings when making a motif purchase. For more information on such instruments and how they may impact a tax-advantaged account, I suggest reading this excellent article "MLPs And K-1s, And UBTI, Oh My!" and consulting with a tax professional.

Now the hardest part for me in the analysis of any strategy - waiting and watching.

Disclosure: I am/we are long EE,PAA,RCL,WLKP,CBAN,DQ,KRA,MU,AFL,ESRX,IX,MATX,TOL,DFS,DXC,ED,MPC,PBF,CNC,KLIC,TPH,WD,SPY,FFTY. 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.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.