Today we formulate the comprehensive share selection criteria
based upon the individual share selection methods discussed over
recent months. This will provide both "buy" selections
and "sell" selections that form the basis of a
"Portfolio Management Strategy" (i.e. what to
"buy", what to "sell" and what to
"hold" in your investment portfolio).
Unfortunately, it is not possible to formulate one single comprehensive criteria. As explained in Part Two, two of the most successful selection methods (i.e. Relative Strength and fundamentally "under-valued" shares) are uncorrelated. Simply ranking shares on each criteria and adding the results will cancel out the success of these two criteria. However, (as previously discussed) these selection methods can be profitably combined.
It is therefore necessary to construct several "buy" criteria and several "sell" criteria that combine the individual share selection methods in different ways.
For the NZ sharemarket we have decided upon three combined
share selection methods (and reversed two of these for a
The first "buy" criteria - based upon "Value" - selects the shares with the lowest Price/Sales Ratios which also have positive Relative Price Strength and which pay a dividend.
This combined criteria selects the most "under-valued" shares that are in long term uptrends.
The second "buy" criteria - based upon "Performance" - selects the shares with the greatest Relative Price Strength which also trade on a Price/Earnings ratio of less than 20 and a Price/Sales ratio of less than 1.0.
These are the shares that are appreciating most rapidly in price - but which have not yet become too "over-valued".
[Editor's Note: Relative Strength Ratings can be calculated in many ways - all of which measure the rise or fall of a company's share price over the recent past. One method is to simply calculate the percentage price change over the last six months or the last year. As a share price fluctuates this method leads to large changes in its Strength Rating. "Market Analysis" calculates its Strength Ratings by dividing a company's average share price over the last 40-weeks with the similar 40 week average price 13 weeks earlier (i.e. the 13 week change in the 40 week average price). This calculation approximates the percentage change over the last nine months, but provides a relatively stable "rating" without the rapid large changes to the Strength Rating.]
Medium and "smaller" company shares, as well as shares that are "neglected" by Brokers, make the best long term investments. So from both the Low Price/Sales selection and the Strongest shares selection investors should favour companies with low Market Capitalisations and "neglected" by brokers (i.e. followed by zero to five brokers).
Investors seeking maximum long term capital growth should use the "Value" and "Performance" criteria, giving particular attention to "neglected" shares of "smaller" companies.
The third "buy" selection - based upon "Income" and financial stability - selects the shares with the highest Dividend Yield from amongst the larger listed companies. A high Dividend Yield often indicates that a share is "under-valued", "out-of-favour" or experiencing some problems. "Smaller" companies are excluded from this selection as they may be unable to survive and recover from any problems. "Larger" companies usually have the financial strength to (1) often maintain their dividend rate during a temporary down-turn and (2) to survive until business conditions improve.
While we have excluded companies with a market capitalisation of under NZ$100 million (i.e. approximately the bottom half of all NZ listed companies), under this "Income" criteria investors should tend to favour the larger companies as well as those with a low Price/Sales ratio.
This "Income" selection criteria is most suitable for "low-risk" investors and those requiring a current income (i.e. retired investors).
Both the "Value" criteria and the
"Performance" criteria described above
will also select the least attractive shares which will likely
under-perform the sharemarket.
Investors should therefore generally sell these shares, freeing up investment money that can be more profitably invested elsewhere.
Our first "sell" criteria is for those shares with the highest Price/Sales ratios and which also have negative Relative Price Strength. These are the most "over-valued" shares which are also in long term downtrends.
The second "sell" criteria is for shares which have the lowest Relative Price Strength Ratings excluding those that trade at a very low Price/Sales ratio or a very high Dividend Yield. That is, these are the shares in long term downtrends, excluding those shares that may already have become too "under-valued"
Under both of these criteria, large companies (i.e. those with the highest market capitalisation) and those which are widely followed by brokers (i.e. followed by 10 or more brokers) are the least attractive and therefore the shares that should be most readily sold.
The "Income" criteria discussed above (i.e. buy the highest yielding, largest companies) will lead to almost a "buy and hold" portfolio with little turnover. A matching (but necessary) "sell" criteria would be somewhat arbitrary, but we would suggest that a share should be sold if it can be replaced by another that offers a 50% higher dividend yield.
For the Australian sharemarket there are four combined share
selection methods (and three "sell" criteria).
As with NZ, there are "buy" criteria based upon "Value" and "Performance". With Australian companies there is data available on buying and selling by directors - and this "Insider" trading is included in the printout of computer selections.
So, in addition to favouring "smaller" companies and "neglected" shares, investors should favour shares where directors have been buying (and perhaps avoid shares where several directors have been selling).
Australia also has an "Income" selection, which is identical to the NZ "Income" selection criteria - except that Australian companies are generally bigger than NZ companies so we have excluded companies with a market capitalisation of under A$250 million. We have also excluded Property Trusts which have high income yields and tend to dominate this criteria. "Insider" buying and selling is shown - which should help with share selection.
The fourth "buy" selection for the Australian sharemarket is "Insider Buying". This is a selection of the shares with the greatest number of "insider" buyers (less "insider" sellers) over the last twelve months, and which have positive Relative Price Strength (i.e. are in long term uptrends). As always, "smaller" and "neglected" shares should generally be favoured.
As with NZ, the "Value" and "Performance"
selection have an opposite "sell" criteria for the most
"over-valued" and the worst performing shares.
Of these shares, the least attractive will also be larger companies, shares followed by nine or more brokers and shares where "insiders" have been selling.
The Australian sharemarket also has a third "sell" criteria based upon "Insider Selling". This is a selection of the shares with the greatest number of "insider" sellers (less "insider" buyers) and with negative Price Strength (i.e. in downtrends).