Qualities of Winning Stocks

Our goal in this section is to understand the differentiating factors between the "Winning" stocks and the rest of the market.  We will do this by analyzing groups of stocks and their respective qualities.  The groups of stocks will be the following:

• Top 5 YoY 
• Top 10 YoY 
• Stocks with best 3yr historical performance
• Stocks with best 5 yr historical performance
• Stocks in 75th percentile or above

The qualities we will be looking into will be based off of theory.  The theory should start with Stock price and be able to work itself down to each of the important ratios that matter for a stock. I have broken down what I believe to be the levers on individual stock price into the tree format to focus on the ratios that "SHOULD" have the largest impact on performance

I know many might disagree that these are the ONLY factors that influence stock price/share, but mathematically they are the ONLY factors by their inherent definition.

• Stock Price/Share = P/E Ratio * Earnings/Share

This is useful for the following reasons:

1. Earnings/share encompasses all fundamental performance of a stock
• It is not the ONLY useful value of measure for a stock, but if earnings are not good then you would expect poor price performance
• Sales growth and profit margin are secondary indicators of fundamental performance
2. Price/Earnings Ratio encompasses all technical performance of a stock

Based on the above we will look at the following at the beginning and end of the periods for those groups of stocks:

• P/E Ratios
• Starting P/E Ratio
• Ending P/E Ratio
• Earnings/Share
• Initial Earnings/Share
• Ending Earnings/Share
• Market Capitalization (Stock Price*Outstanding Shares)
• Initial Market Cap
• Ending Market Cap

There are additional indicators I know have an effect on a stock, but they seem to all fit into the two categories of earnings/share or P/E ratio.  I expect the results will be in the next post which I will hopefully have time to put together for tomorrow March 9th.

Our Theoretical Returns

The goal of this blog was for me to identify how to live off stocks.  Before we get into the qualities of winning stocks it will be helpful to understand what our performance could be if we had invested in these winning stocks of the past. My assumptions will be the following:

• As discussed before I will have 5 open positions per year
• Assume I will catch 40% of the stocks move
• Assume I will have a 2:1 losers to winners ratio per year
• I will always cut my losses at 10%
• Both losers always come before the losers

I want to use this as an example to see if it would have been possible to live off the money made in the stock market if you started at any particular year.  I have created two tables that highlight how you would have done had you averaged the performance of the 5 most winning stocks and 10 most winning stocks.

5 Most Winning Stocks

10 Most Winning Stocks

As you can see from these tables, if you had been comfortable living on 35k or less per year, there would have been only two years in which you would not have been able to pay for yourself.  Although I personally would much rather live on more than 35k per year, it is definitely possible. I have also presented one of the worse scenarios.  

Another method to see if it is possible is to assume we can increase our odds of being in the upper 80% of all stocks on a yearly basis.  The returns for that are outlined in the table below:

So, if we had been able to stay in the 80% for returns on a yearly basis we would have been able to live off the returns for 12 of the last 15 years. 

Before we can claim that it is possible to live off the returns, we need to understand the things that make these stocks different or stand out from the crowd. What godly qualities do they posses that allow them to outperform the other stocks in the marketplace.  That is the discussion for the next post!

Historical Stock Performance

In my last post I identified the top 10 stocks in the past 12 years on a YOY basis.  I would now like to understand the data set a little more in depth and determine the answers to a couple questions:

• What is the distribution of returns across all years? Across the past 5 years? 10 years?
• What are the most winning stocks in the past 3 year period? 5 year period? 3yr period looking back every year for the past five years?
• What are the qualities that make these stocks stand out vs. the crowd? (Answer this in the next post)

The distribution of returns across all 12 years can be seen in the below chart:

The distribution of returns is above and as expected it is centered around 10% which is the historical return of the S&P500. An interesting point to note is the long tail to the right, showing that there are quite a few occurrences when yearly performance is above 100%. 

*Note: The distribution of returns is correct, but the average YoY return for this period is 16.2%, which seems quite high. (I arrived at this number by averaging the percentages as all the YoY returns are equally weighted..I think this is acceptable but could be wrong).  I believe the reason for the higher than expected number is the difference between negative and positive returns, let me illustrate with an example:

• Stock goes from $100 to $110
• % Change = (110-100)/100 = 10%
• Stock goes back from $110 to $100
• % Change = (100-110)/110 = -9.1%
• Average Return
• Actually = (100-100)/100 = 0%
• Average of % = (10%+(-9.1%))/2 = 0.45%---this is WRONG!

