My Top Ten Factors - For Going Long And For Going Short

Jun. 10, 2022 3:38 PM ETBGSF, DLHC, DMTK, DNMR, EBET, FUV, GASS, GRWG, HSON, INTZ, ISTR, MCBS, PRPL, PRPLW, PTSI, RLGT, RNLX, RTNXF, SMMT, TBLT, VAPO, VHI14 Comments14 Likes

Summary

  • I list and explain ten factors for choosing stocks to go long and ten factors for choosing stocks to short or buy puts on.
  • These are factors I use every day, and include earnings growth, share turnover, free cash flow, and many others.
  • At the end of the article I list my top ten stocks for going long and going short, based on these factors and others.
  • I do much more than just articles at The Stock Evaluator: Members get access to model portfolios, regular updates, a chat room, and more. Learn More »

A rising graph containing various factors

Hiroshi Watanabe/DigitalVision via Getty Images

When I invest in a company, I try to look at it from every angle I can. But obviously, some angles are more important than others. In this article, I’ll discuss the factors that are most important to me.

I’m not really a buy-and-hold investor. I like to buy companies with strong earnings reports, and if the next quarter’s report isn’t very strong, I’ll often sell the stock. This practice may not work for everyone, but it’s worked for me: with a portfolio of between twenty and fifty stocks, I’ve made a compounded annual return of 48% since late 2015, when I started using factor-based ranking systems to choose stocks, with lower drawdowns during stock market downturns than those of the major indices.

Like Peter Lynch, I believe in investing in boring, little-known companies rather than cutting-edge, exciting, controversial, highly hyped, or turnaround companies. This strategy has proven to be especially strong lately: after my portfolio went up 105% in 2020, it went up another 73% in 2021 and 27% so far in 2022.

In this article I’m going to spill my secret sauce, as it were, and tell you the factors most important to me in my investing decisions. I’ve intensively tested all these factors using Portfolio123, where I have created ranking systems based on them in order to choose the stocks I buy and sell.

Part One: Going Long

Here are my top ten factors, in order of importance:

  1. Strong earnings growth. Every company has periods during which earnings are improving. It’s a good idea to ride that wave. I’ll break earnings growth down into the six components I examine: a) compare the most recent quarter’s operating income to the same quarter last year; b) compare the most recent quarter’s net income, adjusted for special items, to the same quarter last year; c) compare the current fiscal year’s EPS estimate to last fiscal year’s GAAP EPS, adjusted for special items; d) compare the most recent fiscal year’s net income, adjusted for special items, to the previous year’s; e) compare the estimate for next quarter’s EPS to the GAAP EPS of the same quarter last year, adjusted for special items; and f) count the number of quarters out of the last six in which the EPS was higher than the same quarter the previous year.
  2. Low share turnover. Share turnover is basically volume divided by shares outstanding. I wrote a long article that explains why this measure is so important. I use both a one-year and a three-month measure.
  3. Low volume. The lower, the better, within limits. You want to favor stocks that are essentially flying under most people’s radars. But don’t buy stocks whose volume is so low that buying them will result in major market impact.
  4. Strong analyst sentiment. There are a lot of ways to measure sentiment, but I use a ranking system that Portfolio123 developed many years ago. It includes measures of analyst EPS revisions, EPS surprises, and recommendations. There are plenty of other sentiment measures that you can throw into the hopper: they can’t hurt.
  5. High earnings yield. I favor looking at the current fiscal year’s EPS estimate divided by the price, but I’ll also look at the next twelve months’ EPS estimates and the actual EPS of recent quarters.
  6. Low market cap. I favor small companies for both going long and going short: they’re the ones with the most potential to grow—and the most potential to collapse—and their performance tends to be less affected by what Robert Shiller calls “noise.”
  7. Accelerating sales. This is measured by the sales growth of the most recent quarter over the same quarter last year divided by the absolute value of the sales growth of the last twelve months over the twelve months before that. It’s a bit of a weird and counterintuitive measure (developed, I believe, by Marc Gerstein, to whom I take my hat off), but it works.
  8. High cash flow to enterprise value. I use several different measures here: a) unlevered free cash flow to enterprise value; b) estimated free cash flow to enterprise value; c) unlevered operating cash flow to enterprise value.
  9. Volume increase. I’m looking for stocks with a recent increase in volume, and use a combination of measures to determine that.
  10. High free cash ROA. This is the ratio of free cash flow to total assets; I use a slightly different formula than what you might expect, which is the sum of the most recent quarter’s cash flow from operations and cash flow from investments (the latter is usually negative), all divided by the total assets of the company.

