We’ve refined the strategy creation process down to six rules. They help to ensure your investment strategy is robust and well designed.
Activist investors seek to unlock shareholder value by finding companies where the incentives for managers and shareholders are out of line. We have designed this strategy so that it will find companies that activist investors look for. The idea is to see if we can automate riding on their coat-tails as they agitate for change.
The strategy focuses on looking for the highest quality stocks amongst the 20% best value stocks on the market (as defined by a low price to book value). Companies with low price to book ratios tend to have low levels of investor interest, be neglected by the analyst community, and be in financial distress. They are considered ‘value’ stocks because they are cheap, but are often cheap for a good reason.
The study showed that profitability (as measured by gross profits-to-assets) can be usefully employed to outperform the market.
These stocks have little analyst coverage and are generally ignored by institutional investors. This should mean that there are more opportunities for out-performance within this group of stocks as compared to the market as a whole.
We're not claiming an automated Buffett strategy will out-perform Buffett, but we think it is a useful exercise to see how Buffett concepts and metrics perform over the long-term using rules-driven approach.
Kenneth Fisher highlighted the use of the price-to-sales ratio as a quick and easy metric to find potentially undervalued companies. He reasoned that, "any stock with a low price relative to its previous 12-month sales would rise if its future earnings became large enough to translate into a low future PE"