A New Stock-picking Formula
For the patient do-it-yourself investor, High Returns from Low Risk by Pim Van Vliet is a breakthrough book, in the same league as The Little Book that Beats the Market. In that book, Joel Greenblatt explained how ranking stocks on the basis of high return on capital and low valuation does the job of picking long-term winners. This book, too, offers a quantitative formula. Van Vliet demonstrates that ranking stocks on three filters—low volatility, high dividend yield and rising momentum —yields terrific market-beating results. He shares the excellent back-tested results of this formula. 
 
Van Vliet shows the impact of progressively adding one filter at a time on the same set of US stocks, going back all the way to 1929. He starts with volatility. He took the monthly closing prices of US traded stocks from January 1926 to December 2014, a period of more than 80 years—through the Great Depression of the 1930s, World War II, the prosperous 1950s, the swinging 1960s, multiple recessions, the oil crisis of the 1970s and market excesses like the Dotcom bubble of the 1990s. Any results obtained over such a long period are “unlikely to be the result of pure luck or temporary effects that might disappear at some point in the future.” 
 
To keep things simple, the author picked the 1,000 largest companies by market-capitalisation and excluded penny stocks (less than $1 in price). He ranked these 1,000 stocks, by the volatility of monthly return over the previous three years. He then created two portfolios, one containing 100 stocks with the lowest volatility (low-risk portfolio) and the other with highest volatility (high-risk portfolio). But volatility changes, over time. To ensure that the portfolio retains the initial character, Van Vliet rebalanced the portfolio every quarter. If a stock in one of the portfolios no longer qualified to be there, he just exited that holding and replaced it with a new stock. What were the returns of the two portfolios?
 
Assuming that you put $100 into both of the portfolios on New Year’s Day 1929 and re-invested any capital gains for 86 years until New Year’s Day 2015, the low volatility group yielded a return of $395,000 (compounded annual growth rate of 10.1%), while the high volatility portfolio’s return was only $21,000 (6.3%). High risk does not equate with high returns. Low-risk stocks beat high-risk stocks by 18 times!
 
So why not just buy the top low-risk stocks? Because we can do even better with two more filters. As the author puts it, “If you could choose between two stocks with exactly the same low risk characteristics but one was very expensive and the other was very cheap, chances are you’d opt for the cheap one… like a lot of other things in life, it pays to focus not only on what you buy, but also on the price you are to pay for it. This idea of buying cheap stocks is a popular and well-known investment strategy, applied by many investors all over the world.” 
 
This is popularly known as value investing. One of the ways value is expressed is dividend yield (dividing the dividend declared by market price). But some companies prefer not to pay dividends; they would rather buy back shares. So, Van Vliet ranked stocks by dividends plus buybacks, calling this filter ‘income’. If a stock becomes expensive, the income yield will fall and vice versa. At this stage in the process, we have low volatility stocks with high income yield. We need a third filter. Why? Some low-priced stocks may offer a high income yield but may face poor business prospects which is why they are inexpensive. If so, the stock will languish and even decline—value trap. How to filter these? Enter momentum, the third factor. 
 
There are many ways of measuring momentum, the most common of which is to filter stocks on the basis of their returns over the previous 12 months. The assumption is that strong momentum usually continues. This list of high-momentum stocks was then combined with the other two filters. In practical terms, Van Vliet picked 500 lowest-volatility stocks. He then ranked them on income and 12-month momentum. Each stock got a score between 1 and 500, based on these two factors; these scores were simply added together. Then, he combined these two lists and picked the top-100 stocks. This shortlist now would have a stock with low volatility, high income, and good momentum. With this approach, the average compounded return since 1929 gets bumped up, from 10.1% to 15% per annum. Quite impressive. 
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COMMENTS

Mitesh Shah

1 year ago

i would be pleased to see the stocks in indian context ?

Abhijit Gosavi

2 years ago

Very interesting.

MURALI MOHAN

2 years ago

Impressive study/research by Pim Van Vliet. And very nicely summarised. Thank you.

Sandeep Reddy

2 years ago

but indian market dont have such history...1926.

