The StockRanks — Five Years of Market-Beating Returns

10 essential insights

In 2013, a year after we launched the subscription service on the Stockopedia website we had an idea. Having read through hundreds of academic papers, quantitative research notes and books on the subject of stock selection we realised there were some common threads. Why not bring those threads together into a simple, intuitive and effective rating system for stocks?So were born the StockRanks, which we launched in April 2013 for UK stocks. The system was extended across Europe and other global markets over the next several years. This academically inspired, but intuitive system that ranks stocks for their quality, value and momentum has become the most loved feature of the service. 73% of subscribers tell us it’s had more impact on their results than any other site feature.

Reviewing half a decade of insights…

Last month marked the five year anniversary of their birth and led to some reflection. Over this period, the top 10% of UK stocks by StockRank have generated annualsed capital gains of almost 20%. Significant wealth has been generated through their use. Across more than a hundred years stock market history, five years is not long, but the differential returns between high and low ranking stocks do suggest that our approach has merit.

Since 2013 I’ve published dozens of blogs, videos and webinars about the StockRanks and their use in portfolios which have generated vigorous discussion. Having to respond to such an intelligent community of investors has been one of the most rewarding aspects of my role. It’s helped considerably to deepen my thinking on all aspects of investing — especially with regards behavioural biases, factor investing, diversification and rebalancing.

Last week I conducted an extensive but accessible 2 hour webinar covering the construction, history and usage of the StockRanks. It’s a deep dive into the foundations of factor investing, ranking systems and their use. Any investor using the StockRanks to help in their own stock selections will benefit from the lessons within. Thanks to Ian for the following compliment on the material:

“A lot of ground covered in your latest webinar — Its instant investment expert stuff!”

Market beating returns don’t come without risk…

While the performance to date has been impressive, I try in the webinar to be clear about the risks. Our factor-investing inspired approach has worked across most sectors, size groups and regions in the world to date but these sources of return may not persist perpetually. The old financial industry disclaimer “past performance is not an indicator of future returns” remains true.

Investors using the rankings should be aware that factors like Value & Momentum do not all work across all market cycles, and there are likely to be ‘bad times’ of underperformance in different market areas at different times. This is to be expected. All good systematic investors know that without occasional underperformance, outperformance cannot return. Markets tend to be reasonably efficient after all, and strategies showing good returns tend attract more capital until they are squeezed.

Nonetheless, for me, investing in stocks that display the traits targeted by the StockRanks (high quality, good value, strong momentum) is the only rational way to invest. The day the market doesn’t reward these traits, is the day I’ll throw in the towel and invest in tracker funds. Thankfully, for everyone that enjoys selecting their own stocks, that day doesn’t appear to have arrived quite yet.

Ten key insights from the last five years

While most of my recent work has gone into the webinar, slides and ebook, the following are ten key insights worth reiterating in this blog. The charts below relate to UK stocks above a £10m market cap. If you want a more international perspective you can jump to the relevant section in the webinar.

1/ Quality Stocks have outperformed Junk Stocks Profitable, cash generative, low debt, high margin companies with improving fundamentals have outperformed unprofitable, cash consuming, high debt, low margin companies with deteriorating fundamentals. It’s not rocket science… just good common sense.

2/ Cheap Stocks have outperformed Expensive Stocks Stocks that are cheap according to traditional valuation ratios like the Price Earnings ratio, the Dividend Yield and the Price to Sales ratio have outperformed those that are expensive on the same measures. Bargain bucket investing still pays…. but do note, it’s been a very volatile approach, and is loaded with significant risk. Watch the webinar for more info on how to use the ValueRank.

3/ Strong Stocks have outperformed Weak Stocks Buying ‘Momentum’ is loathed by Value investors… but it’s been almost twice as profitable in recent years. While the value investing brigade have done ok, momentum and trend investors have done far better. Recently the Momentum Rank started outperforming the overall StockRank. Buying shares at new all time high prices is a strongly leading indicator of future price performance.

4/ Higher StockRanks have had a higher chance of being winners The following chart shows the percentage of stocks each year that have on average turned a profit (in blue) or a loss (in red) over the next 12 months. For 90+ ranked stocks there’s been a 2 in 3 chance of picking a winner, for 10- ranked stocks there’s been a 1 in 3 chance. Thanks to Oliver Cooper for his extensive work on these hit rates.

5/ Low StockRanks stocks lose more on average, but win more when they win While higher ranking stocks have outperformed, that doesn’t mean lower ranking stocks should be ignored. Oliver’s analysis has shown that if you do pick a winner in lower ranking shares, you are more likely to pick a big winner. The blue line below shows the average size of a win given a win. There’s hope for blue sky stock pickers yet!

6/ High StockRank stocks have outperformed in all sectors except Energy We use the same universal ranking system across all stocks in the market. Understandably many have queried this approach. Surely the metrics most appropriate to analyse financials are not the same as those most appropriate for healthcare stocks? While these arguments have merit, the results have been surprisingly consistent across every sector in the market except the Energy sector which has been going through a poor cyclical swing.

7/ High StockRank stocks have outperformed across all size groups Given the dominance of small cap shares in recent years, some have questioned whether the StockRanks have any use among large caps. The results show categorically that these approaches have been universally effective across size. While there is a small cap bias, the 9% annualised performance for large cap shares has dramatically outperformed the 3.3% annual performance of the FTSE 100 over the same timeframe.

8/ Sucker stocks really do deserve their label… The Style Classification system that we launched last year was a great project pioneered by Tom Firth here. We wanted to use provocative language to help subscribers think twice whenever they were attracted to lower probability bets. This approach was inspired by Cass Sunstein’s excellent book “Nudge: Improving Decisions About Health, Wealth and Happiness”. While buying lower ranking shares can be highly profitable, the odds are low… and they are never worse than when picking ‘Sucker Stocks’. If you’d like a fun 33 minutes on the “Super Stocks vs Sucker Stocks” debate — watch this speech.

9/ You can’t pick the perfect stock, but you can synthesise one… In the webinar I showed that trying to screen for stocks with great financial metrics is a futile exercise. The perfect stock that has high profitability, high margins, a low P/E, high yield, strong relative strength and a history of beating expectations does not exist. But when using the highest StockRanks in the market, you can synthesize a portfolio that displays these traits on average. It’s a kind of mad alchemy.

10/ We’re psychologically biased against high StockRank stocks, and attracted to low StockRank stocks This classic example from a few years ago really illustrates this point. Dart Group had a rank of 100, and beat expectations, while Synety had a rank of 1 and disappointed by announcing a placing. Dart rallied, Synety plummeted. Comments about dull, predictable Dart discussed taking profits. Comments about exciting, story stock Synety discussed buying more. What happened in the following 12 months is a tale that plays out again and again and again…

I hope these insights have been useful. Please remember that Stockopedia is designed for DIY investors. Make sure you do your own research (DYOR) and take investment advice if you aren’t sure about your own ability to select good shares. We do everything we can to help, but there are no guarantees in the market, and ultimately the future is annoyingly unpredictable.

Here’s hoping the next 5 years are as profitable as the last.

Originally published at www.stockopedia.com.

Disclaimer: This content should be used for educational & informational purposes only. We do not provide investment advice, recommendations or views as to whether an investment or strategy is suited to the investment needs of a specific individual. You should make your own decisions and seek independent professional advice before doing so. Remember: Shares can go down as well as up. Past performance is not a guide to future performance & investors may not get back the amount invested.