Boost your returns, Part III – It’s alive!
In Part 1 of our “Boost Your Returns” series, we introduced the idea of using pattern recognition technology to help identify listed companies with the potential to outperform or to underperform. The idea was to use large amounts of historical financial and market data to teach a machine to distinguish between good and bad investment opportunities.
In Part 2, we tested this approach, and saw some encouraging results. While the machine got many of its calls wrong, it was able to demonstrate a clear edge in terms of getting more right than wrong. In equity market investing, a small edge like this can make a world of difference to long term results.
With that behind us, we move to the interesting part – finding out what the machine would invest in (or avoid) today.
From our testing it appeared that the machine was particularly adept at spotting bad investments – the sort that can wreak havoc on your portfolio when something goes wrong, so that’s where we’ll start. After analysing the ASX200 Index as at yesterday’s close, the machine has proposed the following as 20 stocks as the ones it would be most nervous about.
At the outset it is important to stress that several of these are likely to perform very well, and if a stock in your portfolio appears on this list that does not mean you should necessarily sell it. However, it may be appropriate to consider your rationale for owning it and your confidence in that rationale.
Table 1 – Possible Underperformers
|
Code |
Name |
Q&P |
Sector |
|
TRS |
REJECT SHOP LTD/THE |
B2 |
Consumer Discretionary |
|
OZL |
OZ MINERALS LTD |
A4 |
Materials |
|
SXL |
SOUTHERN CROSS MEDIA GROUP L |
B3 |
Consumer Discretionary |
|
GNC |
GRAINCORP LTD-A |
B3 |
Consumer Staples |
|
ILU |
ILUKA RESOURCES LTD |
B4 |
Materials |
|
BKN |
BRADKEN LTD |
B4 |
Industrials |
|
ACR |
ACRUX LTD |
A3 |
Health Care |
|
ALQ |
ALS LTD |
A3 |
Industrials |
|
MSB |
MESOBLAST LTD |
A4 |
Health Care |
|
MML |
MEDUSA MINING LTD |
A2 |
Materials |
|
WTF |
WOTIF.COM HOLDINGS LTD |
A2 |
Consumer Discretionary |
|
TEN |
TEN NETWORK HOLDINGS LTD |
C4 |
Consumer Discretionary |
|
MMS |
MCMILLAN SHAKESPEARE LTD |
A2 |
Industrials |
|
TWE |
TREASURY WINE ESTATES LTD |
B4 |
Consumer Staples |
|
WHC |
WHITEHAVEN COAL LTD |
B4 |
Energy |
|
PDN |
PALADIN ENERGY LTD |
C5 |
Energy |
|
RRL |
REGIS RESOURCES LTD |
A1 |
Materials |
|
KAR |
KAROON GAS AUSTRALIA LTD |
A4 |
Energy |
|
LYC |
LYNAS CORP LTD |
C5 |
Materials |
|
BRU |
BURU ENERGY LTD |
C4 |
Energy |
The first thing we notice is that more than half of the companies in the bottom 20 are outside the A1-B3 quality and performance range that we consider investment grade. Our investment process excludes these sorts of companies and so we won’t have much more to say about them. For comparison, less than one quarter of the ASX200 fall into this category, so this bottom 20 is definitely overweight low quality/low performance.
Among the investment grade companies there is one that immediately raises our eyebrows – MMS. We own MMS in the Montgomery Fund, and having analysed it at some length we believe that intrinsic value lies significantly above the current share price. We also feel that we understand the reasons why MMS has suffered recently in terms of earnings and share price and having done this work we are comfortable disagreeing with the machine on this one.
Beyond MMS, there is not much on this list that we would want to include in a portfolio, and for those inclined to short sell, there may be some opportunities here well worth considering. It will be interesting to watch the performance of this group over the year ahead.
Let us know if you feel that other companies on the list have been unfairly maligned and in the weeks ahead we will repeat the process with the top 20.
Tim joined Montgomery in July 2012 and is a senior member of the investment team. Prior to this, Tim was an Executive Director in the corporate advisory division of Gresham Partners, where he worked for 17 years. Tim focuses on quant investing and market-neutral strategies.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
Michael Shapiro
:
I own one of the companies on the list ALQ (ALS LTD). I bought it on the 23rd of May. What I saw is a quality company well diversified across industry sectors and geography. PE fell below 10 year average, with 99% dividend stability, paying dividends in July. Technically, It was trading at the bottom of a bear market range in the process of transitioning into a trading range (this is where I prefer to buy bargains). Seasonally, it was week 21. Week 20 to 21 is the negative weekly cluster for ALQ, with average return being -2.95%. More importantly the following week #22 is statistically the best week of the year for ALQ, with average return of 7%, Max return 22% and positive return probability of 83.3%. With the negative cluster almost of the way and a hugely positive week coming up I bought the shares at $7.32. What can I say ALQ didn’t disappoint, trading at about $9 now. I feel there is a reason behind weekly seasonality statistics. They reflect consistency with which quality and rubish companies report year after year.
wayne-anderson-923519
:
Hi Roger, I currently own two of the bottom 20 companies named by the, the machine as companies that shouldn’t be in your portfolio. They are Bradken and the Ten network. Before listening to you on last Tuesday’s night ABC program with Tony, I was contemplating selling on both shares. I will take small loses on both, but I cannot see the worth of hanging onto both these stocks. Ten struggles in a competitive sector, and Bradken seems to have cash flow problems, and ever since their split with Esco America, hasn’t been able to capture enough market share. As with most manufacturing industry in Australia their future in this country looks bleak. Thanks Wayne.
Roger Montgomery
:
Dean and Graham wanted you to know Tim: “Thank you for sharing enviable knowledge through this article :)”
Andrew Legget
:
The only company on the above list which has turned up on my radar has been Wotif. When first learning and researching these types of companies i realised that whilst they were at the time great businesses, they were vunreable to aggressive challengers as although they had a decent brand and “network effect” there isn’t enough of a competitive advantage to protect them from well resourced competitors. This appears to be what is happening at present to them. I decided for WTF that i would prefer to sit on the sidelines and watch the response. There is an arguement they got complacent.
None of the other companies have really ever interested me, some are just terrible. I cannot personally find a single positive aspect or reason gor myself to consider Ten Network as a good addition for example. may be harsh but just how i see it. The fact that your model is flagging these companies as potential underperformers is encouraging.
I obviously don’t know the exact sample and setting this process is using nor do i expect you guys to tell me but looking back at the parameters that you mentioned in part 2 that the model found significant, i can’t help but think that MMS might be a victim of the momentum factor. If momentum starts kicking the other way (if it hasn’t already) then this would probably find itself off the list rather quickly i would imagine.
It will be interesting to see what results continue from this process. Thanks once agin for sharing, i have always said that finding and staying away from “bad” companies is just as important as finding the “good” ones and all of this adds extra information to throw into the cauldron of investment ideas so we can mix it all together and see what comes out.