The ability of investors to out-perform their indexed benchmarks has long been a subject of discussion among finance professionals. On the one hand, hedge funds and day-traders have shown returns that exceed beyond market-levels as a result of their purported ability to time the movements of security prices based on statistical and technical information. That being said, it is also easy to see how it is that these investors then lose their money in the markets just as quickly, and wind up simply re-creating market-levels of return over the long term.
The majority of hedge funds continually show an inability to create statistically significant amounts of value for their clients, against a benchmark of passively indexed securities. While there are some valid reasons to question the feasibility of earning a return as an active technical trader, the last decade has presented evidence that active fundamental investment strategies create returns for investors. By then breaking down these strategies in accordance to their abilities to create returns for investors, we can examine which fundamental strategies are working best, and which ones are better off left alone.
Using the American Association of Individual Investors’ database of stock screens, we can check out how it is that indelible fundamental investment strategies have categorically created annualized returns over the last decade, and compare those returns against those created by the greater market. While the market today is showing an annualized return of 9% over the last 15 years, it is interesting to notice how top returning strategies are generating above 25%/year, and showing a fairly consistently positive trend for generating returns in both up and down years. In doing so, we can see right away how it is that value and growth strategies are topping the charts, with strategies like O’Neils CANSLIM and Piotroski’s F-Scoring mechanism demonstrating the greatest returns. So what’s their secret that nobody else is getting?
Both Piotroski’s F-matrix and O’Neil’s CANSLIM models break down company fundamentals into their ability to provide investors with solvency and value on both the balance sheet and the income statement. From there, O’Neils strategy takes CANSLIM a step further by including a cash-flow analysis of the company’s returns in order to double check for accruals.
Alternatively, CANSLIM looks at some momentum and growth factors that, while having historically demonstrated an ability to create excess returns for investors as a function of volume, seem to be holding it behind in performance. Lastly, the F-Matrix takes a moment to evaluate the actual efficiency of a company’s performance, while CANSLIM prefers to focus in on the actual earnings growth of a company, resulting in a situation where it might miss some opportunities that are being generated internally through scaling.
On the other side of the chart, we can take a moment to see how it is that the worst performance strategies in the sample included indexing strategies that followed the S&P and greater market performance, while those strategies that tried to make specific assumptions about the performance of earnings calls also clustered near the bottom of the table with anything between net-losses to negligible return schedules.
While these earnings call strategies aren’t like the active trading strategies that many people employ to try and profit from earnings calls, they do represent the statistical theories surrounding them. The end result is a fairly obvious take-away: Statistically guess-work doesn’t earn returns, but fundamental analysis is certainly worth an investor’s time. From here, we can start to discuss how it is that all of these top performing strategies work, and how they can be used by a personal investor in a real portfolio.