How many of you can identify with this confession/lament ?

There is nothing more difficult than choosing the right stocks for your portfolio, deciding when to purchase them and when to sell them.

Indeed, whichever stock you are looking at, there will always be an analyst giving a ‘Buy’ or even ‘Strong Buy’ recommendation while another one advises to ‘Sell’ or ‘Strong Sell’. Whom to believe, whom to follow ? The first one, the other one or an average of the two ?

If those analysts, who are paid good money to follow a few companies full-time all year round, cannot even agree among themselves, how can you, as a layman, make a meaningful opinion for yourself ?

Even if you use the average of their recommendations (the ‘consensus’), what do you get in the case described above ? Complete indecisiveness. Did you know that if you analyze all recommendations for all stocks on a given market, you will rarely find more than 20% of stocks with a ‘Sell’ or ‘Strong Sell’ consensus ? Does it mean that 80% of stocks should be bought or kept ? Of course not, and the average recommendation (consensus) is not a reliable indicator for buy or sell decisions. Many studies have shown that such recommendations are always biased, and those among you who have followed them in the past have come to regret it.

If you read the financial press or visit the most popular stock market information websites, you are overwhelmed with information on listed companies. The problem is that this information is inconsistent and varies from one day to the other or from source to source. This constant level of « noise » makes it all but impossible to isolate useful information, to separate useful data from meaningless details, truth from lies and crucial revelations from hype. How often have you heard some good news about a stock and bought some shares in a hurry, only to see them slide in the following hours or days ? In such cases of course you will hear that the market was expecting even better news, that the news had been anticipated and already integrated into the price, or even that the good news in question was in fact bad news in disguise !

In the face of such difficulties, many go back to ‘buying and holding’, arguing that stocks are a long-term investment and that the shares they own are bound to go up sooner or later. While we agree that stock trading should be done with a long-term perspective (e.g. avoiding situations where you are forced to sell in the middle of a bear market), we are convinced that investors should regularly arbitrage and renew shares in their portfolios. All stocks have bullish and bearish phases – what good is it to keep a stock that is likely to slide all year long, while you could replace it with another one that is more likely to rise ? Permanent arbitrage between the lines of stocks in a portfolio is a crucial requirement to outperform the markets.

Our approach is 100% rational. It is not affected by market noise or by rumors, because it is based essentially on numbers. Those numbers are continuously monitored for each stock and processed through an algorithm carefully fine-tuned by Stock Engineering. Its computing parameters are updated regularly to take into account major market evolutions.

Our algorithm specifies at any time whether a stock should be bought, kept or arbitraged or sold , without regrets.

The numbers we feed into our algorithm are mainly :

• Variations in the EPS forecast consensus. We take into account the extent of such variations, their repetition, their consistency…
• The absolute values of the latest effective EPS and of forecasted EPS, as well as earnings growth rate in the recent past and expected short term;
• The stock’s recent trend on the market, when it can be measured in a meaningful and consistent way;
• The company’s competitive position within its market sector and the recent trend for that same sector.
• Other criteria such as market trading volumes, ROE (Return on Equity), stock volatility, highs and lows over the past year…

EPS consensus variations:

Earnings per share constitute one of the key factors influencing stock prices. By purchasing shares at a certain price, investors pay in fact for the expectation of future profits. A stock is always bought on the basis of where it is going, not where it has been. Who is not familiar with the famous P/E (price/earnings) ratio? A stock is considered expensive if its P/E ratio is high, whereas a low P/E is typical of an underrated stock. Moreover, each marketplace has its own typical P/E ratio and each market sector, at any given time, also has its own typical P/E ratio.

Agreeing to a given P/E ratio for a stock boils down to admitting that if the profits (earnings) of the company are forecasted to rise, then the acceptable price for the stock will rise with the publication of the forecasts (and conversely, a downward revision of forecasts will send the price down).

Analyzing earnings in absolute terms has little relevance if you want to predict changes in a stock’s price. A stock whose expected earnings have been stable for a while will usually have reached a price level in line with those forecasts. In such a case we say that the price has ‘integrated’ the earnings forecasts.

On the other hand, studying changes in earnings forecasts is highly relevant. When people find out that a company’s earnings will be 20 instead of 10, this change in forecasts sends the stock price soaring within a couple of days. After the first few days the price keeps rising more slowly for a while, until it reaches a level that fully integrates the good news. From that point on the price will remain stable again pending further good or bad news.

When analysts publish revised earnings forecasts, institutional investors usually react first. For instance, if earnings forecasts are strongly revised upward, institutional investors will seek to increase their holdings in order to profit from the expected price increase. Because institutional investors trade large volumes of shares, they have to split their buy orders and spread them over a number of days. As time passes by, other investors will hear the news or will notice the increased trading volumes on the stock, and they will follow in the institutionals’ footsteps. These new purchases will only reinforce the upward trend on the stock. After a while the stock’s price will have integrated the good news and it will level off. The stock will be quoted at its “rightful price” and the market for it will be efficient.

But if in the meantime another upward revision of earnings forecasts has been published, the stock will shoot up again until it integrates the additional good news. Conversely, if a downward revision is published in the meantime, the price increase will stop prematurely.

This shows clearly that upward revisions of EPS forecasts are the “fuel” that will drive a stock’s price increases.

The first upward revision will give the initial kick triggering the price increase. This first fuel inflow will be “used up” in a few weeks, a few months at most, and beyond that timeframe it makes no sense to keep that stock in your portfolio. On the other hand, if earnings forecasts are regularly revised upward (even by small amounts), the stock will behave as if new infusions of fuel were driving a continuous price increase. The rise will be more sustainable and the stock should be kept for longer in your portfolio.

When the “fuel” stops flowing or as soon as a downward revision breaks the established rising trend, the algorithm will downgrade its assessment of the stock.

You need to use PREDICTIVE indicators for your buy and sell decisions.

Neither do we favor the use of Stop-loss mechanisms, even though we understand the usefulness of this technique as a means of capital protection.

The problem with Stop-loss is that most of the time it causes investors to sell at low points during a “cooling period” in the market. This takes a heavy toll on returns !

We prefer to rely on Stop-parachutes, which should only be used as a safety net and not as a trading tool. After all when you get onto a plane, you do not jump out as soon as the plane arrives at destination – you wait for it to land first, and you jump out only if the plane is on fire. The philosophy of Stop-parachutes is similar.

In the same way that we publish buy recommendations on a weekly basis by detecting stocks recently primed for a rise, we base our sell recommendations on indicators that signal an upcoming weakening of a stock’s price. Such indicators of course include EPS variations, but we also take into account companies’ changes in behavior compared to the prevailing trend in their sector.

We do not take into account analyst recommendations

As mentioned earlier, individual recommendations published by analysts, or even average recommendations, are not highly relevant. An American study has shown that between April 1992 and September 2002, investing systematically into the most highly recommended stocks from a broad universe of companies would have produced an average portfolio return of 7.8% per year. This would have underperformed a portfolio containing all stocks in that universe, including those published as ‘strong sell’ as well as ‘strong buys’, which would have yielded 8%. The study even shows that during stock market recessions, a portfolio of stocks rejected by analysts (‘sell’ or ‘strong sell’ recommendations) generates a better return than a portfolio based on the most favored stocks (‘buy’ or ‘strong buy’).

Final considerations and conclusion

Our method is not interested in speculative stocks and is not affected by market noise.

We keep stocks in our portfolio as long as they have “fuel” driving their price increase (see explanations above). Renewed fuel intakes may sustain the rise and cause a stock to remain in our portfolio for several months. A stock typically remains for 1 to 3 months in a portfolio before being replaced by a ‘fresher’ stock.

Our system should be assessed in a statistical context. This means that if you buy ONE or TWO or THREE stocks recommended by the system, you have no guarantee to see them take off. On the other hand, if you have bought at least 6 recommended stocks, you have a good statistical chance to see a number of them take off and outperform the market.

Neither can this system guarantee that you will make a profit in all circumstances. In times of recession when stock markets are on a downward trend, it will simply help you to fall less steeply than the market.

This system’s main purpose is thus to help you OUTPERFORM the market.

The level of overperformance achieved is of course dependent on the reference index you choose. We have opted for the Eurostoxx index, which appears to be the most appropriate. But you could use other reference indices, for instance the Standard & Poor 350.

All specialists will tell you that outperforming the market is extremely difficult and that only 20% of asset managers are able to do it. Of course such asset managers are in high demand and they only deal with large fortunes, because they need commissions on very high volumes to be paid at their expected level.

Thanks to this site you can now:

• Manage your portfolio like a professional
• Arbitrage your holdings every week in a dynamic and systematic way
• Make use of a well-structured, objective, reliable and INDEPENDENT system
• Base your choices on a scientific evaluation method which only takes into account objective numbers and facts
• Steer clear from the confusing predictions of oracles and gurus of all stripes
• Rely at all times on clear, to-the-point and unambiguous signals covering most stocks traded on European marketplaces, without having to sift through tons of contradictory information.