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Holly LaFon
Holly LaFon
Articles (7125) 

A Strategy That Beat the Bull Market

Backtesting shows a portfolio that would outperform

The stock market performed so well over the past five years that it proved incredibly difficult to outdo it. When 76.2% of active retail fund managers turned in subpar returns last year, many clients began wondering whether they should move their money into ETFs. Back testing reveals one strategy that worked in a market where everything seemed to be going right.

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In the past five years, the S&P 500 index returned 68.8%, with only one down year, as zero interest rates, a reviving economy and corporate profit growth pulled it out of the recession lows of 2008 and 2009. In addition, over the last 10 years, the best and worst-performing sectors showed a 30% difference in gains each year, meaning being in the wrong place at the wrong time for a concentrated portfolio would have dinged returns.

Focusing on fundamentals has also limited opportunities as the market became increasingly expensive. The S&P 500 currently trades at 23.8 times earnings for the last 12 months, compared to the historical average of 16.7%. As hedge fund manager David Tepper (Trades, Portfolio) said last week, “On a multiple basis, it’s kind of full.”

Certain characteristics defined stocks that would muscle through the stampeding crowd to come out ahead. An investor positioned with a portfolio of these stocks roughly five years ago would have gained 101.03%, to ace the S&P 500, the Dow’s 58.69% rise, and the 94.51% rise in the Nasdaq.

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The portfolio had no down years, including in 2015 when it increased 1.10% versus the S&P 500, which fell 0.81% in its single down year. It also would have turned an investment of $1 million into $2.01 million.

The companies are traded on the S&P 500, had a market cap more than $2 billion, a financial strength rating of 2, a profitability rating of 4, and five years of buying back their shares at a minimum rate of 1%. They also had a 10-year EPS growth rate in the range of 5% to 35%, and the portfolio was rebalanced every 12 months.

The criteria bear a highly limited range. Adjusting the bottom bracket of the 10-year growth rate to 10% drops the total return to 82.17%. Asking for even 2% in buyback rates reduced the gain to 98.88% while eliminating the share buyback rate all together plunged returns all the way to 81.73%.

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Of all fifty stocks, the five in the portfolio in the last year with the best performance were Unum Group (NYSE:UNM), Norfolk Southern Corp. (NYSE:NSC), Boeing Co. (NYSE:BA), Torchmark Corp. (NYSE:TMK) and Harris Corp. (NYSE:HRS). Only six posted declines: Target Corp. (NYSE:TGT), H&R Block Inc. (NYSE:HRB), Nordstrom Inc. (NYSE:JWN), Coca-Cola Co. (NYSE:KO), General Mills Inc. (NYSE:GIS) and Coach Inc. (NYSE:COH). The worst, Target, declined 28.99% and the best, Unum Group, rose 55.71%.

See the portfolio here.


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