Lost Opportunity To Dissect Indian Science
Professor CNR Rao’s life has been a long and eventful one. He has produced research papers by the dozen, met the doyens in science from around the world, received the highest national awards, including the Bharat Ratna, and a clutch of foreign awards for science. Yet, Indian science has not done as well as Dr Rao in its chequered history, barring the rare shining examples of scientists who braved the odds to make a signal contribution. So, when one picks up an autobiography of the great man (A Life in Science), it is with an expectation that there would be some in-depth exploration of what ails Indian science. Therein lies the great disappointment with this book.  
 
In the epilogue, Dr Rao mentions a meeting with Professor CV Raman at the Indian Academy of Sciences. Raman told Rao, “Professor Rao, I am eighty-one years old. It bothers me that India is not on the top of the world in science.” Rao goes on to say, “I’m now eighty-two years old and I echo Professor Raman’s statement.” The scientific establishment, and that includes the pertinent ministries of the government, and even the lay reader would have been keen to hear from Dr Rao his take on this problem.  
 
He mentions that not enough money is given to the pursuit of science, which is a measly 1% of GDP, according to him. But, given India’s size, even that amount should produce some results. Instead, all we hear from scientists is a litany of complaints, of seniors stealing the work of their research pupils, bureaucracy, suicides by scientists, and the exodus of the best scientific talent to more hospitable shores. 
 
Indian scientists are bogged down by the nitty-gritty of science administration, the turf battles that are all too common and one in which the best man seldom wins. 
 
Dr Rao was a bureaucrat himself, albeit a scientist. At various times, he was the director of the prestigious Indian Institute of Science (IISc), director of the Indian Institute of Technology ( Kanpur), president of the Indian Academy of Sciences, member of the Planning Commission, member of the US National Academy of Sciences, founding member of the Third World Academy of Sciences (started by Prof Abdus Salam, the Nobel Prize-winning Pakistani scientist), founding member of the Materials Research Society of India, to name a few of the exalted positions he held. 
 
And, here is what he has to say about his time at IISc. “I approached the Planning Commission for a special grant for improving the basic infrastructure… Thankfully, they gave me Rs3 crore so that we could set up a new electric sub-station and change the plumbing on the campus. One of the minor contribution (sic) I could make, in the meantime, was to stop the grazing of cattle in the campus…With patience, I could also stop people from parking their bicycles in the corridors of the main building, effectively blocking the way. I started improving the gardens by planting several thousands of trees.” 
 
Laudable, to be sure. But what about the state of science at the IISc? Not a word about that. Surely, one should expect more insights and analysis about the state of science in India from an eminent scientist who headed two prestigious institutions, the IISc and IIT-Kanpur. Instead, most of the book is a dreary enumeration of the awards he has won, papers published, eminent people he has met and foreign travels.  
 
The prime minister then, Indira Gandhi, called him to a meeting with her and offered him a secretary’s post in the government which he turned down. It might have been illuminating had he explained why he had done so. But, to his credit, it must be mentioned that Dr Rao was an indefatigable scientist who looked upon research as his vocation. At age 37, he was offered the position of director of IIT-Kanpur, which he turned down. “I was asked to take up the directorship by the minister of education in Delhi, but I had no interest in doing so. I had many things to do in science.” Not many in his place would have turned down the offer, coming as it did from the education minister himself. However, later in life, he got all those lofty positions and seemed to relish them. 
 
What emerges from this book is a man undoubtedly dedicated to science, but who also basked in the glory of being a famous scientist. In the process, we miss in this book the rich insight an eminent scientist could have given on the state of science in India and what is needed to rejuvenate it.
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Hayath MS

2 years ago

Strange is Indian society, another xyz Roa running election commission and hell bent on bringing bjp to power with tampered evm , with destruction of democracy Indians see better future with new Indian kingdom .

It’s Not the Product, Stupid!
In the previous issue, I reviewed an interesting new book by Harvard University professor Bharat Anand, The Content Trap. His short point: great products do not guarantee success. It is the connections between users, between products and between different functions that ensure their success.
 

