Cash is King – Featured Screen

New Featured Screen – Cash is King

By this point, most of our users have become pretty good at building successful screens for their accounts. These screens can beat the market at a reasonable rate of volatility and match up pretty well to that individual’s investment philosophy. However, there is always room for improvement, and that improvement is exactly what Mr. Manzitti found when he reached out to discuss having a couple of his personal strategies featured to allow all users to have access to them. One of these screens is his “Cash is King” screen.

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I know you don’t have all of the information of the screen right here; but, without diving into it, what do you think this screener returns over the past 20 years? Well, it’s likely your guess was a little conservative as this screen returns over 100,000% percent over the past 20 years. Of course, this isn’t enough to get me excited because past returns are no indication of future performance.

Let’s dive into the individual parts of the screener

Before we take a look at the positions and performance we need to first understand exactly what this screener is looking for.

· The company’s free cash flow for the trailing 12 months divided by the enterprise value must be in the top 25% of companies.

· The company must have increasing volume over the past 42 days(roughly two months of trading days)

· The FCF ratio must be between 3.5 and 13.5

· Leverage must be below 0.72.

o Mr. Manzitti went ahead and calculated leverage within this screen and can be viewed within the “leverage” tab.

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· Lastly, all conditions within the restrictions tab must be met.

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o These aren’t too complicated of values and are mirror throughout the majority of Mr. Manzitti’s screens.

Any other rules you should know about?

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What’s investing without rules?

Firstly, we are on the standard quarterly rebalance. During the validation process we did go through and try most of the different rebalance periods, and they all work, but quarterly works the best. There is also a trading cost of 0.05% because unless you’re doing all of your investing through Robinhood, you will need to pay a little something in the way of commissions. We are also only trying to find six stocks for each rebalance period – ordered by the company’s FCF yield. (The strategy does match with over 50 companies if you get rid of the max holdings, but you do take a small hit to your annual performance.)

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The results as of 3/7/17, and to be honest, I’ve heard of two of these companies. The others are entirely new to me, and that’s actually pretty exciting.

Now to the exciting part

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If I’m completely honest, when I first saw this backtest I thought that there might be a bug with the S&P 500 line as it looks almost completely flat when this strategy is backtested over the past twenty years. Let’s make it a little more readable.

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There’s no other way to put it other than the screen simply flew away from the S&P 500 and kept going. Though this is exciting, it doesn’t give us the information that we need to decide whether or not to put our real dollars into the strategy. Let’s look at the returns year after year and see if we can see anything unusual.

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The oddest thing I’m seeing is that this strategy made money every single year since we began trading it in 1995. There are a couple of years where it didn’t do as well as the S&P, but overall it seems pretty stable by both winning every year and outperforming the benchmark. I do, however, see a small issue, and that is the 100% return in 1997. Let’s get rid of that year and see if the strategy still outperforms. We can do this by adding not year =1997 into our editor.

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Our backtest naturally took a hit, because we got rid of the best performing year, but we were still able to get around 33% annually without that year. Color me impressed.

How risky is it?

The old mantra of “more risk, more return” is always fresh on everyone’s minds when they are returning more than the benchmark. If you can’t beat the benchmark’s returns at a lower risk profile, you might as well just buy into an ETF. Knowing this, William Sharpe created one of my favorite risk calculations to compare the risk of a strategy relative to the “risk-free” returns of Treasury bonds. We calculate this ratio for both our screener and the benchmark. Remember, the higher the Sharpe ratio, the better.

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When I originally ran this backtest, I was slightly worried about the standard deviations being almost double that of the benchmark. I like building strategies that shoot for long term growth at an incredibly low standard deviation – but that’s just me. However, when you look at the Sharpe ratio of this screen when compared to the Sharpe ratio of the benchmarked S&P, you can see that it is more than double. In all honesty, it has one of the highest monthly Sharpe ratio’s I’ve seen.

Conclusion

Now, I can’t promise that these returns are going to continue in the future because I honestly have no idea what the future holds. All I can do is give you the tools and data that will assist you in making smarter investments. I’d also like to thank Mr. Manzitti for allowing us to validate and feature this screen so that all of our users can play around with the numbers and build their unique strategies from his well thought out base. If you can figure out how these returns could be wrong, we would love to hear about them.

About Tyler McCain

A student of finance at Georgia State University, Tyler has had a passion for the world of finance for as long as he can remember. Joining the Equities Lab team in 2015 he attempts to juggle the perfect mix of school, work, and giving back to the community. When he isn't working at Equities Lab he can often be found helping teach programs at the Rosen Family Foundation - a non-profit that teaches financial literacy to middle and high school students.

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6 Comments

  1. Tyler McCain Eric Darnel says:

    Fascinating, though I wonder if the ‘not classify’ restrictions are bona fide or amount to over-fitting the back-test.

  2. Tyler McCain Eric Darnel says:

    Hmm… I must make some comments that I think this screener is not realistic.

    I do applaud the simplicity and it contains elements that are sensible. However, I think that the result is optimistic for the following reasons:

    1.) not including certain market segments: this should be done only if there is a reason that a given segment is not expected to add above-average value.
    2.) increasing volume and no dividend yield: I am not aware of a fundamental reason why these can be expected to help future returns
    3.) 0.05% rebalance losses are low. I think 0.5% is more realistic

    If you remove the restriction on market segments, increasing volume, and dividend yield, the average return falls from 35% to 10%! To me, this rings alarm bells of data-snooping. Counter-comments are welcome!

  3. Tyler McCain henry says:

    it turns out that you can get rid of the sector selections and it still works. You can also change the numbers and broaden the ranges, and it survives. Selecting out the best year still works. Removing the stipulation that there be no dividends doesn’t work — that seems to be key. Also, while I think that 0.05% is a little light, its not totally insane on IB or Robinhood. Changing the commission to 0.5% and nuking the sectors gave me 30% performance per year; changing all the numbers to allow more stocks (i.e. the 13.5 to 15, the 3.5 to 2.5, the 0.72 to 0.85, the 7 on PE to 5, and the 50 to 75) reduced the performance to “only” 21%. Imposing a minimum holding period of one year forced performance down to 19.6%. So it certainly is too optimistic as written, but it looks more interesting than simple data snooping. Perhaps there’s some oddity with dividendless stocks, as the whole screen fell apart when I removed that rule.

  4. Tyler McCain Richard McKamie says:

    I enjoyed this blog posts but haven’t been able to find the original article regarding Mr. Manzitti. The post mentions “what Mr. Manzitti found when he reached out to discuss having a couple of his personal strategies featured to allow all users to have access to them.” Where is this found because I’d like to read those articles, too. Thanks!

  5. Tyler McCain Ayo says:

    I’m still playing with it, but the most impressive aspect of this screen for me is the drawdown. I’m on a quest for a screen with backtested results showing a drawdown less than 25% (or as close as possible) with an annual return greater than or equal to 11%.

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