The AMR Craton Index: Introduction To Holdings And Backtesting Data

Summary

• This portfolio uses historical performance and qualitative business traits to determine low-risk assets.
• These assets are leading their class and represent sectors that offer lower volatility.
• Backtesting proves that the constituents outperform the S&P 500 since 2011 and with less volatility.

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Introduction

My newly created AMR Craton Index is similar to my prior data-selected investment funds, the Landslide and Glacier portfolios. But now I have now combed the market to find stalwarts, or the highest quality investments around, incorporating more qualitative data to the selection process. As stalwarts, these companies are nearly essential for modern society to operate, but also offer superior financial qualities.

Their importance and longevity is similar to cratons, or the billion year old rocks that form the core continental crust of our Earth. And, as per the Oxford Languages definition, the idea of a stalwart company is one that is sturdy, resilient, relatively risk-free, and reliable. All great traits that indicate the longevity and success of a long-term holding. And, to tie it all together, craton's naming origin comes from Kratos, or the Greek deified personification of strength.

Google, Oxford Dictionaries

Holding Selection Methodology

To this end, I have compiled 30 companies that check some important boxes of low risk and earnings growth. Total return was not one of the key factors I looked for when searching for companies, and this also means no consideration of valuation either. Instead, I wish to construct an index that performs well, regardless of economic state or cycle, and perhaps valuation will not matter in the end. But first, I selected from low-volatility industries such as data & analytics, healthcare, utilities, real assets, and consulting.

Then, I narrowed down the group to high market share constituents of those industries, essentially owning moats over their respective fields. While owning the market is good, I made sure that the low volatility and moat-like traits were met with solid leadership. To do so, I made sure organic and earnings growth is progressing at a sufficient rate by looking for steady revenue growth and rising margins through eras like the pandemic and financial crisis. No 3M-like (MMM) companies that have lost their luster are allowed.

The combination of qualitative and quantitative selection led to the initial portfolio construction containing 30 holdings. They range from a market cap of $236 billion to $5 billion, and average $60 billion. It is also important to note that I focused the index construction on diversification and risk-aversion with just a few holdings, and so there are many other potential candidates that can be considered. As I will highlight later in the backtesting data, my selection process led to a solid group of market beating assets. The question will be whether this performance will last. The index therefore constructed to answer some hypotheses for investors:

• The effect of a high valuation on quality companies.

• The helpfulness of diversification across equities.

• The factors and qualities that create stalwart companies, including future ones.

• And, whether quality lasts forever, and what are the mechanisms for change (size, management, cyclicality, competition, etc).

I hope to answer these questions, and more, in the years to come.

The Index Holdings (Equal Weighted)

