Numbers and sports go hand-in-hand. Millions of viewers have witnessed Jamaican gold medalist Usain Bolt sprint across the finish line 8/100ths of a second ahead of No. 2 Justin Gatlin. The movie Moneyball taught us how Oakland Athletics general manager Billy Beane used analytics to resurrect his baseball team. Watch a football game on any given Sunday and hear a steady stream of statistics spilling out of the broadcast booth.
Sports are only one example of how data can be useful, however. The importance of numbers in finance may seem painfully obvious, yet it's not unusual to hear people discuss markets and investments under a shroud of hearsay and superstition. The best foundation for sound investment decisions, however, is concrete financial data and carefully constructed metrics, not media soundbites or water cooler banter.
In 2013, The New York Times columnist Carl Richards wrote, "The idea of using data to make investment decisions feels foreign to many of us. We've gotten comfortable assuming that our 'have a hunch, buy a bunch' approach qualifies as an acceptable investing strategy. It doesn't take much digging to discover that this so-called strategy amounts to guessing."
At Validea, our guru-based investment strategies are built on a solid foundation of financial data. By researching the investment techniques of some of the most successful investors of our time, we have been able to create mathematical models that simulate their approaches to stock selection. We are able to filter stocks through a huge amount of market data (using our Guru Stock Screener) and determine which pass muster under the various methodologies. Here are four pieces of data that play a significant role in the Validea models:
1. Debt: Most of our guru strategies include a metric related to a company's debt, since high leverage can put a strain on cash flow and make earnings figures misleading. Berkshire Hathaway's Warren Buffett delves deeper than the traditional debt-to-equity ratio to ensure that a company's long-term debt can be paid off from income in two years or less.
2. Price-to-Book Ratio: By comparing share price to a company's book value you can get an idea of whether a stock is undervalued. While our various guru models might define book value slightly differently from each other, the basic idea is always to determine the true value of a business. Our David Dreman-based model, for example, defines book value as common stock less all liabilities and preferred shares, while our Benjamin Graham-based model uses total assets minus both intangible assets and liabilities.
3. Return-on-Equity: While there is no single, sure-fire way to ascertain whether or not a company has what Warren Buffett calls "durable competitive advantage," companies that do have this distinction share a fundamental strength in return-on-equity. For Buffett, an ROE of greater than 15% indicates that management is doing a good job allocating retained earnings and is providing a solid, above-average return for investors. David Dreman viewed ROE as an important measure of a firm's profitability and a way to uncover structural flaws in the business.
4. Relative Strength: This measures the price performance of a stock against the market as a whole. The higher the relative strength, the better the stock price is tracking the market. Our James O'Shaughnessy investment model, for example, looks for a stock's relative strength to be among the top 50 stocks that pass the model's benchmarks. This test is intended to reveal those stocks that investors can purchase as the market is embracing them, before they become too expensive.
The following five stocks pass our various guru-inspired stock screens based on strengths in one or more of the above metrics:
1. Polaris Industries (PII - Get Report) designs, engineers and manufactures off-road vehicles. Polaris gets high marks under our Buffett-inspired investment model based on its earnings predictability and 10-year average EPS growth of 15.7%. The company has shown consistently higher-than-average return-on-equity (10-year average of 44.1%), and the return-on-total capital (which includes debt) of 33.0% well exceeds the model's 12% minimum. Our Peter Lynch-based strategy considers Polaris a "fast grower" and favors the company's price-earnings ratio (16.28) compared to average EPS growth of 20.50% (the result is a price-earnings-growth ratio of 0.79 -- less than the model's 1.0 limit).
2. LG Display (LPL - Get Report) manufactures thin-film transistor liquid crystal display and other display panel technologies. Our James O'Shaughnessy-based strategy looks favorably on LG Display's healthy and consistent earnings growth as well as its price-sales ratio of 0.39 (well under this model's limit of 1.5). Our Joseph Piotroski-inspired screen gives a thumb's-up to the company's positive operating cash flow ($2.48 billion), which more than covers net income ($880.24 million). LG Display also gets high marks from our Lynch-inspired methodology based on its P/E/G ratio of 0.39, and our Kenneth Fisher-based screen favors the company's long-term EPS growth rate of 26.42% (well above the 15% minimum).
3. Helmerich & Payne (HP - Get Report) is engaged in contract drilling of oil and gas wells. Our Benjamin Graham-based screening model approves of Helmerich & Payne based on its strong liquidity (current ratio of 4.71) and modest long-term debt ($493.2 million) in relation to net current assets ($1.21 billion). The P/E ratio of 11 (three-year average) falls within the model's maximum of 15. The price-to-book ratio multiplied by price-earnings equals 15.73 and falls under the maximum level of 22, indicating fairness of price according to this investment strategy.
4. Syntel (SYNT) is a global provider of digital transformation, information technology and knowledge process outsourcing services. Our Buffett-based stock screen favors the company's capacity to pay off all debt ($84.4 million) with earnings ($262.9 million) within two years, and likes the solid return-on-total-capital (which includes debt) of 23.4% (three-year average), well above the minimum 12% required under this model. Earnings per share are considered predictable, having grown consistently over the past 10 years, and positive operating cash flow per share ($2.45) adds appeal.
5. Natural Health Trends (NHTC - Get Report) is a direct-selling and e-commerce company that offers personal care, wellness and quality-of-life products. The company earns a perfect score under our Joel Greenblatt-based investment strategy in light of its earnings yield of 21.57% (earnings before interest and taxes divided by enterprise value) which places it among the top 12 stocks in our database. Return-on-total capital of 95.19% adds interest. Our O'Shaughnessy-inspired methodology likes Natural Health Trend's price-sales ratio of 1.20 (based on trailing 12-month sales) and the stock's relative strength of 73.