Stockopedia demonstrate how we can beat the stock market buy using specific factors.
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Today we look at the concept: Factor Investing, an approach which aims to quantify particular characteristics or ‘factors’ of a company. The factors are often categorised through metrics of Quality, Value, Momentum and Growth.
These known factors have been proven to be highly correlated to stock market returns.
To demonstrate the theory, I use a service called Stockopedia, they give each company a score based on these individual factors. Each factor is scored between zero and 100 and the weighting of each factor translates into a total score for the company.
Here we can see the unquestionable correlation between the combined factor scores.
The chart in this example is based on all stocks within Europe, and the factor score used is a combination of Quality, Value and Momentum, or the QVM Stockrank score.
To the left we have the portfolio returns.
This benchmark line shows the return of the FTSE All Share index, and since the service began the benchmark is showing a return of around 10%.
The top green line shows the return of stocks which were ranked with a QVM score of between 90 and 100, suggesting they were the strongest stocks within the EU universe.
The next line shows stocks ranked between 80 and 90.
And then all the way down to the lowest ranked stocks, scoring between 0 and 30.
Also note the stockrank scores are rebalanced quarterly.
If you applied such a strategy against a portfolio of companies with a Stockrank score of between 90 and 100, you would have yielded a return of approximately 200%, in contrast to the FTSE all share index of just 10%.
In theory, this ‘factor’ investing approach relies heavily on the fundamental attributes of a stock. But imagine if you combined this approach with technical analysis and applied such analysis to stocks with the best combined ‘factor’ score.
This is the same approach I take, I put fundamental analysis first by evaluating the factors (made easy with the Stockopedia platform), and then follow up with specific technical analysis. Such an approach can be very effective indeed.
Let’s look at factor investing in more detail.
Described as a quantitative approach due to the ability to place a specific number against each piece of information, and condensed into factors of quality, value, and Momentum.
Personally, I give a higher weighting to the factors of quality and momentum, but only because its suits my style and philosophy.
Here we can see how my current portfolio is apportioned in terms of the Quality and Momentum factors.
As you can see by the cluster of blue bubbles, my portfolio is weighted towards good quality stocks which are also classed as leading stocks in terms of momentum.
This is another great analytical tool provided by the Stockopedia team. In addition, their research shows that good, leading stocks tend to outperform, and lagging, junk stocks tend to underperform.
Again, by applying your trading strategy to this portion of stocks can improve your chances of success considerably.
But what is the fundamental criteria used to form the Quality, Value and Momentum factors…..
First, we look at quality.
This chart shows the performance of quality factors measured from 2013 to 2018. To the left, the average annual