ValuScore Performance

When we first introduced the PowerStocks ValuScore, we showed that small portfolios of JSE shares with scores of six (4 shares) and five (9 shares) significantly outperformed all other stocks on average, over a 5 year period. The graph below illustrates this performance on an accumulative basis:


Notice how the portfolios of shares with scores of 5 and 6 really "powered" ahead from year 3. These were real "PowerStocks"! Also notice how from year one already, the PowerStocks were already pulling ahead of the rest of the pack, and stayed ahead of the pack for the entire 5 year bull market! In fact shares with ValuScores of four (12 in total) were the only other group of companies that kept pace with the PowerStocks in the initial 3 year period. This is illustrated below:


The above graph also shows us that the PowerStocks (and the "4" stocks) almost doubled the average growth of the whole market in years one, two and three. Also note how remarkably quick the recovery of the PowerStocks were, coming out of the bear market. They doubled in year one and by year two had grown by 240% versus the group average of 120%. This is promising as it means we may not have to sit forever to realise our gains.

The reason for this is by design - PowerStocks, when bought at the trough of a bear market are:

1. very undervalued/oversold compared to the rest of the market
2. are cheap in relation to their per-share earnings power
3. are financialy strong (enough to survive economic slowdowns)
4. have the highest statistical probability of superior price growth

Remember, this is not some concocted methodology we have devised. It is based on accepted and proven principles used by the greatest value investors of all time (including Warren Buffet) for the last 100 years. All we have done is prove and tweak them for the JSE, added some automation to the financial analysis (Piotroski) and devised a nifty scoring system to help you screen and build up portfolios of stocks. For your initial portfolios to capitalise on the new bull market, we feel that stocks of ValuScores of 6, 5 and 4 should be selected for the first 3 years as this will offer a portfolio of suffcient size (15-25 stocks) and appropriate diversification.

To get a list of all JSE stocks together with their current ValuScores (as at 29 October, still our current "bottom pick" for the 2008 bear market) go HERE.

PowerStocks ValueFinder

It now makes logical sense for us to want to perform a "Value" screen on the JSE by seeking stocks that are "cheap" (have low PE's and low Price:Book ratios, as with the PriceFinder screen) but are ALSO "quality" (financially sound, as shown with Piotroski Screen). We can do this by combining the Piotroski rankings with those PE and Price:Book scans we did previously. We call this triple-combo screen our PowerStocks ValueFinder.

Using this screen yielded a portfolio of only six shares at the trough of the last Bear market, that grew an impressive 593% on an equal weighted basis or a staggering 1042% on a market-cap weighted basis. (The weighted basis is merely the method you use to contruct your portfolio.) Every single stock in this portfolio grew more than 250%. To pick such a small portfolio with such impressive results is truly remarkable.

The flow diagram below shows how the PowerStocks methodology successively screened the JSE down from 271 to 6 stocks in the trough of the last Bear market.

We bet you are just itching to see which stocks currently meet the ValueFinder criteria right? If you would like a complete ValueFinder report of ALL 425 JSE stocks then proceed to PowerStocks JSE Rankings Report. However we strongly suggest you resist temptation and read the next section first, as we will show an even MORE powerful refinement to the ValueFinder stock picking methodology.

NEXT UP : Even more powerful, the PowerStocks ValueScore

Introduction to Piotroski

Our previous writings showed how the trend in overseas markets for low price-to-book (PB) "value" stock portfolios to outperform high PB value portfolios was spectacularly confirmed on the JSE.

It has also been shown that large portfolios of low PB stocks outperform smaller portfolios, because in general, a few stocks in the low PB portfolio have to perform spectacularly, to make up for all the losses of the other stocks in the portfolio.

This is because many low PB stocks are low for a reason and as the lowest PB stocks are generally distressed, very few of them manage to claw out of the hole they are in. Having said that, our previous PB analysis on the JSE showed that very few low PB stocks (not more than 15%) "crashed and burned" and had you put together a portfolio in May 2003 of 10 or more low PB stocks you would have done rather nicely, especially if they had PE's between 2-4.

Nevertheless, it would be nice to apply some sort of financial "evaluation" to low PB stocks to further screen out "weaker" issues and focus on those most likely to have strong financial fundamentals turn in their favour in the short term, further accelerating their over performance of the ALSI, and allowing us to get good performance by only having to manage smaller less risky portfolios.

One particular person came up with such a methodology that is quite successful. He is Joseph Piotroski and he is a professor at the University of Chicago. His paper, “Value Investing: The Use of Historical Financial Information to Separate Winners from Losers”, available as a PDF here, was published in 2000. In that paper, Piotroski showed that by using a set of nine different fundamental signals taken straight from the companies financials, to screen among low P/B stocks, an investor could separate the winners from the losers. By buying only those stocks that had the highest scores, an investor could have outperformed the market by an average of 10% per year from 1976 to 1996.

Piotroski started by screening for the stocks with the lowest P/B ratios that were non-negative. This limits the strategy to true value companies. After the price to book ratio, nine other pieces of information were used, as follows:

1. positive earnings
2. positive cash flow from operations
3. increasing ROA
4. quality of earnings : operating cashflow > net income
5. decreasing long-term debt as a proportion of total assets
6. increasing current ratio, indicating increasing ability to pay off short-term debts
7. decreasing or stable number of shares outstanding
8. increasing asset turnover ratio, indicating increasing sales as a proportion of total assets
9. increasing gross margin

Each company is given either a one or a zero on each variable to create an "F"-Score ranging from 0 to 9. The strategy calls for buying every company with the requisite low P/B ratio and a "F"-score of eight or nine. As Piotroski's research shows, low P/B stocks with high rankings are less likely to go bankrupt or to fall drastically in price than are those with low rankings, so this further adds to our defensive value picking investment strategy.

NEXT : Piotroski U.S Performance