Further Exploration of Increasing Income

Exploration of Increasing Income

Yesterday I posted an article exploring a single parameter – whether or not a year-after-year increases in net income for the past five years was an investable idea. Lo’ and behold, it was. However, it wasn’t the most appetizing investment, and, as stated in the article, shouldn’t be the sole parameter used when determining a potential investment. Rather, it should be used as a green flag, suggesting that you are heading in the right direction with your strategy. In furtherance of the ideas driving the topic of that article, we are going to build a strategy using a year-after-year increase in net income as the base.




Here is the backtest featured in yesterday’s article. We actually get a pretty nice base to build our strategy off, but I can see some areas where I’d like to get improvement.



· Want to receive a total return of at least 700% since 2000

· Drop the monthly standard deviation

· Increase the Sharpe Ratio – even if by only slightly

· Beat the benchmark’s return for the past few years reliably

Though this took a few hours of tinkering, and eventually deleting the majority of my strategy because at some point it became useless to the screens performance, I finally accomplished the goals stated above.




· Like yesterday’s article, all stocks that are found by this screen must have a year-after-year increase in their net income, and net income at year 0 must be positive.

· In those five years, the company cannot have increased their total liabilities by more than 5%

· Finally, these companies must be offering a dividend, even if that dividend is microscopic.


How does it perform?




Fantastically it seems! Now for the bad news, though it checks off a few of the boxes, it doesn’t check them all.


How about if we “strangle” the strategy down a bit and set a max number of positions we can hold?




This is sort of a one sided strangle, but we can go ahead and add a max number of holdings to our strategy so that we only return 10 stocks. *You may get more than 10 stocks if your order by item is something where stocks have duplicate scores.* Here we are going to order the returns by the income statement score found inside the Equities Lab software.




We get a total of 13 results, all of which are fairly large with only one company having a market cap of less than $1 billion.




And here is the finished strategy’s backtest. We lost a bit of performance, but we were able to check off a major box – the strategy defeats the benchmark over the past four years. (Three included in the chart below, and 2016 which hasn’t officially concluded so it isn’t included in the chart.)



We cut down the standard deviation without eliminating too much upside resulting in a slightly increased Sharpe ratio – still hitting our goal overall return of over 700%.




All in all, I have to associate success with this little experiment. We were able to build a fundamentally simple screen based on the basics of running a successful, goal oriented company, and it paid off. This screen is far from perfect, and we will continue working on it until it is investment ready. Until then, play around on the software and get a feel for how things operate. It’s one thing to use the systems strategies for your portfolio, and a very different thing to understand why or how to build your own – even if you don’t use your own in your investments.

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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