Beat The Market - Invest by Knowing What Stocks To Buy and What Stocks To Sell

CharlesD.
KirkpatrickII
BeattheMarket:
InvestbyKnowingWhatStockstoBuyandWhat
StockstoSell
(FTPress,Sept2008)
www.charleskirkpatrick.com
Outline
TechnicalTheory
PredictionisHazardous
SecretisintheRelatives
Price
EarningsGrowth
Value
TechnicalTheory
Pricesarenonrandom
LoStudies
Pricestrend
Charts
RelativeStrength
Riskiscapitallossnotvolatility
Lawofpercentages
Volatilityisdesirable
Cantmakemoneyonadullstock
LoStudy
SpecificationTest
ThisHausmantypespecificationtestexploitsthelinearityofthevarianceofrandom
walkincrementsintheobservationintervalbycomparingthe(perunittime)
varianceestimatesobtainedfromdistinctsamplingintervals.Etc.,etc.
Asanempiricalillustration,weperformourtestonweeklystockmarketdatafrom
1962to1985andstronglyrejecttherandomwalkhypothesisforseveralstock
indexes.
AndrewW.LoandCraigA.MacKinlay,1988,StockMarketPricesDoNotFollowRandomWalks:
EvidenceFromaSimpleSpecification,NBERWorkingPapers2168,NationalBureauof
EconomicResearch,Inc.
PriceTrends
PriceTrends
RelativePriceStrength
RiskisnotVolatility
Volatilityisoftendescribedby
standarddeviation
Howmuchapricedeviatesfromthemean
RiskisCapitalLoss
LawofPercentages
VolatilityisDesirable
Predictionishazardous
History(miserable)
Economists
Gurus
SecurityAnalysts
Technicians
EconomistsForecasting
FromresultsofWallStreetJournalsemiannualeconomic
survey:
Outof56economicforecasters2001:Q1&2001:Q2,only2
correctlypredictedGDPgrowth
Averageforecasterror=2.6(actual forecast)
Source:FederalReserveBankofBoston
TheanalysisshowsthattheconsensusforecastofU.S.
Treasurybondyieldchangeispoorandanaveforecastis
moreaccurate.
Source:Brooks&Gray,HistoryoftheForecasters,
UniversityofAlabamaworkingpaperNo030601(2003)
GurusandStrategists
WWW.CXOadvisory.com
SecurityAnalysts
78,695forecastsstudied(197393),only1in170chance
analystsconsensusforecastwithin5%forany4consecutive
quarters. Dremen,DavidMissingtheBarnDoor Forbes
(10/21/96)
managementrelationshypothesisthatanalystspurposely
inflateearningsestimatestogainfavorwithmanagement
Francis&Philbrick,JournalofAccountingResearch,31:216230
Analystsforecastsarenotnecessarilybetterrepresentations
ofthesecuritymarketsearningsexpectationsthanaretime
seriesorsecuritypricebasedforecasts. Elgers,Lo&Pfeiffer,
AccountingReview76:613632(2001)
Advisors
ProposedSECrequirementforanalystforecasts:
Theundersignedstatesthathehasnoidea
whatsgoingtohappeninthefuture,and
herebydeclaresthatthispredictionismerelya
wildlyunsupportedspeculation.
BarryRitholtz
(realmoney.com 2005)
PickingStocks
ConventionalAnalysisfocuseson:
Value(Fundamental
Pricetoearnings,sales,expenses,bookvalue
Presentvalueofcashflow
Dividenddiscount
Growth(Fundamental)
Earningsgrowth rate
Prices(Technical)
Relativestrength
Trends
Patterns
WhatHaveIFound?