Company (Market Cap Order)	Ticker	Sector	HQ	Key Qualities
Oracle	(ORCL)	Tech	US	Leader in advanced data storage and analysis technologies, now cloud-based.
Novartis	(NVS)	Healthcare	Switzerland	A pharmaceutical with the best pipeline in the industry.
Abbott	(ABT)	Healthcare	US	A diversified healthcare giant that offers lower-cyclicality products such as nutritionals and essential medical devices.
S&P Global	(SPGI)	Financials	US	The leader in global financial market data and analysis.
NTT	(OTCPK:NTTYY)	Tech	Japan	Although a legacy telecom provider, NTT is also a leader in the growing data center industry.
American Tower	(AMT)	Real Assets	US	The largest, and most diversified, of the cell tower REITs.
ADP	(ADP)	Tech	US	The leader of human capital management solutions, capably fending off competition from app software.
Merck KGaA	(OTCPK:MKKGY)	Healthcare	EU	The diversified leader in chemical supply to the life sciences and semi industries, with profits flowing into pharma research.
EssilorLuxottica	(OTCPK:ESLOY)	Healthcare	EU	The leader in both medical and recreational eyewear/contact solutions.
Enbridge	(ENB)	Utilities	Canada	The largest energy pipeline network owner, and safe due to strong relationships with regulators in the US and Canada.
RELX PLC	(RELX)	Tech	UK	The leader in professional data and analytics, including now mostly subscription-based services.
Deutsche Post AG	(OTCPK:DPSGY)	Industrials	EU	The parent company of the world's largest freight and express company, DHL.
Dassault Systemes	(OTCPK:DASTY)	Tech	EU	The provider of essential 3D modeling and design software.
London Stock Exchange Group	(OTCPK:LNSTY)	Financials	UK	One of the world's largest exchanges, now diversified by owning the analytics company Refinitiv.
Daikin	(OTCPK:DKILY)	Industrials	Japan	The financially conservative, diversified, and leading air conditioning tech provider globally.
Sempra	(SRE)	Utilities	US	A US utility focusing on natural gas supply in California and Texas, along with major infrastructure investments.
Sika	(OTCPK:SXYAY)	Industrials	Switzerland	A financially sound speciality chemicals provider, capitalizing on construction solutions.
Seven & i Holdings	(OTCPK:SVNDY)	Staples	Japan	The parent company of 7 Eleven convenience stores, offering global operational scale.
Kroger	(KR)	Staples	US	The largest pure-play investment in supermarkets across the US.
Capgemini	(OTCPK:CGEMY)	Tech	EU	A major tech consulting company with a high-quality offering and customer base.
Verisk	(VRSK)	Industrials	US	The leader in providing risk analysis data and research to companies around the world.
CoStar	(CSGP)	Industrials	US	The leader in commercial real estate data, along with owning Apartments.com and other listing sites.
American Water Works	(AWK)	Utilities	US	The largest public water utility, albeit with the weakest financials of the index.
JR Central	(OTCPK:CJPRY)	Real Assets	Japan	The largest and most profitable of Japan's rail operators, currently rebounding after the pandemic.
Mitsubishi Estate	(OTCPK:MITEY)	Real Assets	Japan	A real estate company with the highest quality developments in Tokyo, along with growing assets abroad.
Brookfield Infrastructure	(BIP)	Utilities	Canada	An energy LP with diversified holdings and stable financials.
Nordson	(NDSN)	Industrials	US	A financially conservative industrial manufacturer of high quality precision tech.
Bruker	(BRKR)	Healthcare	US	A rising leader in the life sciences analytical instruments industry, with the world's leading NMR machines.
Stantec	(STN)	Industrials	Canada	A key construction and engineering consultant focusing on sustainable development.
Exponent	(EXPO)	Industrials	US	One of the world's leading contract scientific research companies, particularly focusing on failure analysis.

Click to enlarge

Sector Breakdown and Notes

The Index's constituents are broken down by sector in the chart below. At first glance it may seem strange that industrials are the most common, as the industry is typically more cyclical than others, Seeking Alpha lists research and consulting companies within the industrial basket, and many great companies are in that sector. Some examples include Verisk, a leader in business analytics and risk management (including the only major choice in P&C insurance data), and CoStar, the owner of Apartments.com and a leader in real estate analytics. Other industrial holdings like Sika and Daikin offer exposure to the constantly growing construction industry, with excess exposure to emerging markets around the world.

The second largest sector of tech holdings is diversified into critical services such as data centers and storage, design software, and tech consulting. While leveraging high growth opportunities that are more cyclical in nature, these investments are more steady in nature and focused on conservative growth and high-quality services. I will note that there are more viable investments to be made, but to avoid trading in-line with the market, the index does not contain mega-caps or other major S&P 500 constituents.

Sometimes it helps to diversify away from the norm, and I believe the index reflects that. The exposure to multiple high-quality industries allows the index constituents to perform well in most business environments, mostly due to the essential nature of their services. There are also some special situations, such as my inclusion of the staples pair-trade in Kroger and 7-Eleven (you can read my thoughts here), and the inclusion of physical assets like Enbridge's pipelines, JR Central's rail network, and American Tower's cell tower and data center real estate. In the coming reports, I will dive into each subsection to discuss the implications, outlook, and competitive landscape. Now, let's move on to the financial aspects.

Compiled by Author. Data from Seeking Alpha, Koyfin, and Company Data

Growth and Profitability

Two main factors are the drivers for shareholder returns: growth and profitability. As I researched, I found that companies that are stalwarts offered both in spades, although organic growth may be limited due to market saturation. However, the best opportunity is when a company is able to improve their margins over time and drive earnings growth. Therefore, looking at both factors is important when considering long-term potential. A company with revenues falling will not be able to keep providing earnings growth as profit margins typically reach a high point. Conversely, too much focus on growth can hurt profitability and the rise in revenues does not always equate to shareholder returns.

As shown in the chart below, the AMR Stalwart constituents are mostly growing in the mid-single digits. A small subset are losing revenues over a longer period, but this is due to the abnormal pandemic preventing travel in Japan (JR Central), and various divestitures for Novartis. One fourth of the companies offer revenue growth above 10%, and this mostly implies a focus on inorganic growth strategies, capital gains rather than dividends or buybacks, and secular growth opportunities. However, strict profitability analysis prevents risk despite the higher growth.

