Introducing The Urbem Quality Score

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Includes: AAPL, ACN, ANSS, BIIB, BKNG, CACC, CELG, CHE, CHKP, CPRT, CSVI, CTSH, DASTY, EGHSF, EGOV, EW, EXPO, FAST, FDS, FFIV, GGG, IDXX, INTU, ISRG, JKHY, LSTR, LULU, MA, MED, MNST, MORN, MSB, MSFT, MTD, NKE, NVO, PAYX, PZN, RHHBY, ROL, ROST, SEIC, SLP, SPY, TJX, TPL, TXN, USNA, V, WAT, XLNX
by: Steven Chen
Summary

The Urbem Quality Score is programmed to rank business fundamentals across the total stock market.

The Score is based on a quantitative factor-based model.

We backtested some investment strategy based on the Score for the past 15 years of the US stock market.

Introduction

Those who read my previous articles, including my investment strategy statement, should be familiar with the investment approach that I have been sticking to - buying wonderful businesses at sensible prices. The core here is to evaluate the "wonderfulness," which points to fundamental qualities of a business.

This is why I leverage this factor-based ranking model taking various quantifiable aspects into consideration to screen for qualities and track evolvements.

Now thanks to the advancement of information technology, there is the easier way to uncover top-quality businesses per my definition of qualities out of the total stock market in real time - the programmatic way.

Portfolio123 is one of the platforms enabling investors/traders to develop various algorithm-driven strategies in hope to outperform the market. I am curious enough to try out its Ranking feature so as to 1) add to the efficiency of my investment process, and 2) easily and more comprehensively backtest my strategies over time. I call the scoring model "Urbem Quality Score" (the Score), which calculates the weighted sum of factor values.

The Score

Urbem Quality Score basically "imitates" my conceptual ranking model, including most quantitative factors with appropriate weights but excluding qualitative ones - those, such as durable competitive edge, management, industry stability, competitive landscape, are based on subjective assessments, and hence, not supported by quantitative platforms like Portfolio123.

However, many qualitative aspects are implied somehow through numeric histories. For example, a consistently superior ROIC may indicate a wide moat; a long record of dividend increase could tell about the management's willingness of returning capital to shareholders; a stable sales growth history may imply a stable industry environment facing limited disruption.

With regards to the quantitative factors, the Score overweights the followings (in order of descending significance), which should be no surprise to my frequent readers:

  • Pre-tax and FCF returns on invested capital, total assets, total equity, tangible equity, and retained earnings, including absolute current and historical-average levels, relative current and historical-average levels compared to industry averages, and volatilities;
  • Profitability measured at multiple levels (e.g., gross, operating, pre-tax, FCF), including absolute current and historical-average levels, relative current and historical-average levels compared to industry averages, and volatilities;
  • Growth history and momentum at multiple levels (e.g., sales, operating income, FCF, dividend), including absolute current and historical-average levels, relative current and historical-average levels compared to industry averages, stability (e.g., no negative annual sales growth for the past few years), and trend (e.g., growing at a faster pace for the past 3 years than for the past 10 years on average);
  • Financial strength in terms of short-term liquidity and long-term solvency, including absolute current levels, relative current levels compared to industry averages, and recent-year improvements/deteriorations;
  • Capital-intensity and cash generation, measured by the recent and historical percentages of CapEx to annual revenue and operating cash flow, as well as by comparisons of recent and historical free cash flow and operating cash flow to net profits;
  • Other factors, such as reductions in shares outstanding, insider ownership, payout ratio.

The Score is purely focused on business fundamentals and does not include any valuation or security-specific (e.g., volume, beta) factors into consideration.

Please be aware that although quite infrequently, I do find the needs of making occasional adjustments to the model over time in light of special situations and/or with improvements resulting from my continuous learnings in the stock market. Any key update will be covered in my subsequent writings.

Below is the list of 50 stocks of the highest Urbem Quality Scores per the model calculation as of 5/3/2019 -

