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Robot Stocks  .

a Simple Stock Selection Strategy With Big Returns  .

Here’s a simple stock selection strategy that reportedly returned 63 percent in 2003 (including dividends), compared to the overall market’s 29 percent return, as measured by the S&P 500 index. What’s more, this strategy is no flash in the pan. It outperformed the S&P 500 by at least 19 percentage points in each of the past five years.

Here’s the best part. You can use almost any Web stock screener to pick the stocks, and you don’t have to do any complicated analysis.

It’s called the Robot Portfolio, and it comes from John Dorfman, whose investing columns run twice weekly on Bloomberg’s financial site (www.Bloomberg.com). Dorfman, who runs Dorfman Investments, a money management firm headquartered in Boston, practices the value style of stock picking.

Value investors look for stocks the market doesn’t like. Maybe they are facing slowing growth, or confronting new competition or changing economic conditions that casts doubt on the their future viability. But value investors know that stocks move higher when the underlying company’s results exceed the market’s expectations. So they seek out these unpopular beaten down stocks because, in their view, the market’s low expectations for those stocks are easy to beat.

One thing I like about Dorfman’s Bloomberg column is that every so often he describes a relatively simple stock selection strategy, uses it to pick a 10 stock portfolio, and then reports on the portfolio’s performance one-year later. If the strategy produced worthwhile results, he picks another 10 stocks and tracks it for another year.

Robot Portfolio
A few weeks ago, Dorfman updated readers on the performance of his Robot Portfolio, the same numbers I related to you earlier, and listed this year’s Robot stocks.

The Robot strategy finds the 10 cheapest stocks, based on price/earnings ratio (P/E), that meet just three simple qualifications. I’ll go into more detail in a minute when I’ll show you how to come up with your own list of Robot stocks.

In this year’s Robot Stocks column, Dorfman was less than enthusiastic about four of the picks. They were title insurance companies, an industry that he thinks will be hurt by rising interest rates.

You can see Dorfman’s most recent column by selecting News & Commentary on Bloomberg’s homepage, clicking on Commentary (left-menu), and then selecting John Dorfman from the All Columnists list. To see older columns, scroll to the bottom of that column and click on “More John Dorfman.”

Create Your Own Robot Portfolio 
Bloomberg only archives Dorfman’s columns for about a month, so his January 2 Robot Stocks column will probably be gone by the time you read this. But that’s not a problem because you can run your own Robot screen. There are two advantages to running your own screen.

For starters, you can create a new list anytime during the year, but more important, you can tailor your list to avoid stocks in industries you think are cheap for a good reason, and still come up with 10 stocks that fit Dorfman’s Robot philosophy.

Quicken's Stock Screener
Here’s how to find Robot picks using Quicken’s stock screener. From Quicken’s homepage (www.quicken.com) select Investing and then click on Quotes & Research. Then select Stock Screener and finally pick the Full Search option.

Dorfman likes small stocks, but not too small. So he requires stocks with at least a $500 million market capitalization. Enter $500 million as the minimum acceptable Market Cap in the Valuation section of the screen.

Dorfman only wants profitable companies, that is, firms with positive net income. You can’t search for net income directly on Quicken, but you can accomplish the same result using its Net Profit Margin parameter (NPM). Since NPM is net income divided by sales, NPM will only be positive if the firm’s net income is also positive. Consequently, you can avoid money-losing firms by specifying a minimum 1 percent NPM (Financial Strength section).

For his final qualifying requirement, Dorfman requires that passing stocks have a maximum debt to equity ratio of 1, meaning that the firm’s debt cannot exceed its shareholder’s equity (book value). You can satisfy that test by requiring a maximum long-term debt to equity ratio of 1 (Financial Strength).

Click on Show Results to run the screen after you’ve entered the three search conditions. Quicken listed more than 1,300 stocks when I ran the screen last week. The Robot stocks are the 10 cheapest stocks, meaning the 10 with the lowest P/E ratios.

You can sort the screen results with the lowest P/E stocks at the top by selecting P/E Ratio from the Sort dropdown menu above the stock list, and then clicking the Show button.

Add Common Sense
Inspired by Dorfman’s lack of enthusiasm for the industry, I eliminated all stocks involved in the residential real estate market. I also deleted stocks not headquartered in the U.S. or Canada because, in my experience, financial information on foreign stocks can be seriously out of date.

After those cuts, the 10 cheapest stocks were: Winn-Dixie Stores (supermarkets), Flagstar Bancorp (savings bank), Fresh Del Monte Produce (produce marketer), Odyssey RE Holding (reinsurance), Montepelier RE Holdings (reinsurance), Renaissancere Holdings (reinsurance), Canadian Natural Resources (oil & gas), Invision Technologies (luggage screening devices), Partnerre (reinsurance), and Marathon Oil (oil & gas).

The list was reasonably diverse except for the four reinsurance firms, which are companies that share insurance risks with the policy originators. Given all that’s going on in the world today, it’s understandable that the market is doesn’t like that industry.

Dorfman’s Robot Stock’s returns are impressive, but, alas, as we all know, past performance is no guarantee of future results. So only put you play money, not funds you’re going to need for retirement, into Robot stocks.
published 2/8/04

 

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