From the above example it becomes clear that I cannot average the returns.

Identifying Stocks that can do this consistently:

The stocks that we have identified so far have been the best performing stocks as measured across one year.  It will be easier to make money if we have more time to get into a stock and spend less money on commisions and slippage.  I have filtered stocks that have performed the best in the past 3 years and five years respectively with the list reproduced below.  This will be our starting point to understand what differentiates these stocks when they began their run from the average stock.

Next time we will examine the qualities of these stocks compared to the rest of the market.

Identify Winning Stocks

I read a book once titled “If you don’t know where your going, you’ll probably end up somewhere else.” How does this pertain to my work? We want to focus on stocks that are in the 95th percentile or above in terms of performance, hopefully that is where we are going.  This post will explain how to identify stocks in past years from the 95th percentile, in addition we will highlight the performance you can expect from the market itself.

Understanding Yearly Performance of Stocks:

• Use Microsoft Excel with the data sources mentioned in a previous post
• Utilize January 1st as measuring day (if market is open)
• Complete for past 10 years

Below are the top ten performing stocks from each year for the past 12 years:

That took a little while to put together, if anyone would like the actual table don't hesitate to ask instead of trying to copy and paste the picture. I'm all for conserving time/energy! In the same vein, if I am doing something on this site that you have already accomplished let me know!

A QUICK WARNING!! This is the "SURVIVOR" data set, meaning I used a current list of symbols to generate this list.  Stocks had to make it to present day to be included on this list which means you can expect the average returns that I provide here positively biases and I could also be missing a few stocks from the list.

In the next post I will take a more in depth look at the data set to understand expected returns over the period .

Stock Data Sources

Now the fun part, the actual analysis!!

To begin we need data and lots of it, I am going to expect that individuals will want to duplicate my results (if anyone actually reads this) so I will be posting the sources that I will be getting data from.  Or if you are looking for data I have gotten privately I can possibly provide via a link on email:

Data Required:

• Symbol List - All tickers, current and historical
• EOD Data is the best website I have found to get symbol lists from, the downside is that it includes mutual funds and some stocks that cannot be invested into....these can be rooted out using google finance and a little bit of excel programming
• The list itself can be found here http://www.eoddata.com/download.aspx, after a quick and easy registration the list is yours. The downside is that it does not provide historical tickers later than about a month ago
• If you have access to a financial station (Bloomberg/Reuters) you easily have access to this information. Many large universities have access to these, or some public libraries (before budgets were squeezed).  These financial stations are unrivaled in their breadth and quality of data, so make sure to use it if you have it.
• Historical Stock Data
• YLoader - Historical Quotes Downloader
• The most helpful downloading program I have found.  I got mine for free but it looks like they upped it to a 15 day free trial or a lifetime subscription for $20 from the CNET Downloads link here.  Also includes a command line utility that downloads all the symbols and the exchange they are on.
• Yahoo & Google
• Free to download, just enter your ticker, click historical prices and download to spreadsheet
• Slow if you are downloading multiple tickers, I wrote an excel program to do this for me...which was still slow
• EOD Data
• Cheapest access to intraday data you can find
• 3 years of historical data for platinum members (29.95/mo) 
• Data has been cleaned and formatted for you (not sure of quality)
• Bloomberg/Reuters station
• If this is an option for you, obviously take it...these dedicated stations have techs ensuring they have the most accurate data at all times
• Historical Earnings / Financial Data
• Earnings.com
• Thomas Reuters provides the best free earnings website I have found
• All tickers with up to 3-4 years of their historical quarterly earnings
• Bloomberg/Reuters station
• Past 3-4 years that earnings.com provides, I have only found that a station has the data required to do longer historical analyses
• Would love to know of others that are more than 1 year old, below are the sources I know of that only have data for the past ~1.5yrs
• MSN Money
• Yahoo Finance
• Google Finance

Thats it for right now on the data, hopefully it is clear that price is the determining factor in stock performance which is why we need it most important.  The reason I highlighted earnings data is the expected relationship to stock performance.  That relationship will need to be tested regardless of whether it is correlated to the winners or not.  There will be many additional levels of information required such as ROE, Quarterly Revenue (will give us profit margin), and other stock ratios, as well as macroeconomic ratios.  Access to this information will allow us to determine which of the individual ratios, or combination of ratios increase the probability of choosing a winning stock.

Feedback (because I definitely don't know everything, and would love to learn), Comments, and Questions are always welcome!

