President and Founder
US Advanced Computing Infrastructure, Inc.
We ran our Chicago Quantum Net Score model last night. 2,663 common stocks of operating companies listed on US equity exchanges (think NASDAQ and NYSE) passed our test for data validation and sufficient size/liquidity to ensure they can be traded. That number includes about a dozen ETFs we include to allow for comparisons against indices and alternative investments (think debt, a few currencies, and select commodities).
The two most restrictive 'covenants' were that stocks had to trade at least 20,000 shares per day and to have a market capitalization of $200mm or more yesterday. We also exclude negative BETA stocks, of which there were maybe a dozen.
So, 2,663 stocks were included in our model. The 'best' ones have relatively low risk to expected return (mostly due to high BETA or high historical dividends), and some of the best ones seem to have price action that keeps them looking good over an extended period of time. They move with the market, maintain strong correlation to market moves, and have lower price volatility than we would expect.
A 'winning' Chicago Quantum Net Score portfolio today has between 1 and 8 stocks, and those stocks are not household names. They are anomalies. They are new economy stocks that lose money (except one) and have significant debt. We are not sure this is where we want our clients, investors or friends to be investing anymore. Sure, we can all make money counting on the market makers to keep things rolling as they are, and to short the dogstar stocks, but I am rethinking things.
I am surprised that the best stocks in our model lose money and have significant debt. That corporate debt is getting more expensive to service as sovereign UST and foreign debt becomes more expensive. We just saw Yellow Corporation file for bankruptcy based on rising expected, future wage costs, a 'must-do' corporate restructuring that was foiled by a union negotiating move targeted at UPS, and around $1.5B in debt.
If we remove the negative Net Income companies from our analysis, we drop from 2,663 to 1,793 stocks.
If we account for companies with negative AOCI or Additional Other Comprehensive Income, which is not included in Net Income, and subtract that from earnings, we drop from 2,663 stocks to 1,465 stocks. This accounts for things like companies holding investments that lost value, but do not have to be shown in net income. As interest rates rise, the value of most bonds fall, and those losses are accounted for here. I think other things like interest rate swaps, hedges, and contingent losses go here. I like to account for AOCI. This is my 'thing' and it eliminated another 328 companies from the list of profitable companies.
Now, here is the hard part. How much debt is too much for a company with at least $200mm in market cap? We could look at a multiple of market cap to get a sense of leverage and ability to repay debt with equity sales. We can look at a multiple of annual earnings to get a sense of leverage and ability to pay off debt with earnings. Apple can carry more debt than Pollo Loco.
A Long Term Debt to Equity Ratio of 4 limit is very loose, and only eliminates 39 companies with an equity market capitalization of at least $200mm. A Debt to Equity limit of 3.0 (or lower) is also loose, eliminating only 59 companies out of 2,663. We will stick with a D/E of 3.0.
A Long Term Debt to Comprehensive Income that is positive, but is less than 20x seems extremely loose logically, but eliminates 1,628 companies from our run. Lowering the limit to 15x eliminates another 69 companies, and lowering the limit to 10x eliminates another 111 companies.
In the end, the only 'filter' we need to set in python is that a company has 10x or lower multiple of debt to comprehensive earnings, and we are in a world of profitable companies with conservative Debt to Equity ratios. That filter eliminates 68% of companies.
Stock Market BLOG
President and Investment Advisor Representative