Month 8 running our Growth At A Reasonable Price Strategy sees a a rebound with total returns rising from 12% to 24% over the last quarter.
Our strategy weathered a 10% downturn in the last 3 months but is comfortably outperforming the S&P 500.
We analyse what’s happened in the last few months and why our strategy has remained so resilient.
In the summer of last year, we published How To Return 29% A Year From This Successful GARP Strategy. The article demonstrated a data-driven trading strategy which identified dividend-paying companies that exhibited strong recent growth in their financials and were reasonably priced when compared to their book value and free cash flows.
You can see the live version of the strategy by clicking here. This shows our strategy weathering the recent pause for breath in the markets by dropping in February and March but powering back in April:
Total Return (8 months)
Win Rate (Closed)
Why The Strategy Has Worked
Our strategy has worked so well because it does exactly what it says in the title – seeks growth at a reasonable price. The GARP strategy looks to identify companies that have a recent history of growing both its top line income and bottom line earnings that are still undervalued according to their current price compared to book value, cashflows and historical growth.
Because the stocks that the strategy picks have shown growth in fundamentals but not yet in price (we specify a PEG ratio of less than 0.9), we select stocks which have a high chance of popping higher in the short term. Coupled with the fact that the strategy also tends to only hold stocks 1-3 months, this enables us to take profits on successful positions quickly and drop losing positions before they can do too much damage to our returns
How The Strategy Works
The strategy was built and tested using the InvestorsEdge.net platform – you can find more risk and strategy performance information on the model, together with the actual strategy definition details, by clicking here.
As a quick summary, each month we rebalance our portfolio using the following rules – we begin by defining a universe of stocks that have:
Market capitalizations greater than $150m and share price greater than $2.
A PEG ratio less than 0.9.
An average EPS growth rate greater than 10% for the past 8 quarters.
Net Current Asset Value of greater than $-750m.
Gross Income greater than Gross Income from the last quarter.
On 1st January (our last rebalance point), this would have returned 76 stocks, which we then rank using the following factors:
Price to Book Value
Price to Free Cash Flow
We then buy the top 10 stocks in our ranked universe of securities, dropping existing positions unless they continue to rank in the top 10.
Our original backtests displayed compounded average returns of 29% a year since 2000 with remarkably low volatility for a strategy that invests primarily in small cap companies.
As of 9th May 2018, the strategy held the following positions:
A key risk that we always examine with mechanical investing strategies is that the data phenomenon that we are exploiting will simply stop working. To combat this, we look to see if a strategy intuitively makes sense – our model invests in companies with high historical and estimated EPS growth, high yields and assets and that are cheap relative to their book value and free cash flows, and that are showing improving gross income figures. To us, these are all logical and understandable factors as to why our system works and should continue to be profitable.
The average company our strategy invests in has a market capitalization of $250m-$2.5bn, leading to potential problems exiting positions at the lower end of our range in a market downturn. Risk appetite is an individual thing – for us the enhanced returns that come from focusing on smaller companies more than compensate the liquidity risk we take on. If this is a concern, operating the strategy with a higher market cap threshold would have resulted in smaller but still substantial historical profits.
Our Growth at a Reasonable Price strategy has held up as US stocks headed lower. The value of our holdings grew by 12% in the three months between January and April, and we feel that the strategy has demonstrated a good level of resilience during the recent market turbulence.
As you can see by the disclosure, we have invested in this strategy with our own funds.
Disclosure: I am/we are long HCLP, MERC, ANF, MRVL, SGU, TOL, PHM, JE, AEO, TLYS.