So, how can you best dilute the role of luck in your portfolio’s performance? A good first step is to follow a disciplined strategy that ensures a consistent approach—to set goals and objectives and implement a clearly-defined, repeatable process that you can stick to.
The methodologies I use at Validea are inspired by the strategies of some of the most successful investors, including Warren Buffett, Peter Lynch and Benjamin Graham. These are process-driven strategies built on a solid foundation of financial data and focused on long-term results. By researching the investment techniques of these market gurus, we have been able to create mathematical models that are able to filter stocks through a huge amount of market data to determine which pass muster under the various methodologies. Our models focus on a wide array of metrics, including the following:
- Debt: Most of my 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.
- 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 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.
- 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.
- 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.
Using these stock screening models, I’ve identified the following four high-scoring names: