Screening, Stock Selection and Portfolio Construction147 views 2012-09-20 10:30 Tags: stock portfolio construction
When I decided to start this blog, I did not know whether to make it about deep and thorough fundamental analysis which focused on long-term value or about short-term technical analysis strategies. I have always been attracted to both methods of analyzing and selecting stocks mainly because both methods can be profitable if one has the right approach towards them. So this was my dilemma. After thinking through it for a while, I decided to do a mix of the two. I want this blog to be a place where me and my readers can visit regularly, share investment ideas and stock picks and compare strategies and their performance. I think that a blog dedicated to full-fledged fundamental analysis would not accomplish this goal (at least not right now) because performing good and thorough fundamental analysis takes a lot of time. I currently do not have sufficient time because of work and study commitments. That being said, I will definitely make an effort to introduce some fundamental analysis posts to this blog focused on value stocks, special situation stocks and general market commentary.
Therefore, as I said before, I decided to focus this blog discussing stock picks and portfolios consisting of these picks. These securities are selected using a mix of technical and fundamental factors. I believe this will give me a greater chance to communicate with my readers on a more regular basis and still be able to keep my work-study-life balance. So, to start things off, I will discuss the methods I use to screen for stocks, to select entry and exit points and to construct portfolios with the stocks I choose to buy. Always keep in mind that these are virtual picks and portfolios. No real money is involved.
For me, stock screening is the fundamental analysis portion of the decision making process. All stock picks and portfolios will start from September 4, 2012 (the first trading day of the month). Stock screens will be run on the first trading day of every month to narrow down the universe of possible choices. The stock screener that will be used will be the Yahoo! Finance Stock Screener because of several factors:
- It contains the fundamental criteria that will be used to select stocks.
- It has the ability to divide screens based on market capitalization.
- It has the ability to export the screen results into an Excel worksheet.
The fundamental criteria utilized for screening potential investments are:
- Return on Equity
- Price to Earnings Ratio
- Forward Price to Earnings Ratio
- Dividend Yield
The stocks returned by each screen are then further divided based on market capitalization as of the date of the screen as follows:
- Large Cap (Over $10 billion)
- Mid Cap (Between $2 and $10 billion)
- Small Cap (Between $250 million and $2 billion)
After subdividing the screen results in this manner, we end up with 12 groups of potential investments. Each group will be the universe of available investments for each of the 12 portfolios during said month.
The universe of available investments for each of the 12 portfolios are then submitted to a final screening process based on two technical indicators. I utilize these two indicators to help me select the stocks with the most favorable entry points. I will not discuss which two indicators are used for two reasons: I do not know if the strategies will work for a reasonable period of time (hence, the purpose of this blog); and, if the strategies do work, I don't feel I should just give them away for free.
What I will discuss is the general purpose in my use of these indicators. I am a strong believer in the buy low-sell high motto of investing. I like to pick up bargains and re-sell them for a profit. That's definitely the value investor in me. Therefore, my indicators are not momentum indicators. Quite the contrary, they are designed to pick up beaten down stocks that may be poised for a rebound in the short or long-term. Stocks are purchased or sold to a portfolio when both indicators agree on the same action.
The last step is the portfolio construction process. Portfolios will start with a value of $1,000,000 in cash. Whenever my two technical indicators give a buy signal at the same time, the stock is purchased for the specific portfolio that corresponds to the screener list for which the stock belongs. Buy signals for the same stock can occur for several consecutive days, therefore, purchases are made in $5,000 increments. A commission of $0.05 per share is applied to every purchase (with a maximum commission of $25 for any single trade). The same rules used for purchases (technical indicator signals, increments and commissions) are applied for stock sales. Sales are only made whenever both technical indicators agree on said action. No sales are made if a stock fails to meet the specific portfolio guidelines (market cap or fundamental criteria).
Every portfolio will have a maximum of 25 positions. Portfolios can contain less than 25 names if it reaches fully-invested status first. Cash will be considered when measuring portfolio performance. Dividends will be reinvested in the shares of the dividend-issuing company if both technical indicators indicate a buy signal on the date when the stock paid the dividend. If no buy signal is given on the dividend payment date, said amounts will be added to the portfolio's cash balance. In the case of a company being taken over, we will sell the stock on the same date that the deal is announced to the public.
Finally, there are two important things regarding portfolio construction. First, any single company can be part of more than one portfolio at any given moment. Second, I do not consider diversification, correlations between portfolio components, maximum or minimum weights, betas, total portfolio risk or any other measure that might limit which stocks will be purchased. Portfolios are constructed with the mindset of buying the most attractively priced stocks for the purpose of achieving significant capital appreciation without giving consideration to any other factor.
I will make all possible efforts to update on all portfolios' purchases and sales as well as their performance on a regular basis. Please keep in touch for my first portfolio update coming very soon.