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A Winning Stock Selection Process in ISEQ

For as long as stock markets have existed, investors have tried to select stocks by looking to what the future holds. The trouble is that practitioners of the forecasting approach have consistently failed to match the market average returns. So, unless you think you are Warren Buffett, you should probably forget about picking stocks on the basis of what you, or others, think the future holds.

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In contrast, there are much less complicated ways to select stocks and with better odds. Using historical data alone to judge which companies offer the best value at any point in time and by diversifying sufficiently, an investor can build in what is commonly referred to as a 'Margin of Safety'. For as long as the majority of retail investors, brokers and fund managers continue to tread the 'forecasting' route, value investing has the edge (and a strong one at that). And the reassuring news is that this method of stock selection has been around for over 70 years, ever since Ben Graham wrote 'The Intelligent Investor'. An additional benefit of using only historical data is that the success or otherwise of the approach can be measured back in time. No huffing, no puffing, no bluffing - just facts!

As part of its service to members of its website, GillenMarkets (www.gillenmarkets.com) selects stocks annually in the Irish, UK (FT 100) and US (DOW) markets using historical data only, and tracks the performance of these portfolios throughout the year. Our track record is well above average.

Perf. Irish Stock Picks 31.12.09

How Did Our Selections Fare in 2009?
The ten Irish stocks selected at the start of 2009 with a market value of at least €100 million delivered an average return of 62.9% compared to a gain of 29.7% in the ISEQ Index (returns include dividends but exclude transaction costs). The ten Irish stocks selected irregardless of size advanced by 73.2% in 2010 against a 29.7% rise in the ISEQ Index. The outperformance can be attributed to two main factors:

  1. Selecting better value on average
  2. Equal weighting the stocks selected. Afterall, the ISEQ returns were weighted down not by the average stock but by the relatively lacklustre recovery of several of the heavier weighted stocks in the index

Good Out-performance is Evident Over the Long Term Also
Over the 15-year period from 1995 to 2009 inclusive, a portfolio of ten stocks selected in this way at the start of each year (and with a market value > €100m) and reviewed annually generated a return of 15.9% compound per annum compared to a 6.0% return from the ISEQ Index over the same timeline. Again, these figures include dividends but exclude transactions costs. The approach does not out-perform the index each year but the odds are good. In the fifteen years from 1995 to 2009, the approach has out-performed in eleven years and under-performed in four years (3:1 odds).

The 2010 Selections
On 31st Dec 2009, the stock selections in ISEQ for the year ahead (2010) are as follows - the ten stocks with a market value of at least €100 million and fitting the selection criteria include Dragon Oil, IFG, Independent, Total Produce, Origin Enterprises, Greencore, Kingspan, DCC, Paddy Power and Aryzta. The ten stocks selected irregardless of market value include CPL, Dragon Oil, UTV, IFG, First Derivatives, Independent, Total Produce, Origin Enterprises, Greencore and Kingspan. The performance of these stocks throughout 2010 can be followed via the 'Model Portfolio' section of the website for members.

The Stock Selection Process Explained
We use two financial criteria to select stocks from ISEQ. First, we calculate the 'Return on Capital Employed' for each Irish listed stock and rank according to how well each stock scores on that measure. Then we calculate the 'Earnings Yield' on each Irish listed stock and rank according to how well each stock scores on that measure. The combined scores determine the top ten stocks. The approach does not select financial or insurance stocks (where the Return on Capital cannot be measured in the traditional sense). Our source of data is Annual Reports.

Buying Relative Values
This approach to stock selection is not an attempt to 'time the market' nor a substitute for it. Rather, it assumes an investor has already made the decision to be in the market and is content to buy the stocks that offer the best return prospects relative to the market

There is a comprehensive research note that you can buy in PDF format covering this Irish Value Approach at the eBooks section on the 'Home Page'. You can buy the eBook online with a credit card.

Rory Gillen
8th January 2010