Norman Rothery is the value investor for Globe Investor's Strategy Lab. Follow his contributions here and view his model portfolio here.
Getting a good education opens up many doors. But even after years of schooling, too many people know little about the financial markets and investing, which is a real shame.
Money manager Patrick O'Shaughnessy hopes to bridge the gap with a new book called Millennial Money: How Young Investors Can Build a Fortune. In it, he encourages young adults to invest in the stock market to take full advantage of the magic of compounding.
Mr. O'Shaughnessy thinks Millennials need an extra nudge to get them started because they've been dissuaded from investing by the big market crashes of 2000 and 2008. Proselytizing about stock ownership is one of the book's biggest strengths, but it is also one of its weaknesses.
Problem is, after a multiyear bull market, valuations are stretched. As a result, it's hard to be wildly enthusiastic about the market's prospects in the short term. On the other hand, I very much agree that it will provide some great opportunities over the long run and young savers should be prepared to take advantage of them.
To his credit, Mr. O'Shaughnessy addresses such concerns by focusing on quality stocks trading at bargain prices. He also suggests scouring the world for the best stocks and investing internationally when local stocks are too expensive. Call it the "buy global" movement.
More specifically, he favours a multistep, numbers-based approach to stock picking that he details and explains extensively in the book. But, in brief, he likes stocks with high stakeholder yields, strong returns on invested capital, high-quality earnings, large relative returns over the past six months and low enterprise value to free cash flow ratios. (The latter compares the market value of a company's equity plus net debt to the cash flow it generates above the amount needed to maintain its facilities.)
He reviews several ways to combine the five factors. But he likes a ranking method that sorts stocks by each factor and gives them a score based on their position relative to other stocks. The scores are then averaged together and those with the best averages are deemed to be worthy investments.
The approach is more flexible than a simple stock screen, which he also provides, because it allows a stock to be a little weak in one area provided it makes up for it in the others.
The method has been highly profitable based on a back test of a portfolio containing the top 25 liquid U.S.-listed stocks – including international firms with U.S. depositary receipts. The portfolio gained an average of 20 per cent annually from the end of 1973 to the summer of 2013. By way of comparison, the market climbed 10 per cent annually over the same period.
Lured in by the high returns, I asked Mr. O'Shaughnessy this week to recommend a couple of stocks that fit his criteria. He pointed to Take-Two Interactive Software Inc. and Seagate Technology.
Take-Two (TTWO) is a well-known video-game publisher based in New York that recently hit a new 52-week high. Despite the advance, the company still trades at a relatively low enterprise value to free cash flow ratio of 7.2, according to S&P Capital IQ.
Seagate (STX) is based in Dublin, Ireland and makes hard drives for computers. The firm generated a healthy 17-per-cent return on capital over the past year and pays a 3.2-per-cent dividend yield. As it happens, its stock also hit a 52-week high this week.
If Mr. O'Shaughnessy is right, both stocks deserve consideration by young and old investors alike.
Those who are new to the markets should also check out his book. If they're particularly lucky, they might find a copy of it under the tree this holiday season.
Norman Rothery