In a previous post in August 2015, I presented my idea of a systematic score sheet for picking stocks in the financial sector. It is inspired by the Piotroski F-Score, a well-known checklist for quickly analyzing if a company’s fundamentals are improving. Piotroski’s F-Score does not apply to financial companies, like banks and insurance firms, so I made my own score sheet based on which pieces of information I thought were more important to selecting quality investments in those types of companies. The criteria for inspecting a company’s fundamental data in my system are:
1) If Net income is positive, score 1, otherwise 0
2) If Return On Assets latest year is greater than ROA previous year, score 1, otherwise score 0
3) If Operating cash flow is greater than Net income, score 1, otherwise 0
4) If Ratio of long-term debt to total assets latest year is equal or less than Ratio of long-term debt to total assets previous year, score 1, otherwise 0
5) If Shares outstanding latest year is equal or less than Shares outstanding previous year, score 1, otherwise 0
6) (New, as in no existing equivalent, I introduced this test myself) Financial leverage (total assets divided by total equity) latest year is equal or less than Financial leverage previous year, score 1, otherwise 0
For every point that a company matches, it gets 1 point, for a maximum total of 6 points. With Portfolio123.com’s backtesting tool, I screened for US-based companies in the financial sector, excluding real estate stocks from April 30, 1999 to October 31, 2017.
Investing in American financial stocks with a score of 5 or 6 would’ve produced an annualized return of 12.24%, whereas stocks with a score of 3 or 4 would’ve given 8.91% and score of 0 or 1 would’ve produced only 6.93%.
An important question would be if this methodology could work also for foreign companies. My assumption is that a logical-sounding technique or method should be able to apply in other situations or markets. With the same parameters, I tested for non-US based companies and for Canadian stocks only (Portfolio123 also has access to Canadian markets).
Investing in Canadian financial stocks with a score of 5 or 6 produced a return of 13.21%, versus 11.65% for companies with a score of 3 or 4 and 8.41% for those that score 2 or less. Foreign financial companies that trade on US stock exchanges, which are the only ones that can be looked up in Portfolio123, are few and far between, so results with them should be taken with a large grain of salt. But the results do suggest that using a system such as my own to select high quality stocks is possible and can be profitable.