Best,

Dylan

Limits for historical analysis

My Goal is to identify stocks that will provide the largest possible percentage return in the shortest amount of time. Once these "Winning" stocks have been identified I will search for commonalities among them. The limitations for identifying winning stocks will be the following:

• I will only be trading in stocks
• I will invest in up to 5 stocks at a time but do not need to be fully invested at all times
• It's assumed I have $100,000 to invest, on margin $200,000 - up to $40,000/stock
• Minimum Liquidity Requirements
• Minimum Trading Flow/day - $800,000
• Price * Volume = Trading Flow
• Minimum Volume/day - 150,000
• Minimum Price - $1.00
• Price Entry/Exit
• Use rule based system to get into and out of stocks
• Assume 0.5% slippage on entry as stocks will likely be passing through buy/sell points at a high velocity
• Commissions
• Assume $5 per trade

For now that's it on limits! This should give me a sense of what the maximum possible returns are in a perfect world. Even this perfect world needs to be stemmed in reality which is why there are three important points I would like to make about the historical analysis I will be doing:

1. Avoid bias
• Focus on the entire world of stocks
• Utilize all time frames data is available
• Look for trend changes in "Winning" stocks qualities from older to newer periods in time
2. Ensure entry would have been possible
• I only have access to daily historical data which will limit entry/exit to open/closing prices
• The limits on liquidity, slippage and entry/exit are to ensure it would have been possible to enter at the position the historical data says to enter
3. Keep it realistic and find a pattern
• I'm not going buy a stock for $.01 and sell it at it's top of $2 without valid reasons for doing so. If I cannot find a connection between any of the stocks data and performance I will pass until I find that connection. Sticking to the data and avoiding emotional decision is my advantage vs. other traders.

Next time we discuss how I will find and organize the data!! The fun never ends :)

Data for my Ground Truths | Top Stock Books

I have already discussed two of my deep beliefs:

• The first being that the efficient market hypothesis is completely false
• The second being that all great traders/investors base their trades on data

In describing these I did not provide any data on why I believed these things.  Here is a quick list of books that led me to come to the above conclusions, although there have been many additional sources that have lead my to these conclusions these were some of the influences to my thought process.

• The Alchemy of Finance
• Author: George Soros
• I read this book 4 and a half years ago in my school library and found it quite interesting.  One of the best investors in the world was discussing the behaviorial/emotional component of a stock, and wasn't even debating that it existed.  It was just PRESUMED! In addition he took it a step further to explain how stock prices act as a reinforcing control system (to a point) in which as price increases, the company has the ability to borrow more, can expand more quickly, earn more and the therefore can increase in price even more quickly (you obviously run into a limit quite quickly once you have saturated the market with your product).  Great read, I could use a re-read.
• Contrarian Investment Strategies - The Next Generation
• Author: David Dreman
• Thought provoking book that was one of the first I read that directly challenged the basis of the efficient market hypothesis.  Focuses on understanding how to make money in the markets by understanding the stock types that have historically outperformed. It is a thorough review but I think he misses the ability to take advantage of the markets emotional swings, which makes sense as his investment horizon is 2+ years.
• Reminiscences of a Stock Operator
  