Part Two: Going Short

I don’t usually sell stocks short, preferring to buy puts on the rare occasions they’re not overpriced. Here’s what I look for in companies whose price I expect to fall, in order of importance:

  1. High price volatility. Stocks with huge ups and downs in price are good stocks to bet against.
  2. Low market cap. See above.
  3. Unstable sales. I look at the standard deviation of sales over the last twelve quarters divided by their average. Companies whose sales are going up and down a lot are good companies to bet against.
  4. High net operating assets. Stocks with a high ratio of net operating assets to total assets have very little cash on hand and might plummet if there’s the least sign of trouble. I’ve written about this measure here.
  5. High share turnover. See “Low share turnover” above.
  6. Terrible momentum. I look at the relationship of the price of the stock a month ago to its price six, nine, and twelve months ago, and also to its 52-week high. If those ratios are low, the stock has a lot going against it.
  7. Divergent or unstable fixed-asset turnover. Take the ratio of fixed assets (gross PP&E) to sales and compare it to both a) the industry median and b) the same ratio last year. The higher the differences, the more horrible the situation you’re looking at. Companies with fixed-asset-turnovers that are far from the industry median either have too much invested in their fixed assets and low sales, or sales that are relatively unsustained by their fixed assets. And companies whose ratio changes radically from year to year are inherently unstable.
  8. Sales deceleration. See “Sales acceleration” above.
  9. Low industry group momentum. If the industry group (or subsector) the company belongs in is doing badly, it’ll help you in terms of shorting the stocks in that industry.
  10. Low cash flow to enterprise value. See “High cash flow to enterprise value” above.

Part Three: Stocks to Go Long and Go Short

Based on all these factors, as well as a number of others, if I were to confine myself to U.S.-listed stocks with a minimum daily dollar volume of $50,000 and a minimum price of $3, I would suggest going long the following ten stocks: DLH (DLHC), Valhi (VHI), P.A.M. Transportation Services (PTSI), Summit Financial (SMMF), StealthGas (GASS), BGSF (BGSF), Investar (ISTR), Hudson Global (HSON), Radiant Logistics (RLGT), and Metrocity Bankshares (MCBS). I own shares of all these stocks myself.

Given the same restrictions, I would suggest shorting or buying puts (if the price is right) on the following ten stocks: Arcimoto (FUV), Ebet (EBET), Danimer Scientific (DNMR), GrowGeneration (GRWG), Toughbuilt Industries (TBLT), Renalytix (RNLX), DermTech (DMTK), Purple Innovation (PRPL), Intrusion (INTZ), and Vapotherm (VAPO).

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

My marketplace service, The Stock Evaluator, comprehensively ranks over 7,000 stocks weekly based on a sophisticated multi-factor system with deep roots in accounting and valuation methods. It has a strong out-of-sample record: since the service began over four years ago, high-ranked stocks have consistently outperformed the market while low-ranked stocks have consistently underperformed it.


This article was written by

Yuval Taylor profile picture
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Weekly evaluation of thousands of stocks based on sound financial metrics.

I am the author of Zora and Langston: A Story of Friendship and Betrayal, as well as other books; I am also product manager at Portfolio123, a small financial technology firm. In my spare time I invest, primarily in microcaps; investigate investment conundrums; and write about my investigations on Seeking Alpha and on my blog, http://backland.typepad.com/investigations. I am now offering a subscription service, The Stock Evaluator, which sends out weekly rankings for over 4,000 stocks; you can reach it here: https://seekingalpha.com/author/yuval-taylor/research.

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Disclosure: I/we have a beneficial long position in the shares of DLHC, VHI, PTSI, SMMF, GASS, BGSF, ISTR, HSON, RLGT, MCBS either through stock ownership, options, or other derivatives. 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.

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