Cooling Prices Bring Slater Zulu Stocks Back In Play

14th May '14 by Ben Hobson

7 comments 20016 reads

Jim Slater’s Zulu Principle strategy of buying growth stocks at reasonable prices (GARP) has earned a popular following among UK investors. Over the past year Stockopedia’s own Slater-inspired Zulu screen has returned 40.5%, making it one of the best performing of all our Guru Models. With the prices of many growth stocks soaring in 2013, the number of companies qualifying for the screen fell substantially. But with prices now taking a breather in parts of the market, Slater-esque GARP shares are emerging once again.

Jim Slater wrote his legendary investing book The Zulu Principle back in 1992. In it he encouraged investors to research shares thoroughly and look for those with track records of earnings growth and strong cash flow.

Stocks, he said, should also be priced reasonably in the context of their future earnings forecasts. To calculate that, he applied his famous PEG ratio (price-to-earnings-growth), which rates stocks based on the relationship between their forecast P/E and forecast earnings growth rate. The lower the PEG the better.

One of the biggest advocates of this approach is Jim Slater’s son Mark, who has used it to great effect at his MFM Slater Growth Fund. The formula has helped his fund produce one of the best returns in the UK All Companies sector over the past 12 months, at 39.9% - just a snip behind our own stock screening model.

Zulus are gathering in number

Last October we highlighted the fact the number of UK companies meeting the criteria for Slater’s Zulu strategy had fallen sharply - down from 17 to just seven through the year. At the time it seemed that the prices of many growth shares had simply gone beyond reasonable and they were failing to pass the screen on valuation grounds.

A recent example of this occurred with Utilitywise (LON:UTW) - a company that continues to be highly rated by Mark Slater. Utilitywise made it into the Zulu portfolio in March but its forecast P/E ratio has since risen to to a whisker over 20x, which means it currently fails to qualify for the screen. Despite that, a slight dip in prices over recent weeks has caused the Zulu screen to begin filling up again, with 18 stocks now qualifying.

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pka

15th May '14

Ben, you wrote in your article: "In Stockopedia’s soon to be released 1-year StockRank performance results, companies ranking in the top 5% of the market produced a market-trouncing average return of 33%." I assume that those 1-year performance results will be based on Stockopedia's usual practice of rebalancing the portfolios every 3 months. Out of interest, was there a lot of turnover of companies from one 3-month period to the next? To put it another way, were companies that were in the top 5% of the market by StockRank in one 3-month period also likely to be in the top 5% in the next 3-month period?

Edward Croft

19th May '14

@pka. We'll be publishing the results in the next couple of weeks. Actually, our tests have been run on portfolios of stocks held from 20th April for a whole year. We've found that the 99+ StockRank stocks from last April with over a £20m mkt cap have returned about 40%. While we put the rankings together using first principles and a common-sense approach, we really didn't expect to see results that were quite this stunning in the first year. We've taken 4 dates over the last year and checked the results of portfolios constructed and held from each of those dates - in every timeframe the top decile rankings have outperformed all other deciles.

As a sneak preview have a look at this chart - please note that the bottom deciles have a lot of 'survivorship' which is reducing the overall performance - i.e. a lot of low ranking stocks either end up delisting or going bust - this will be cleaned up this week to give a more accurate representation of the returns - but the overall correlation is very, very clear. Please DYOR, past performance no indication of future returns etc etc.

Not only this, but the 'crossover' ranks... Q+V, V+M and Q+M... have all had similar results, but all performed a fair notch of 5%+ below the QVM with more volatility. Also you may remember we initially launched a QVGM composite rank which included the Growth factor 'G' into the results. It still performs well but not as well as the QVM ranking - this backs up our argument that G is too correlated with M and Q to be a useful metric to include.

Most investors have been rather frightened off investing in a lot of high StockRank stocks as they always look quite punchy due to often strong price momentum. Staffline and Dart Group are classic examples - there are strong behavioural reasons why momentum works - we all hate to buy into prices that are rising, so the trend tends to persist. But there have been some notable high ranking failures in recent months... e.g. Sweet Group and Space & People... so it's not like we've cracked the code of the stock market... but these results do illustrate very clearly how correlated stock market returns have been to quality, value and momentum over the last year. Diversification is so important.

I really have been rather excited by these results ! ;-)

jjis

Hi Ed. thanks for this, will look forward to seeing the full update. See DRS a 99 rank had a PW today too which supports the argument about diversification.

Hi Ed, Thanks very much for the sneak preview. I agree the results look very exciting.

When you do publish the results, I would be interested to see the results of QVGM, QG, VG, GM, Q, V, M, G on their own, as well as those of QVM, QV, VM and QM. Also I would be interested to know whether, in each case, the performance of the deciles was always in the order 1 to 10, i.e. decile 1 always performed better than decile 2, decile 2 always performed better than decile 3, etc.

Have the relative components of each ranking system changed over the last year, e.g. has the Quality Rank always been defined in exactly the same way over that period? If not, then one might not be able to draw valid conclusions from the results.

20th May '14

pka - We have indeed done just that. Rather amazingly the QV, VM and QM crossovers all performed similarly with the top decile beating all others. There is a bit of a mix in the decile ordering... quintiles tend to have performed in a much more ordered fashion. I would imagine that over 10 years this would iron out though.

What has been most wonderful of all is the fact that the top decile stocks in the Energy, Basic Materials and Financial sectors have performed outstandingly. Goes to show that in spite of what everyone says in these sectors that really they don't work so differently. These results are very similar to what O'Shaughnessy found in What Works on Wall Street for his Value Composites which have somewhat inspired this whole system... his Value Composite had across the board the most consistent results in every single sector it was applied to as a value screen.

I am though very mindful of the potential for hubris with this. This is only 1 year of results. I think we've been quite lucky that the stock market has played nicely for the launch of these ranks. We have yet to test the European stock ranking history, but I would anticipate a similar picture. What all professional quants know is that not all models like this play nicely all the time ! So DYOR.

In that test above jjis I've removed all stocks with a market cap < £20m. The results actually look better when you include microcaps below this level, but there are 1000 stocks on the market in this mktcap range and the spreads get wide and returns are volatile. I think most p.i.s are interested in slightly more established & liquid companies so I removed them from that test. It should really be an investable set of stocks imo.

A few other spots of note... What I'm also finding is that many of the 0-10 ranked stocks are microcaps. And there are lots of them that end up delisting. We are finding more stocks go missing from this segment than any other. In the decile test above there were only 88 stocks in the 0-10 segment vs over 250 in the 90-100. As you climb the market cap rankings you find stocks in general become less junk like - unsurprising really, but good to note.

Another point of note. The makeup of the indices. The FTSE Small Cap is actually a strong StockRank index. The average QVM score is about 71, the average QV score is 70. I would expect this index to do reasonably well over time as a result - it's actually loaded with stocks that people like Greenblatt or Buffett might think are ok. The FTSE 100 is ranked pretty similarly. If I were an index investor though I'd want to track the small cap index.

But the AIM 100 index... median QVM of 50... and AIM All Share... uh-oh... only 35 !!!!

One has to be hugely careful where one invests !

PhilHofGrowYourDough

23rd Jun '14

Takeover bid announced for Kentz (LON:KENZ) today, share price up 32% to 927.8p. Yummy!

http://online.wsj.com/article/PR-CO-20140623-902518.html

Regards
Phil

Cooling prices bring Slater Zulu stocks back in play

Zulus are gathering in number

Zeroing in on Zulu stocks with the StockRanks

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Ben Hobson

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