Do the numbers tell a strong story?
The first step in our process is to quantify-with certain critical modifications-the research that traditional analysts perform by hand. We use our own model to rank a universe of over 10,000 stocks according to expected investment return. The top 100-ranked stocks are large-, mid- and small-cap companies with better-than-average profitability and long-term growth prospects selling at market or below-market multiples.
Our model does not consist of one simple screen or a combination of vendor-supplied screens; it is a truly proprietary approach to measuring expected investment returns. The model is the mathematical definition of expected return, rewritten in standard accounting variables. It takes into account the relationship between forecast growth and profitability as measured by return on equity on the one hand, and valuation ratios on the other. The inputs to this model are forecasts, developed algorithmically based on our proprietary research. This research adjusts consensus numbers to take into account Wall Street analysts’ overestimation bias and anomalous accounting items such as the frequency and magnitude of one time charges and unusual tax rates. The programs that perform these computations were originally written by Managing Partner & Chief Investment Officer, Michelle Clayman, CFA.
After the model ranks securities from highest to lowest in terms of expected return, we use a series of tools to allow us to better focus on the best opportunities. These metrics include:
We have determined through our backtesting that companies where our estimates on forecast growth are higher than the consensus tend to have positive earnings surprises, and therefore stock price outperformance.
The Zacks indicator measures earnings surprise and upward revision, has proved valuable to us in our backtesting.
Measures the increase in gross margins that are not attributable to increases in capital or headcount. We calculate a score for each company that emerges from the model. Our backtests indicates that those companies with higher relative scores tend to outperform.
We make sure that we consider the counter-arguement against any name we are considering.
We have always focused on company debt. We also make sure we understand the terms and nature of debt.