• Author: Jesse Livermore
• This book is a must read at a minimum for the story that it provides, combined with his biography it is an extremely telling book of Jesse's life and ultimate suicide.  Jesse essentially grew up in the markets, starting in the bucket shops (branches that sold stock) and made a killing, eventually being banned as he made so much money. This led him to speculate in stocks and eventually he became extremely successful.  The story is entertaining, and there are many interesting takeaway's from this book; the first is that the market is definitely not efficient as he was able to personally move the market in many different stocks. The second is that emotions are a huge component to trading as you see the emotional grips that individuals go through as they trade around him. And finally understanding stock movement (price and volume) is as critical as understanding the fundamental reason for a move, this was how he differentiated himself from others.
• Snowball - The life of Warren Buffet
• Author: Alice Schroeder
• An interesting read because it highlights how different Warren's life was from that of a normal kid from the start.  As a brilliant young kid he understood the value of compound interest and always had a business venture, that was successful on the go. His method of investing was always to dig and get much more information than anyone else, then once he had enough information to know that a company was severely undervalued he would let the market in on the secret making large amounts of profit from each trade.  Once again, this disproves the efficient market hypothesis, but confirms the data oriented approach.
• How I made 2,000,000 in the Stock Market
• Author: Nicolas Darvas
• Great story regarding Nicolas's struggle to make money in the stock market. He ended up catching a bull cycle with a method that was perfect for it based on large increases in both price and volume.  Its an interesting read, but lacks in depth that would help understanding his trading strategy.  One of the most helpful discussions throughout the book is his battle with his emotions which shows that even when someone is getting it right, it is an emotional battle. In the end he learned to avoid anything that would make him overly emotional, and focus only on the data and the truth that it holds.
• Lessons from the Greatest Stock Traders of All Time
• Author: John Boik
• This book is helpful at comparing different traders styles allowing the reader to understand their similarities.  I read it over a year ago, but I remember that I did not feel that the author did a great job at understanding these individuals and truly making the meaningful connection between them all.  The model character from this book that I wanted to understand was Wiliam O'Neil as he followed a completely data based approach.  He was also the youngest person ever to buy a seat on the NYSE and still holds that record to this day.
• How to Make Money In Stocks
• Author: William O'Neil
• William O'Neil has had the most rigorous data approach that I have read about.  It details from start to finish how he went about making money in the market and amassed his initial fortune.  Although his system is specifically tuned for the individual investor who can move easily in and out of stocks without causing liquidity issues, it has no equal for that audience.  I wholeheartedly recommended the book, however my one caution is to watch out for the details.  There is quite a bit of information and as much as they try to dumb it down for the reader, the writers do not do a particularly good job at identifying the priority order of the winning qualities for trades.  Also, when a stock looks "perfect" from IBD's numbers, typically a large portion of the profit has already been missed.
• Invest like a Shark
• Helpful insights into emotions and some basic practical advice...dumbs down the theory component way to much to be particularly helpful. Very much a momentum based system that is helpful in pointing out how to pick up on money flowing into a stock from a chart.
• Trading for a Living: Psychology, Trading Tactics, Money Management
• Helpful practical advice to trading, one of the most important was how to prevent yourself from making emotional trades. As the author Alexander Elder is a pyschologist he describes the emotional basis of the problem, its similarities to that of alcoholism and an effective treatment method.  One at least that I found helpful
• Intermarket Technical Analysis: Trading Strategies for the Global Stock, Bond, Commodity, and Currency Markets
• Haven't gotten the chance to read it completely.  A little bit of a slow read, it does a good job at connecting based on data the equity, commodity, bond, and currency markets.  Also gives a guideline from a macroeconomic perspective as to the general relationship that it will follow. I got into it because my buddy on a trading desk recommended it as the goto book to read for technical analysis (Many of the trades that he makes were based off of this relationship, and betting that it would hold)

Sorry for the length of the post, hopefully next time I will get into outlining the process by which I will approach the data analysis.

Welcome

Hi All,

In case the name of the blog doesn't give it away, the goal of this blog is to track my journey in the stock market.  I will be trying to earn enough money from stocks to live off for the rest of my life. A complication here is that I would prefer not to discuss how much money I start with, so for simplicities sake we will assume I have 100k in the bank and use that to review whether or not I could make a living off the cash outflow.

First, let me apologize for my poor writing skills. I would never claim to be talented, nor even proficient at writing it is only a means to transmit thoughts. But enough of that, I would like to start with some ground truths that I truly and deeply believe in.

First, I believe that the market can be beaten, and beaten mightily. Countless individuals have done this from the early well known investors such as Jesse Livermore, Bernard Baruch, and John Maynard Keynes, to the equally well known George Soros, Steven Cohen and of course Warren Buffet. All of these individuals year in and year out do something that you supposedly cannot in efficient markets, make more money(or lose less) than everyone else. They run the gamut from short term traders to long term "investors". All have on thing in common though, they see an opportunity and go after it, even if it is not the popular course to follow.

Second, I believe the answer on how this can be accomplished can be found in the data. Although I will not go into depth on stating why this is the case, an example can be found in the work of William O'Neil (the found of IBD and a massively winning investor) or David Dreman. Before these extremely successful traders put on trades they understood both the macroeconomic theory they were investing in and the microeconomic stock picture. I believe that this understanding and focus was one of their most critical assets and one of the main defining quality that I have connected among leading investors. They focus on the most important data, understand as much as they can about what it means, act appropriately and immediately.

My next post will highlight how I go about figuring out what data is most important, and how to analyze it. I expect to get into a discussion(with myself) regarding how the stock market actually works (which I know little about).

Best of luck to all investing! Also, any feedback on this is more than welcome