RelativePriceStrength,
RelativeReportedEarnings
Growth,
RelativePricetoSales,
ChartPattern
RelativeStrength
AcademicStudies
Levymethod(1968)
Jegadeesh &Titman
(JT)(1993)
ModifiedLevyMethod
Steps:
1. Foreachstockcalculatetheratio
CurrentPrice/SMAPrice(26weeks)
2.Rankeachstockinuniverseby
ratioandcalculatepercentile 99
=highest;0=lowest
OtherCalculations
Earningsgrowth ratioofcurrent4
quartersvs.4quartersonequarter
back
Pricetosales rawfigure
Chart 3X1Point&Figure,breakout
aboveorbelowtwopriorhighsorlows
FirstTests
From19821998live:
RelativeReportedEarnings
Growth
ChartPattern
Valueof$1Invested
100
Kirkpatrick&CompanyGrowthListPerformance
July1982 Dec1998
10
1
GrowthList
S&P500
ValueLineGeo
0.1
Valueof$1at12/31/98
GrowthList=28.118
S&P500=11.030
ValueLineGeo=5.228
1998
Observations
Chartpatterndeletionsalmostnever
occurred
MostdeletionsfromR/SorR/EPS
Lookingforreducedriskonadditions
ratherthanstops(R/Swouldalways
stop)
ReadOShaughnessyonPricetoSales
ratio
SecondTestsLive
19992007
RelativeReportedEarningsGrowth
RelativePricetoSales
Nochart
GrowthandValueListPerformance
Jan1999 March2007
Valueof$1Invested
10
Valueof$1at3/23/07
ValueList
GrowthList=2.972
ValueList=8.498
S&P500=1.175
ValueLineGeo=1.093
GrowthList
S&P500
ValueLineGeo
0.1
1/1/1999
1/1/2000
1/1/2001
1/1/2002
1/1/2003
1/1/2004
1/1/2005
1/1/2006
1/1/2007
NewandCurrentTests
Testthreebasicmethodsfor
accuracyandarriveatanew
method
TestingMethod
CompareVariablesversusR/Pfor
eachweekduringperiod20002006
at3,6,and12monthintervals
Determineslopeandr2of
correlations
Desiredoutcomeishighslopeand
highr2
3MonthsAhead
RelativeEarningsGrowth
CurrentRelativePricetoSalesand
RelativePriceStrengthThree
MonthsAhead
RelativePriceperformancethreemonthsout
54.00
52.00
50.00
48.00
46.00
R2=0.3749
Slope=0.0629
44.00
42.00
BESTFITPERCENTILES
ACTUALPERCENTILES
MarketAveragePerformance(50%)
40.00
2 7 12 17 22 27 32 37 42 47 52 57 62 67 72 77 82 87 92 97
RelativePricetoSalesPercentile
RelativePricePerformancePercentileThreeMonthsAhead
CurrentRelativeEarningsGrowth
PercentileversusRelativePrice
PerformanceThreeMonthsAhead
54.00
52.00
50.00
48.00
46.00
44.00
R2=0.3464
Slope=0.0342
ACTUALPERCENTILES
BESTFITPERCENTILES
42.00
7 12 17 22 27 32 37 42 47 52 57 62 67 72 77 82 87 92 97
CurrentRelativeEarningsGrowthPercentile
CurrentRelativePriceStrength
PercentileandRelativePriceStrength
PercentileThreeMonthsAhead
RelativePriceStrengthPercentileThreeMonthsAhead
70.00
60.00
R2=0.893
Slope=0.326
50.00
40.00
BESTFITPERCENTILES
30.00
ACTUALPERCENTILES
20.00
10.00
2 7 12 17 22 27 32 37 42 47 52 57 62 67 72 77 82 87 92 97
CurrentRelativePriceStrengthPercentile
6 MonthsAhead
RelativePricePerformancePercentileSixMonthsout
60.00
55.00
RelativePriceStrengthSixMonths
Ahead
R2=0.7177
Slope=0.0940
50.00
45.00
BESTFITPERCENTILES
40.00
ACTUALPERCENTILES
MarketAveragePerformance
(50%)
35.00
2 7 12 17 22 27 32 37 42 47 52 57 62 67 72 77 82 87 92 97
RelativePricetoSalesPercentile
RelativePricePerformancePercentileSixMonthsAhead
CurrentRelativeEarningsGrowth
PercentileSixMonthsAhead
53.00
52.00
R2=0.2444
Slope=0.0199
51.00
50.00
49.00
48.00
47.00
46.00
45.00
BESTFITPERCENTILES
ACTUALPERCENTILES
(50%)
2 7 12 17 22 27 32 37 42 47 52 57 62 67 72 77 82 87 92 97
RelativePriceStrengthPercentileSixMonthsAhead
andRelativePriceStrengthSix
MonthsAhead
56.00
54.00
R2=0.7290
Slope=0.0746
52.00
50.00
48.00
46.00
BESTFITPERCENTILES
44.00
42.00
ACTUALPERCENTILES
(50%)
40.00
2 7 12 17 22 27 32 37 42 47 52 57 62 67 72 77 82 87 92 97
12MonthsAhead
RelativePricePerformancePercentile12MonthsAhead
RelativePriceStrength12Months
Ahead
51.50
51.00
R2=0.1309
Slope=0.0051
50.50
50.00
49.50
49.00
BESTFITPERCENTILES
ACTUALPERCENTILES
48.50
(50%)
48.00
2 7 12 17 22 27 32 37 42 47 52 57 62 67 72 77 82 87 92 97
CurrentPelativePricetoSalesRatioPercentile
andRelativePriceStrengthPercentile12
MonthsAhead
RelativePricePerformancePercentile12MonthsAhead
56.00
54.00
R2=0.0635
Slope=0.020
52.00
50.00
48.00
46.00
44.00
BESTFITPERCENTILES
42.00
ACTUALPERCENTILES
AverageMarketPerformance(50%)
40.00
2 7 12 17 22 27 32 37 42 47 52 57 62 67 72 77 82 87 92 97
Percentile12MonthsAhead
RelativePriceStrengthPercentile12MonthsAhead
51.00
50.50
R2=0.0025
Slope=0.0008
50.00
49.50
49.00
BESTFITPERCENTILES
48.50
ACTUALPERCENTILES
AverageMarketPerformance
(50%)
48.00
2 7 12 17 22 27 32 37 42 47 52 57 62 67 72 77 82 87 92 97
Conclusion
Longterm(greaterthan6months)investingis
problematic.
