KISS 101 Investing Strategy

KISS 101 is a value investing strategy created to illustrate the 1st of 4 steps in the investing and stock screening process - a documented strategy to define WHAT we are going to do. The remaining 3 steps of the process will be derived from this documentation.

This strategy is straight-forward and sustainable but robust enough to make it worth the effort. It is derived from the work of Michael Higgins (Dogs of the Dow) and Geraldine Weiss (Dividend Yield Investing)

Step 1: WHAT are we going to do

Defining an investing strategy requires us to document the following:

  1. Universe
  2. Portfolio
  3. Selection criteria and rules
  4. Ranking system
  5. Holding period
  6. Performance expectations
  7. Market Timing/Hedging
  8. Health check

NOTE:

Because this is a sample investing strategy to illustrate the investing and stock screening processes, only criteria that should be readily available in all tools are used.


1 - Universe

By the way, if you are looking for a sector rotation type tool to augment your investing strategies, Sector Surfer may be just what you are looking for. Check it out here.

The universe defines the pool of stocks the investing strategy uses to look for candidate stocks.

Following the lead of Higgins and Weiss, choices are limited to a pool of stocks with inherent quality - the S&P 500. Stocks are selected for this large cap index based on the work of the analysts at S&P Global.

While doing research for a new sector rotation strategy I am building using Sector Surfer, it became apparent that 3 different sectors (Consumer Staples, Utilities and Healthcare) out-performed the S&P 500 during the period 1/1/2000 to 12/31/2017. Not only out-performed on a risk adjusted basis (alpha) but also had less draw-down.

This is illustrated in Table 1 (created using Portfolio123 back-testing).

S&P 500 Sector Performance StatsTable 1 - S&P 500 Sector Stats

The Sharpe and Sortino ratios are significantly improved. Using the sector also suggests lower risk as noted by Beta.

With this in mind, the universe will be reduced to include only S&P 500 stocks in the Consumer Staples sector. As of July 2017 there were over 30 stocks in the universe.

As defined by the global classification system (GICS), Consumer Staples (GICS = 30) includes the following:

  • Food & Staples Retailing (3010)
  • Food, Beverage & Tobacco (3020)
  • Household & Personal Products (3030)

Trading liquidity is not an issue since every stock in the sector currently trades over US $5 million per day.

2 - Portfolio

Since there are currently over 30 companies from the specified sector in the S&P 500, only 5 of these stocks will be held at any one time. This parallels the universe size and portfolio size of the Little Dogs of the Dow.

All 5 will be purchased at the initial buy on August 1, 2017.

3 - Screening criteria and rules

Criteria and rules determine how the universe is reduced to only the companies which are buy candidates. Screening criteria from both value and financial strength data classifications are specified.

Notice in Table 1 that dividend paying stocks of the S&P 500 index out-perform the index. Dividend payers provide a slight improvement within the Consumer Staple sector, but not much since most companies in the sector pay dividends.

NOTE: The dividend used for the test was the forward looking dividend yield, not the historical yield. The forward looking yield is calculated using the dividends per share paid in the previous year and the price per share of the stock.

Value criteria

Like the parent investing strategies, companies must pay a dividend to be considered. As noted above, this is the forward looking dividend yield.

Screen rule: Yield > 0

No company can pass the screen if they have not paid a dividend in the past 4 quarters.

Financial Strength criteria

KISS 101, like most dividend based investing strategies, uses payout ratio to evaluate the financial strength of a company.

Dividend payout ratio is the ratio of dividends paid to total net income. If it exceeds 100%, the company is dipping into financial reserves or increasing debt.

Screen rule: PayoutRatio < 100%

4 - Ranking system

Although selecting all the dividend paying stocks in the sector did very little to improve performance, selecting the 5 with the highest dividend yield worked very well (see Table 1).

Ranking is used to select a specific number of the "best" stocks.

