Validate and Improve Strategies W/ Backtesting
June 5, 2014
Assigning a Number to Represent a Stock’s Value
June 12, 2014
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Free Cash Flow Growth Leaders Vol. 2


Cash is King! We have created a strategy that locates stocks that offer strong free cash flow growth as well as value. The strategy was then validated in the back test to significantly outperform the market in the past. In this article we are going to discuss that strategy and provide you with the list of stocks that currently pass. Hopefully from reading this you will learn more about fundamental analysis and find potentially good investments.

The Strategy

The strategy, saved in Equities Lab as FCF Growth Leaders Top 10, combines multiple criteria that stock’s must pass. The criteria are represented in the screenshot below:

Let me explain to you each of the criteria from top to bottom:

  1. FCF per share in 2013 was at least 10% greater than in 2012
  2. FCF per share in the 4th quarter of 2013 was at least 10% greater than the 4th quarter of 2012
  3. FCF per share in the 3rd quarter of 2013 was at least 10% greater than the 3rd quarter of 2012
  4. Market cap must be greater than $250 million
  5. The valuation based on price to free cash flow per share must be at least 15% greater than the close
  6. The valuation based on average price to free cash flow must be at least 15% greater than the close.
  7. The stock can’t be in the financial sector
  8. The stocks price to free cash flow per share must rank in the bottom 35% of its industry.
  9. The passing stocks of the criteria above are then sorted by their cash to shares and the top 10 cash to shares stocks pass the strategy

Why are we so confident in this strategy? Let’s take a look at the back test performance of the strategy listed above. The Equities Lab back test hypothetically buys the stocks as they pass a strategy and sells them when they no longer pass with a weekly rebalance since 2003. We then plot the return if you would have done so since 2003 and compares it to the S&P 500 and the Russell 2000. Let’s take a look at the back test graph:

The strategy produces a 29.2% annualized return and a 1800% total return from 2003 up until today. On the other hand, the S&P 500 would have given you about an 8% annualized return since 2003. Let’s now look at the year by year breakdown of the performance:

 The strategy outperforms the S&P 500 in 12 of the 12 years the back test covers.  In 2014 the strategy has  returned 11.3% while the market is up about 5%. Let’s now look at what sort of stocks have passed this strategy in the past:

The two pie graphs above help us visualize the size and sector of the stocks bought and sold in the back test. Throughout the back test there were a total of 1862 trades (about 180 per year). As you can see, most of trades were on technology and health care stocks. In terms of size, the strategy actually produces a pretty equal weighted portfolio.

It is important to validate strategies with a longer re-balance period to make sure they still outperform. We understand most people do not want to be making 5 trades a week. This is the backtest of the strategy with a quarterly rebalance and much less trades than the weekly rebalanced back test:

This backtest makes a total of 604 trades, which is about 54 per year, or 1 per week. The back test still produces a 26% annualized return.

Now that you love this strategy let us now present to you the stocks that currently pass it:

Corning Incorporated (GLW) Citrix Systems (CTXS) Activision (ATVI)
Sony Corporation (SNE) Alimentation Couche-Tard (ANCUF) UniFirst (UNF)
Kimball International (KBALB) Herbalife (HLF) ICON Public (ICLR)
Strayer Education (STRA)    

Please read our Disclaimer before investing.

Nick Stephan
Employee account created by MemberMouse

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