The man and his model
When Robert McWhirter appears on the Business News Network to discuss stocks, he likes to refer to his "model," which ranks each stock as high, low or neutral. But what is the model that McWhirter speaks so reverently about--and just how does he use it to determine whether to buy or sell a stock?
Breaking the model down
McWhirter, a money manager for the last 30 years, runs a Toronto-based firm called Selective Asset Management. His model is the complex formula he uses to pick growth stocks, including those in his Long-Biased Equity Hedge Fund, which holds $8 million of the $125 million that Selective manages.
McWhirter has developed his own set of stock-picking criteria with the help of high-end data and software he purchases from Toronto-based Computerized Portfolio Management Services Inc. (CPMS). CPMS sells its customers, which include institutional investors and brokers, --a range of equity information; McWhirter's research bill comes in at about $60,000 to $70,000 each year, an expense he considers well worthwhile.
Using data from CPMS, McWhirter ranks stocks across three broad categories: --earnings changes, price changes and return on equity. These are then narrowed further into: (1) price to earnings ratios; (2) price/earnings ratios to book values; (3) earnings surprises; (4 & 5) earnings revisions by analysts over two different time periods; (6, 7, 8 & 9) stock price increase over four time periods; (10 & 11) earnings growth over two four-quarter periods; and, finally, (12) return on equity.
An investor can use this type of analysis to spot a stock that's ready to take off--and more importantly, try and avoid one headed for a fall or stuck in a rut.
"I have two rules for investing," says McWhirter. "The first rule is don't lose money. The second rule is, see rule number one."
In his hedge fund, McWhirter also has the flexibility to sell his stocks and park the proceeds in cash if his data tells him the markets are poised for a fall. For example, he was high on cash when the market tanked in August, which limited his losses to a mere tenth of a percentage point, although the overall market burned off 1.5%.
So far, McWhirter's hedge fund has generated a 45.7% return since its inception in 2004. As of Sept. 30, 2007, it was up 12.4%, compared to a 9.5% rise for the Toronto Stock Exchange as a whole.
The trend is your friend
One of the things McWhirter considers when he evaluates a stock is whether a company's earnings prospects have been upgraded or downgraded by the analysts who research it on a regular basis. If analysts raise expectations for a company's earnings, this usually causes the stock price to rise. The reverse is often true if the estimate is downgraded. However, many investors make the mistake of thinking a stock is a bargain if its price drops after its earnings outlook is cut.
"Just look at Nortel Networks in No--vember 2000, when its first negative surprise took place," McWhirter says. "In---vestors said 'Oh well, it's just a one----quarter toss-up,' and kept buying, but we now know that it was the harbinger of an industry-wide downturn.
"It's nice that people are looking for the good news, but people don't pay enough attention to the bad news, be--cause when bad news happens you get spanked twice as hard."
In his experience, McWhirter said, bad news tends to last for months or even years, and can often be seen as the first sign of a downturn for the industry as a whole. This was certainly the case for Nortel and other technology stocks when the sector blew up early this decade. Conversely, a company that's expected to post better earnings than previously forecast can often sustain that momentum in the coming months and may be a good buy--depending, of course, on how it ranks according to the rest of McWhirter's factors, such as price to earnings ratio and return on equity.
Sometimes it's okay to buy sky-high stocks
Investors can also make the mistake of shying away from a stock trading at a relatively high price to earnings ratio, despite strong prospects, says McWhirter. But a good stock may be worth as much as forty times earnings. By using the 12 criteria, investors can now figure out if it's worth putting their money in those types of stocks. For example, back in the 1990s, some colleagues questioned McWhirter's decision to purchase shares of JDS Uniphase at a time when the Ottawa tech company was trading at a seemingly high price-to-earnings ratio. But McWhirter ended up making a good return, because the stock eventually rose even higher.
Investors are now grappling with the same questions regarding BlackBerry manufacturer Research In Motion--though the jury on this one may still be out, McWhirter says. But if growth rates are brisk, analyst estimates are increasing and the return on equity is high, why not go along for the ride?
What can you do at home?
If you don't happen to have $5,000 dollars a month to spend on software and research, you can do similar stock screens at home for a lot less on the four investor websites described below, or at GlobeinvestorGold subscriber website, the destination McWhirter most frequently recommends.
The advanced stock filter function on GlobeinvestorGold includes many--though not all--of the 12 criteria McWhirter uses. For example, an above-average stock should consistently generate a minimum return on equity of about 10% he says. Investors can also set minimums for many of his other criteria in order to screen out potentially disappointing buys. A test of this process at McWhirter's office yielded good results when compared with his more sophisticated program: All the stocks identified as losers on the website also fell into McWhirter's bottom quartile--which should help you, too, follow his two rules for investing.
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Search low, sell high
You don't need a $60,000-a-year software service to analyze top stocks. Here are two low-cost and two no-cost alternatives that could work just fine in your toolbox--pull one out to shake loose some new ideas to buy stocks or to check up on those you already own
THE NASDAQ GURU SCREENER (nasdaq.com/reference/guru.stm) Benjamin Graham died in 1976, but his stock-picking theories are very much alive today among value investors. What stocks would Graham like if he were around today? The guru screener on the Nasdaq stock market's website will give you an idea by sifting through the U.S. indices for stocks that would have met Graham's requirements. Other gurus covered here include James O'Shaughnessy, author of What Works on Wall Street and U.S. mutual fund legend Peter Lynch.
VALIDEA.COM (validea.com)
Validea is a website--it costs $270 (U.S.) per year--that offers a torqued version of the no-cost Nasdaq guru screener. The idea here is to supply regularly updated portfolios representing the stock-picking styles of 11 different gurus, including the über-investor and philanthropist Warren Buffett. All the guru strategies are combined into what Validea calls its hotlist, which has more than tripled the cumulative return of the S&P 500 Index since mid-July 2003.
STOCKSCORES.COM (stockscores.com)
This site opens up the arcane world of technical analysis by synthesizing various indicators into "sentiment" and "signal" stock scores that are designed to help investors determine which stocks are heading up and down. There's a free service that allows you to look up individual stocks and more advanced tiers that start at $29 (Canadian) per month.
This site was started by professional stock trader Tyler Bollhorn of Calgary.
RISKGRADES (riskgrades.com)
You may never buy a stock again without checking this free site, which is run by RiskMetrics Group, a firm that specializes in financial risk management. There's a full database of global stocks, including those listed in Canada, and each is assigned a risk grade that compares a stock's price volatility with that of a basket of global equities. In addition to looking up individual stocks on RiskGrades, you can also analyze your entire portfolio