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A Strategy That Beat the Bull Market

- By Holly LaFon

The stock market performed so well over the past five years that it proved incredibly difficult to outdo it. When 76.2% of active retail fund managers turned in subpar returns last year, many clients began wondering whether they should move their money into ETFs. Back testing reveals one strategy that worked in a market where everything seemed to be going right.

In the past five years, the S&P 500 index returned 68.8%, with only one down year, as zero interest rates, a reviving economy and corporate profit growth pulled it out of the recession lows of 2008 and 2009. In addition, over the last 10 years, the best and worst-performing sectors showed a 30% difference in gains each year, meaning being in the wrong place at the wrong time for a concentrated portfolio would have dinged returns.

Focusing on fundamentals has also limited opportunities as the market became increasingly expensive. The S&P 500 currently trades at 23.8 times earnings for the last 12 months, compared to the historical average of 16.7%. As hedge fund manager David Tepper (Trades, Portfolio) said last week, "On a multiple basis, it's kind of full."

Certain characteristics defined stocks that would muscle through the stampeding crowd to come out ahead. An investor positioned with a portfolio of these stocks roughly five years ago would have gained 101.03%, to ace the S&P 500, the Dow's 58.69% rise, and the 94.51% rise in the Nasdaq.

The portfolio had no down years, including in 2015 when it increased 1.10% versus the S&P 500, which fell 0.81% in its single down year. It also would have turned an investment of $1 million into $2.01 million.

The companies are traded on the S&P 500, had a market cap more than $2 billion, a financial strength rating of 2, a profitability rating of 4, and five years of buying back their shares at a minimum rate of 1%. They also had a 10-year EPS growth rate in the range of 5% to 35%, and the portfolio was rebalanced every 12 months.

The criteria bear a highly limited range. Adjusting the bottom bracket of the 10-year growth rate to 10% drops the total return to 82.17%. Asking for even 2% in buyback rates reduced the gain to 98.88% while eliminating the share buyback rate all together plunged returns all the way to 81.73%.

Of all fifty stocks, the five in the portfolio in the last year with the best performance were Unum Group (UNM), Norfolk Southern Corp. (NSC), Boeing Co. (BA), Torchmark Corp. (TMK) and Harris Corp. (HRS). Only six posted declines: Target Corp. (TGT), H&R Block Inc. (HRB), Nordstrom Inc. (JWN), Coca-Cola Co. (KO), General Mills Inc. (GIS) and Coach Inc. (COH). The worst, Target, declined 28.99% and the best, Unum Group, rose 55.71%.

See the portfolio here.

This article first appeared on GuruFocus.