As any serious investor appreciates, stock valuation is an art form and not a science. There is a myriad of ways to look at a stock for the purpose of determining its value and its relative attractiveness.
Clouds in the Coffee: Some investors rely on fundamental analysis, others on technical analysis, while some utilize both. A few investors even interpret clouds in their coffee as their main source of research for selecting a stock. Whatever your preferred technique, there is no absolute way to approach stock valuation. When you think you’ve “broken the code”, it changes.
CEF Market Segment Esoteric: When it comes to investing in the closed-end fund (NYSEMKT:CEF) market segment, it becomes even more esoteric due to its small market capitalization, its conduit status (must pay out its earnings as a dividend), its retail investor clientele whose knowledge-base greatly varies, its asset type diversity, its highly visible “intrinsic value” and its low visibility with regards to components of distribution, etc.
Ranking Criteria: I rely heavily, but not solely, on numbers reflecting observable investment facts and events. The reliability of the methodology is found in the cyclical nature of the stock market and its related patterns. If I may paraphrase Mark Twain, “History may not repeat itself, but often rhymes.”
Eqcome’s Eight CEF Ranking Criteria: I use an eight criterion ranking system for closed-end funds (CEF) that culminates in a single “1” to “5” ranking: “5” being the most attractive. The ranking can be found on my website (click here).
Those eight criteria are listed below:
1. Historical Absolute NAV Total Return: This is an important criterion as it relates to the investment prowess of the investment manager. A high net asset value (NYSE:NAV) total-return implies that the investment manager is consistently performing its major function of successfully investing its assets.
2. Total Return NAV/Price Spread: This is the difference between the total return on the NAV versus total return market value. Since in theory they should trade in tandem, when a positive spread is generated, it implies the price may not have caught up to the NAV return.
3. Current Versus Historical Premium Discount: This is the difference between the current discount/premium and the historical discount/premium. This is addressing the “gravitation to the mean” phenomenon.
4. Relative Premium/Discount: This is a measurement of a premium/discount relative to a peer group.
5. Distribution Yield: This is a measurement of the distribution yield within a “bell curve” ranking, i.e., the tails have lesser value as they are viewed as less attractive.
6. Current Premium/Discount Difference YTD: This is a measurement looking for abnormalities in returns on a relative time basis.
7. Relative Strength: This is a momentum measurement looking at the stock price performance relative to the market to determine sustained investor interest. (This is not to be confused with the Relative Strength Index (RSI) which is a calculation of a stock price movement against its recent historical price movement.)
8. Weighted Alpha: This is a measurement of a stock price risk adjusted movement that is time-weighted and is another form of assessing stock price momentum.
Short Comings of Any Valuation Model: Ranking systems rely heavily on historical data as valuation criteria. So, to some extent, stock ranking systems are the equivalent of driving a car forward while looking out the rear view window.
Randomness of Rankings: This was clearly evident in Morningstar’s CEF rating system being used by investors as a predictive performance guide. In an article Morningstar CEF Rating System: Worse than Random (6/6/09), it was demonstrated that there was an inverse relationship between Morningstar’s CEF ratings and future stock price performance over the period highlighted in the article.
CEF Rankings Confusion: To eliminate any confusion regarding Joe Eqcome’s rankings as stock recommendations, such rankings have been relabeled Eqcome CEF Historical Performance Index Rankings (“HPIR”) to better reflect that reality. The HPIR is one of the fundamental screening tools and building blocks for CEF stock selection. (A separate report regarding Joe Eqcome’s CEF recommendations shall be forthcoming.)
Parting Comment- There is no one right formula for successful stock investing—particularly for CEF investing. What has been offered here is just one guy’s approach which may or may not be of help to my fellow retail investors.
There is a wealth of information on CEFs at CEFConnect.com.
Joe Eqcome (No Disclosures)