We all know indexing has many advantages. If you aren’t aware simply google them. One of the main drawbacks is you tend to get the good the bad and the ugly. It drives me nuts knowing my index funds hold/held zombie companies like JCPenny, Macy’s, GM, airlines, etc when many of these businesses are obviously not good or have tough futures. They exist, but they ain’t thriving or haven’t thrived in years.
So I thought, what if i had a basic way to screen out the zombie companies. For me there are a few elements of all businesses that are basically universally good:
Sales are growing, shareholders aren’t diluted, debt is low, there are healthy gross margins and valuation is reasonable. I use these elements are to develop a ranking system. That’s it. They can have no or plenty of operating profit, net profit, ROEs, and so on.
Many factor based strategies look for the metrics included above but I feel that is not a great idea. In my view, there are just too many counter examples to focus on “factors” to make them reliable (AMZN, TSLA, CRM, NOW, etc). Hell a dividend can be interpreted as a sign the company doesn’t have good investment opportunities. And no operating profits (in the case of AMZN/CRM) were the results of aggressive investments in dominating businesses.
I took this theory and ran it in portfolio123 which has controls for backtesting biases and anecdotally looked into a few companies:
A company like Macy’s never qualified in the past 20 years.
NVDA first made the cut in 2015 when it was at $5 or $6 (split adjusted)
Kohl’s never made the cut.
Disney would have made it and been kicked out, PayPal still showing great fundamentals despite it’s getting obliterated.
I'd love to hear your thoughts and engage in a discussion about this investment strategy. Do you think focusing on the metrics above would lead to a better portfolio in the real world?
Thank you for reading, and I look forward to your insights!
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