Rank Ticker Name Score
1 MA Mastercard Inc 80.9
2 BIIB Biogen Inc 78.4
3 BKNG Booking Holdings Inc 77.9
4 INTU Intuit Inc. 77.7
5 JKHY Henry Jack & Associates Inc 77.4
6 FFIV F5 Networks Inc 75.2
7 ACN Accenture PLC 75
8 CHKP Check Point Software Technologies Ltd 74.5
9 NVO Novo Nordisk A/S 74.2
10 AAPL Apple Inc 73.5
11 SEIC SEI Investments Co 73.5
12 TXN Texas Instruments Inc 72.9
13 FDS FactSet Research Systems Inc. 72.8
14 XLNX Xilinx Inc. 71.5
15 WAT Waters Corp 71.3
16 USNA USANA Health Sciences Inc 71.2
17 LULU Lululemon Athletica Inc 71
18 CPRT Copart Inc 71
19 PZN Pzena Investment Management Inc 70.9
20 ISRG Intuitive Surgical Inc 70.4
21 CACC Credit Acceptance Corp 69.8
22 MSFT Microsoft Corp 69.7
23 EXPO Exponent Inc 69.1
24 TPL Texas Pacific Land Trust 69.1
25 MTD Mettler-Toledo International Inc 68
26 OTCQX:CSVI Computer Services Inc 67.6
27 OTCQX:RHHBY Roche Holding AG 67.5
28 GGG Graco Inc. 66.5
29 ROL Rollins Inc. 66.4
30 CTSH Cognizant Technology Solutions Corp 66.2
31 MNST Monster Beverage Corp 66.1
32 TJX TJX Companies Inc 65.9
33 ROST Ross Stores Inc 65.8
34 PAYX Paychex Inc. 65.7
35 EGOV NIC Inc 65.6
36 SLP Simulations Plus Inc 65.5
37 OTCPK:EGHSF Enghouse Systems Ltd 64.8
38 CELG Celgene Corp 64.7
39 EW Edwards Lifesciences Corp 64.6
40 MED Medifast Inc. 64.4
41 NKE Nike Inc 64.3
42 ANSS ANSYS Inc 64.2
43 MSB Mesabi Trust 64
44 IDXX IDEXX Laboratories Inc 63.9
45 FAST Fastenal Co 63.9
46 OTCPK:DASTY Dassault Systemes SA 63.6
47 V Visa Inc 63.6
48 MORN Morningstar Inc 63.5
49 CHE Chemed Corp 63.5
50 LSTR Landstar System Inc 63.5

Source: Portfolio123; data as of 5/3/2019.

Quality-focused investors should find many familiar names from the above. I will be covering any major change to the list in my subsequent writings as well.

Strategy

So does the Score add value for investors? Using the Simulation feature on Portfolio123, I then built the following simple back-testing strategy -

  • A mildly-concentrated portfolio consisting of 50 US-listed stocks;
  • Rebalancing once every 52 weeks to include, with equal weights, the 50 stocks with the highest Urbem Quality Score;
  • Excluding penny or illiquid stocks (i.e., price of less than $1 or past-20-day-average volume less than 20k).

It is worth mentioning again that the strategy only looks at the quality of business no matter how expensive the stock is to buy (or cheap to sell). It does not care about the economic outlook, interest rate, political event or other top macro topics that many media are busy covering on a day-to-day basis.

Backtest

I run the back-testing of the above strategy regarding Urbem Quality Score from January 2004 till now against the S&P 500 (SPY), and below is the result -

Source: Portfolio123; data as of 5/3/2019.

High scored stocks outperformed by a wide margin over the time horizon of past 15 years or so. Setting the time frame to past 10 years, 5 years, 3 years, 2 years and 1 year, we should see similar results -

10-year Backtesting

Source: Portfolio123; data as of 5/3/2019.

5-year Backtesting

Source: Portfolio123; data as of 5/3/2019.

3-year Backtesting

Source: Portfolio123; data as of 5/3/2019.

2-year Backtesting

Source: Portfolio123; data as of 5/3/2019.

1-year Backtesting

Source: Portfolio123; data as of 5/3/2019.

Over the period from January 2004, below are more statistics from the backtest:

Source: Portfolio123; data as of 5/3/2019.

Source: Portfolio123; data as of 5/3/2019.

Source: Portfolio123; data as of 5/3/2019.

It is worth noting that the high score stocks as a whole provide more downside protection (max drawdown of -45.73% vs. benchmark's -55.19%) while generating fewer upside crazes.

The long-term average of annual turnover is around 1/3 (33.20%), indicating the relative stability of the ranking year over year. The longest history of annual underperformance is 6 years, meaning the strategy outperformed the benchmark during any 7-year period since 2004.

Summary

Quality investing works! Urbem Quality Score is developed to uncover top-quality stocks in a programmatic way. The Score proves to add value to investors seeking risk-adjusted alpha and is the indication that probably valuations and macro conditions are not the top factors on long-term investors' priority list.

For those on Portfolio123, feel free to check out my profile and the strategy there.

Disclosure: I am/we are long MOST OF THE STOCKS MENTIONED. 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.