Reactratherthanpredict.
Thereareusefulmethodsforshorterperiods.
Relativepricestrengthisthemostsuperior.
Earningsgrowthistheleastsuperior
Advancing&DecliningMarket
RisingMarket(20032006)
3MonthResults
RisingMarket
RelativePriceStrengthThreeMonths
AheadinaRisingStockMarket
54.00
52.00
50.00
48.00
R2=0.1291
Slope=0.0243
46.00
BESTFITPERCENTILES
44.00
ACTUALPERCENTILES
42.00
(50%)
40.00
2 7 12 17 22 27 32 37 42 47 52 57 62 67 72 77 82 87 92 97
CurrentPricetoSalesPercentile
RisingMarket
CurrentRelativeEarningsGrowthand
RelativePriceStrengthinaRisingStock
MarketThreeMonthsAhead
56.00
54.00
R2=0.8915
Slope=0.0701
52.00
50.00
48.00
46.00
BESTFIT
PERCENTILES
44.00
ACTUAL
PERCENTILES
42.00
AverageMarket
Performance(50%)
40.00
2 7 12 17 22 27 32 37 42 47 52 57 62 67 72 77 82 87 92 97
RisingMarket
inaRisingMarketandRelativePrice
StrengthPercentileThreeMonthsAhead
80.00
70.00
R2=0.9692
Slope=0.3249
60.00
50.00
40.00
BESTFITPERCENTILES
30.00
ACTUALPERCENTILES
20.00
(50%)
10.00
2 7 12 17 22 27 32 37 42 47 52 57 62 67 72 77 82 87 92 97
CurrentRelativePriceStrengthPercentile,RisingMarket
DecliningMarket(20002003)
3MonthResults
DecliningMarket
RelativePriceStrengthThreeMonths
AheadinaDecliningMarket
60.00
R2=0.4836
Slope=0.0827
55.00
50.00
45.00
BESTFITPERCENTILES
40.00
ACTUALPERCENTILES
(50%)
35.00
2 7 12 17 22 27 32 37 42 47 52 57 62 67 72 77 82 87 92 97
CurrentRelativePricetoSalesRatioPercentile
DecliningMarket
andRelativePriceStrengthPercentileina
DecliningMarketThreeMonthsAhead
54.00
52.00
50.00
48.00
R2=0.0004
Slope=0.0014
46.00
44.00
BESTFITPERCENTILES
ACTUALPERCENTILES
42.00
2 7 12 17 22 27 32 37 42 47 52 57 62 67 72 77 82 87 92 97
DecliningMarket
inaDecliningStockMarketandRelative
PriceStrengthPercentileThreeMonths
Ahead
70.00
60.00
R2=0.9103
Slope=0.2928
50.00
40.00
30.00
BESTFITPERCENTILES
ACTUALPERCENTILES
20.00
(50%)
10.00
2 7 12 17 22 27 32 37 42 47 52 57 62 67 72 77 82 87 92 97
CurrentRelativePriceStrengthPercentile,
DecliningMarket
NetResultsforTriggers
Relative
Buy
Trigger
Sell
Trigger
PriceStrength >=97
<=52
Earnings
None
None
Growth
Value
>=17and <=7or
<=42
>=67
ExampleofRelativeStrengthBuy
ExampleofRelativeStrengthSell
ExampleofRelativeValueSell
BargainModelPerformance
KirkpatricksMarketStrategist
Weekly&Monthly
Containsallstocksonalllistsandchangesforthat
week
Emailedovertheweekend
Updatesonperformanceoflists
Marketcommentary
www.charleskirkpatrick.com

Beat The Market - Invest by Knowing What Stocks To Buy and What Stocks To Sell

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