Dividend yield is the sole ranking criteria used by KISS 101. Even if your stock screening tools don't handle ranking directly, it is only a matter of sorting the passing companies by yield.

Pick as many of the 5 highest yield stocks as you need to meet the target portfolio size.

5 - Holding period

The target minimum holding period is 3 months.

Since the market timing and health check options will be implemented, an update to the portfolio may occur before the holding period expires. See below for the details.

Prior to the first trading day of February, May, August and November the universe will be screened for the top-ranked companies. On the first trading day of the month, the portfolio will be updated to include only the top 5.

6 - Expectations

The goal is to out-perform the S&P 500 index CAGR by 5% for any 3 year period. Based on the sector analysis, this seems reasonable.

Max draw-down should not exceed 30%.

It is desirable to save the screening criteria for all companies within the sector if your stock screening tools do not provide historical point-in-time data. Otherwise, there is no way to go back and examine the criteria at the time the decision was made.

And not just the criteria used, but additional criteria. In particular proprietary data.

The initial review of the implementation will be October, 2017.

The initial performance review will be January, 2018.

7 - Market timing

The monthly market timing system based on the 17 month CCI and the 11 month SMA of the S&P 500 will be checked prior to the first trading day of the month.

This is a simple check on a system like FreeStockCharts.com. Just set up for monthly S&P 500 data and add the CCI and SMA indicators.

If the market goes from favorable to unfavorable, the portfolio holdings will be set to 14% each and 30% of the equity will be put in an S&P 500 index inverse ETF.

When the market returns to favorable, the inverse ETF will be sold. The top 5 ranked stocks will then be set to 20% each. If the portfolio is not holding the top 5 stocks when the market condition changes to favorable, update the portfolio to the top 5 stocks. In this case, any non-top 5 position must be closed.

Although we publish the market condition for this timing system, it may not be online for use in a timely manner. Plan to have a tool to check the market.

8 - Portfolio health check

The health check will be run prior to the first trading day of each month to confirm that the current portfolio positions remain healthy. This does not mean that they must still be one of the 5 top-ranked companies in the sector.

It does mean:

  • The dividend still exists
  • The stock still exists and remains in the S&P 500
  • The payout ratio is still less than 100%

In the unlikely event that one of the companies in this sector eliminates the dividend, it will be difficult (perhaps impossible) to detect it in a screener. This is something we are investigating. Since there are only 5 companies, it is best to check relevant news.

If the stock is no longer in the S&P 500 or has merged with another company or been acquired, it will not show up when you screen your portfolio for S&P 500 companies.

Note that the health check is run against the portfolio, not the strategy universe.

Finally, any company that starts paying more than 99% of their total net income for dividends will be sold.

Investing Strategy Summary

The KISS 101 investing strategy will screen the Consumer Staples sector of the S&P 500 every 3 months for the 5 top-ranked stocks of the sector. The holding period of the stock may be as short as 1 month. There is no limit on how long a stock can be held as long as it is top-ranked.

Since the portfolio will be held in Folio Investing, the portfolio will be re-balanced any time a trade is made.

Stocks must have a dividend yield and a payout ratio less than 100%.

Stocks will be ranked by dividend yield - higher is better.

The portfolio is expected to outperform the S&P 500 total return by 5% per year over any 3 year period. Draw-downs should not exceed 30%.

Monthly market timing will be used to hedge the system.

  • When the market is favorable, 20% of the portfolio capital will allocated to each of the 5 stocks.
  • When the market is not favorable, 30% of the portfolio capital will be allocated to an inverse S&P 500 ETF, and each of the 5 stocks will be allocated 14%.
  • Any time the market condition changes, the portfolio will be forced to the top-ranked 5 stocks.

Each month, a health check of the portfolio will look for eliminated dividends, excessive payout ratio, and membership in the universe. Any holding with one or more of these symptoms will be sold and replaced with the highest ranked stock not currently in the portfolio.

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