Mark's Investment Blog

This blog is intended to keep clients and friends current on my investment management activities. In no way is this intended to be investment advice that anyone reading this blog should act upon in their personal investment accounts. There are other significant factors involved in my investment management activities that may not be written about in this blog that are equally as important as the things that are written about that materially impact investment results. Neither is this blog to be construed in any way to be an offer to buy or sell securities. To be notified via e-mail when new posts are made, CLICK HERE TO SUBSCRIBE.

Ranking Stocks for Investment – First in Series

July 1, 2021

Our Ranking

Our proprietary investment analysis system is able to rank the 1200 companies I keep in our database according to several factors. These factors lead us to six ranks based upon traditional investment concepts: Earnings Growth, Financial Strength, Value, Momentum, Quality and Fundamentals. Each of the rankings combines several financial ratios that reflect each of the above investment concepts, and they are chosen based upon years of analysis that show that these specific ratios provide me with a clear picture of how the company fairs under each concept. They are ranked from 100 (best) to 1 (worst) on a relative basis to their industry and to the S&P 1500.

Quality Ranked Companies

Today, I thought we would look at our Quality Rank – one of the factors that lead to their being designated as High Quality or Low Quality. The other factors include having 9 of past 10 years as profitable, a Return on Invested Capital > Weighted Average Cost of Capital, Growing Book Value, growing earnings, bear market stock price performance, etc.

However, being either high or low quality in and of itself is not a reason to buy or sell a company – there are times in the market that High Quality companies under-perform Low Quality companies,and visa versa. No one set of ratios can tell you everything you need to know to buy or sell a company, but it gives you a place to start due diligence that gets you to the buy or sell decision.

Starting with our Quality Rank, this set of ratios gives me a feel for the soundness of a company’s financial position. The ratios I use are centered around four major items that comprise quality: Gross and Operating Margins; Asset Turnover; ROE and ROI; and Debt Management.

Below is a non-exhaustive list of companies from our database that are categorized as either High Quality or Low Quality.

Quality	Company Name	BCNA Quality Rank	3yr Avg Return
Low Quality	Alaska Air Group Inc	50.6	6%
Low Quality	Bank of America Corp	17.1	15%
Low Quality	Cornerstone Building Brand	42.8	-1%
Low Quality	Chevron Corp	18.4	-1%
Low Quality	Ford Motor Co	22.2	11%
Low Quality	Fifth Third Bancorp	61.5	14%
Low Quality	General Electric Co	18.7	1%
Low Quality	JPMorgan Chase & Co	49.8	18%
Low Quality	Truist Financial Corp	51.4	8%
Low Quality	Valero Energy Corp	63.3	-9%
Low Quality	WESCO International Inc	44.1	22%
Low Quality	Wells Fargo & Co	26	-2%
Low Quality	Exxon Mobil Corp	38.4	-5%
High Quality	Dollar General Corp	91.4	32%
High Quality	Genmab A/S	99.7	37%
High Quality	Barrick Gold Corp	98.6	24%
High Quality	Kirkland Lake Gold Ltd	99.9	33%
High Quality	Mercury General Corp	92.9	14%
High Quality	Boston Beer Co Inc	59.5	61%
High Quality	Southern Copper Corp	91.5	16%
High Quality	Skyworks Solutions Inc	79.8	20%
High Quality	Taiwan Semiconductor	86.9	47%
High Quality	UnitedHealth Group Inc	95.2	20%
High Quality	Veeva Systems Inc	71.4	53%
High Quality	Vertex Pharmaceuticals Inc	99.8	11%

To get a feel for whether High Quality companies are a better investment than Low Quality companies, we can scan the list above and see that, by and large, the 3-year Average Return for High Quality Companies is much better than Low Quality Companies. But I thought we should be a bit more rigorous and look at a linear regression of each quality designation to see the magnitude of the difference.

This scatter plot makes it easy to see that the Blue Dots representing the High Quality companies are well above (i.e., higher three year average return) the Red Dots representing Low Quality companies. Again, let me restate this: Low Quality does not mean they are bad, it just mean that in the three most recent years the ratios that define them as Low Quality were not as high as other companies in their industry or in the S&P 1500.

Why Is This Important Now?

At some point, we will have a market correction that exceeds a simple 10% 0r 20% move down in price. With the Federal Reserve now beginning to talk about tightening money supply due to above target inflation, that could be a catalyst for such a correction (or even a bear market). As such, we want to have the best companies in client portfolios that can withstand a major draw down when the inevitable happens down the road.

Investment Strategy

In the normal course of portfolio management during this period in time where we have been warned that monetary tightening is in the plans, we want to book the gains on the companies that show the least ability to withstand a bear market and focus on the companies that have the best ability to withstand a bear market. We do not want to see the gains we have made be lost by not monetizing them when the market tells us it is time.

What’s Next?

Our next discussion will be on our Earnings Growth Rank – the original analytical system whose nexus started with my Masters Thesis that set out to disprove the Efficient Market Hypothesis (yes, that is how long ago it was – it has graduated to a Theory and is no longer a Hypothesis). The synopsis of the thesis was that in spite of the strong support for the Hypothesis, there really are certain financial ratios in the public realm that when viewed as a whole can provide index beating returns over the long run. And given our track record of beating the index over the long run, the Earnings Growth Rank is a very important part of our investment process.

-Mark