Compiled by Author. Data from Seeking Alpha, Koyfin, and Company Data

The chart below highlights how almost 3/4th of all holdings exhibit a level of rising profitability. While some cyclicality of earnings is acceptable, I focused on assets that have at least 15 years of margin expansion history. This also includes selecting for companies that exhibited resilience during the financial crisis of '08. Those companies with flat margins are typically already extremely profitable and may be less prone to cyclicality. This includes cloud data management provider Oracle, business process outsourcer ADP, and partially consumer-cyclical vision specialists EssilorLuxottica. When visualizing the data manually, it is clear that all three companies may have moments of weakness, particularly with the pandemic, but other periods like the GFC of '08-'10 showed resilience and reliability. This is where manual analysis can outperform factor-based quantitative selection tools and will set my index apart from others.

Compiled by Author. Data from Seeking Alpha, Koyfin, and Company Data

Backtesting Vs S&P 500

Backtesting is a useful way to measure whether a group of companies have performed well, although it does not predict future performance. However, the AMR Craton Index met its goals to beat the market in terms of both total return and reduced risk. Since 2011 (with Sika AG excluded due to ticker availability on portfolio visualizer), the equal-weighted holdings have provided an annual total return rate of 15% compared to the Vanguard S&P 500 ETF's (VOO) 12% rate. This led to a hypothetical portfolio turn from $10,000 to $55,000. The AMR Craton Index also offered less risk, with both the Sharpe and Sortino Ratios being 30-40% higher than the benchmark, even with fewer holdings and higher returns.

Unfortunately, backtesting beyond 12 years is difficult to accomplish due to the lack of ticker availability for the foreign assets within the index, but with time I will discuss the historical performance through prior bear markets for the portfolio in detail. Also, one key risk is that the constituents are not guaranteed to continue beating the market. My selection metrics did not take into consideration valuation, and so there may be additional volatility and risk from current levels. Thankfully, I will use the index data to determine if this is so, and I will be sure to discuss the implications and index performance in future reports.

Portfolio Visualizer

Replication

While the AMR Craton Index outperformed VOO by approximately 25% per year, due to the recent formation and lack of investable fund, this relative performance is unhelpful for investors. Therefore, some clarity can be found when using other indexes and funds that are tradable in the market. As an example, two similarly compiled ETFs are the Morningstar Wide Moat ETF (MOAT) and the MSCI International Quality Factor ETF (IQLT) (with Vanguard FTSE Europe ETF (VGK) as a market comparison). We can also compare to the leaders of the market, or the Vanguard Mega Cap Growth ETF (MGK).

As shown in the correlation backtesting below (constrained due to the recently formed funds), selecting for quality or a moat has outperformed the broader market, particularly with MOAT. MOAT's performance has also beaten the largest growth companies in the market, even if the correlation is high. The pattern is the same on the international side, with IQLT beating the broader European market. This suggests that stalwarts are both the best performers in the market, and the drivers for broader market growth in general. Therefore, it is easy to reach market level returns, but with far less risk. However, my Craton Index outperformed by ~25% per year, compared to MOAT and MGK outperforming by 10% annually. My index is more comparable to IQLT, which outperformed the broader European market by 25% per year.

Portfolio Visualizer

Portfolio Visualizer

Conclusion

I believe that the AMR Stalwart Index is a great representation of only the highest quality companies in the market. The constituents offer both qualitative and quantitative advantages in terms of longevity, stability, and success. While only time will tell how the index performs, I believe the assets will do well in providing market beating returns and reduced volatility. I will also be actively managing the index and make any necessary adjustments on a quarterly or semi-annual basis. For those familiar with my articles, you will notice that I have written on many of these companies in the past and offer more insights into why they are included in the index.

For now, I will let readers mull over the index holdings and I will certainly take into consideration any constructive commentary on the holdings and selection methodology. I will also be providing regular updates on the portfolio that showcases different analyses of the portfolio, whether comparing constituents to peers, showcasing key financial qualities, or discussing recent news and events. I hope you will follow to see where this index can go, and my goal will be to provide quality actionable conclusions even if the index is not directly investable.

Thanks for reading.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of CJPRY 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

For informational purposes only. The AMR Craton Index is not investable, nor is this article a recommendation to buy or sell any equity.