A program-driven quantitative model can assist investors with two things that it can do more efficiently than humans - to screen for stock ideas and to backtest a strategy. This is why we, as quality-centric investors, developed our proprietary model to assess and quantify the business quality of individual stocks. Each stock is assigned a rank called the "Urbem Quality Score." The higher the score, the better the quality. Additionally, we hope to prove alpha generation out of our quality investing strategy through backtesting.
Using tools like Portfolio123, we built the algorithm to generate Urbem Quality Scores mainly based on the following quantitative factors:
- The magnitude and consistency of returns on capital over a multiyear period.
- The magnitude and consistency of profitability over a multiyear period.
- The magnitude and consistency of historical growth and momentum.
- The magnitude and consistency of cash generation and capital requirement.
- Financial strength in terms of short-term liquidity and long-term solvency.
- Other considerations, such as the trend in shares outstanding and insider ownership.
You may notice that the model does not address the valuation, but only focuses on business fundamentals on a quantitative basis (qualitative factors like an economic moat, growth prospects and management are not within the scope here). Some top-ranked U.S.-listed stocks currently include MasterCard (NYSE:MA), Intuit (NASDAQ:INTU), Booking Holdings (NASDAQ:BKNG), Accenture (NYSE:ACN), Check Point (NASDAQ:CHKP), Texas Instruments (NASDAQ:TXN), FactSet (NYSE:FDS), Jack Henry & Associates (NASDAQ:JKHY) and Xilinx (NASDAQ:XLNX).
In Portfolio123, we also developed a simulation to backtest our strategy. The hypothetical portfolio (check here for details) picks the 50 U.S.-listed stocks with the highest Urbem Quality Scores, with equal weights, and rebalances annually. As you can see below, the portfolio has beated the benchmark, the Vanguard Total Stock Market Exchange-Traded Fund (VTI), by a sizable margin since 2005. As of annual performance, the quality-centric strategic managed to outperform its passive counterpart in 11 out of the previous 15 years.
Source: Portfolio123; data as of Jan. 12, 2020.
In terms of sector allocation, technology, health care and consumer staples represent the most significant holdings of the current portfolio (see below).
Source: Portfolio 123; data as of Jan. 12, 2020.
Large-caps account for the very majority (over 85%). FactSet, Check Point and Amphenol (NYSE:APH) are the longest holdings so far in the hypothetical portfolio (all for more than 12 years now). The equal-weighted average of returns on equity is 63%, signaling superior capital efficiency and sustainable competitive advantages. At the same time, the average dividend yield is only 1.05%, and the price-earnings multiple is a hefty 32.2, indicating that Mr. Market is likely paying a premium for such quality.
Disclosure: The mention of any security in this article does not constitute an investment recommendation. Investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the financial market. We own shares of FactSet, MasterCard and Check Point.
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- Two Interesting Emerging-Market Retailers From Fundsmith's Latest Portfolio
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This article first appeared on GuruFocus.