Often investors take a singular focus in their investment decisions. I’m not referring to sector focus or specific capitalization classes but rather investment philosophies. People tend to jump on band-wagons or stick to theories that are espoused by “so-called” experts, without regard for further analysis and review. The same mistakes are made by many academics and practitioners. Following the heard is always safer and smarter right? Wrong!

The Best of the Rest - Value Line, CANSLIM and The Magic Formula

The best and longest running stock ranking models like Value Line and Investor Business Daily’s CANSLIM approach are primarily growth-oriented models. The key factors in these models are earnings growth/acceleration and stock price momentum. The models generally have little focus on valuation and profitability. They worked phenomenally well for several years and gathered a large following. Unfortunately their success has led to diminished performance in recent years as too many people started using similar strategies. Olson, Nelson, Witt and Mossman tested the CANSLIM (Investors Business Daily) ranking system and found that it delivered returns that were only 2% above the S&P500, and that the outperformance may be temporary as the returns were even lower in the second half of the data set. In addition, they theorized that the excess return could be contributed primarily to momentum.

More recently Joel Greenblatt – the successful former hedge fund manager- popularized the “Magic Formula” system, which ranked top stocks based exclusively on valuation and profitability. The strategy is a classic Buffett-style value ranking system. The “Magic Formula” is simple and works on both large and small stocks. So far, the returns to the strategy had not diminished over time. The problem with this model is that it does not help you select stocks for the short-to-medium term (1-6 months) and it only emphasizes stocks with low P/E ratios. A major limitation is that it doesn’t take into account stocks that may have higher P/E ratios but that are cheep as a percentage of their book value or on the basis of their annual revenues.

Ahead of its Class - The MVP Rating System

After reviewing these models it seemed obvious that the strategies could be complementary. Style investing is sort of like religion; value investors tend to stick to their own philosophy and reject the principles of growth investing. A value investor does not believe in momentum, and growth investors do not believe that valuation is important. If it is true that both classic growth and value factors are important in determining stock returns, then logically the best stocks should have elements of both styles. However it seems that value investors prefer stocks with extreme value characteristics, and growth investors similarly prefer stocks with extreme growth characteristics. Therefore, there should be less interest and competition for stocks that have both growth and value characteristics. In fact the discovery by CSS Analytics was that by combining elements from these successful systems, you could achieve a much higher and more consistent return than the “Magic Formula” or “CANLSIM” on its own.

The key to superior and consistent performance lies in knowing what factors are the most important in driving stock prices. Through intensive study and historical back-testing, CSS Analytics with the help of several PhDs at RiskLabs at the University of Toronto, developed the most sophisticated and robust stock ranking system to date. They call it the MVP Rating System, which is an acronym for Momentum Value and Profitability- which were found to be the three most important factors in driving stock returns. More importantly these are the three factors that work best together.

The MVP Rating System works for stocks of all sizes in both the US and Canadian stock market. It selects the superstar stocks that are poised to outperform the market, and it does a great job of identifying the future losers to weed out of your portfolio. It can be used for trades as short as 1 month with good success, and as long as 12 months. You can also use it as a complement to your own stock research, you can avoid buying too early by waiting for a stronger MVP score, and also help you figure out when to sell a really big winner by liquidating when the MVP score declines significantly---telling you that your stock may be overvalued and/or losing momentum.

The key to success for the MVP Rating System s that it buys stocks that are cheap and are already on the move up because of recently good fundamentals. This allows you to have a combination of a good return with a higher probability of success on each stock. By contrast, pure momentum stocks tend to suffer larger and unexpected collapses because of their higher valuations (by extension higher expectations). When you buy them, you need to have very good timing on your entries and you need to have a very strict sell discipline to be able to capture good returns from this “hot-potato” strategy. Buying pure value stocks can be perilous because a large percentage of them do poorly, and are only redeemed by the few really big winners that double or triple in price. In addition, pure value stocks tend to suffer from a lack of buying interest and/or poor fundamentals which can keep them in the cellar for a long time. It can be frustrating to force yourself to hold a position for years that is going nowhere. Furthermore, you need to have strong accounting and financial skills to be able to pull really good value investing off successfully.

We believe in keeping things as simple and easy to implement as possible, while eliminating the “art” and “judgment” required for other strategies from the equation. We also believe that it is just as important to have a trading system that is psychologically easier to handle, because most investors will fail to follow a system that causes them too much stress and frustration.