Another Harvard professor, Clayton Christensen, has exactly the same proposition to make in his new book, Competing against Luck, namely “rarely is it the product itself that is the source of the long-term competitive advantage.” Christensen comes up with a different reason for enduring competitive advantage: products and services that get the real job done, that consumers are desperate for. Christensen, who made his name 20 years ago, with his theory of disruptive innovation, calls this the ‘Job to Be Done Theory’. He says that people buy products to get a job done. The same product (like a milkshake) can be used for different jobs: to fill up a rider embarking on a long commute or to give joy to a father who has taken his son out. If companies can understand what jobs customers are buying their products for, they can enhance the experience and create a competitive advantage. Without this customer insight, adding product features is meaningless.
 
Take the case of a mid-size home building company in Detroit which was a tough market to sell new homes and condominiums. The company’s homes were attractively priced, with high-end touches, to give a sense of luxury. Buyers could customise every detail, from the knobs on cabinets to tiles; the company offered a 30-page list of options. A sales team was available six days a week to greet any prospective buyer. A generous ad campaign made the offers widely known. And, yet, sales were weak. Focus group participants asked for more features, which got added. But still no rise in sales. Bob Moesta, a management consultant who has worked with Christensen, set out to learn what job the condominium was meant to do for people who had already bought a unit. He learned that there wasn’t a clear demographic, or even psychographic, profile for one of the company’s new-home buyers. In fact, the many customisable features actually were a problem: they overwhelmed the buyers. 
 
But Moesta clued on to something unusual: the dining room table. Though prospective buyers wanted “a big living room, a large second bedroom for guests and visitors, and a breakfast bar to make entertaining easy and casual, they were stressed about what to do with their existing dining room table. Moesta and his colleagues couldn’t quite understand why the dining room table was such a big deal. In most cases, people were referring to well-used, out-of-date furniture that might best be given to charity, or relegated to the local dump.” 
 
What prevented buyers from completing the purchase was not missing product features “but rather the anxiety that came from giving up something that had profound meaning… Every decision of what she had enough space to keep in the new location was emotional. Old photos. Children’s first-grade art projects. Scrapbooks.” The company understood what homebuyers were really going through. “I went in thinking we were in the business of new home construction,” recalls Moesta. “But I realized we were instead in the business of moving lives.”
 
With this new understanding of the job to be done, the company made many small, but important, changes. For example, the architect managed to “create space in the units for a classic dining room table by reducing the size of the second bedroom by 20%. It also focused on helping buyers with the anxiety of the move itself, which included providing moving services, two years of storage, and a sorting room space on the premises where new owners could take their time making decisions, about what to keep and what to discard, without the pressure of a looming move. Instead of 30 pages of customized choices, which actually overwhelmed buyers, the company offered three variations of finished units—a move that quickly reduced the ‘cold feet’ contract cancellations from five or six a month to one. And so on.” By 2007, when sales in the industry were down by 49% and the market all around them was plummeting, the developers had actually grown the business 25%.
 
 
This book is brimming with many such examples. Take the case of American Girl, which has been so successful in nailing the job to be done, of mothers and daughters. Parents pay more than a hundred dollars for a doll, several times, without counting the money spent on extra clothing and accessories. “By one estimate, the typical American Girl doll purchaser will spend more than six hundred dollars in total,” writes Christensen. To date, the company has sold 29 million dolls and racks up more than $500 million in sales annually. What’s so special about an American Girl doll? Well, it’s not the doll itself… In recent years Toys“R”Us, Walmart, and even Disney have all tried to challenge American Girl’s success with similar dolls, at a fraction of the price but, to date, no one has made a dent. American Girl is able to command a premium price because it’s not really selling dolls. It’s selling an experience.”
 
According to Christensen, “preteen girls hire the dolls to help articulate their feelings and validate who they are—their identities, their sense of self, and their cultural and racial background—and offer them hope that they can surmount the challenges in their lives. The Job to Be Done for parents, who are actually purchasing the doll, is to help engage both mothers and daughters in a rich conversation about the generations of women that came before them, and their struggles and their strength. Those conversations had disappeared as more and more women entered the workforce in the years after the women’s movement, and mothers and grandmothers were craving an opportunity to bring them back into their lives.” 
 
American Girl founder, Pleasant Rowland, has been quoted as saying, “You’re not trying to just get the product out there, you hope you are creating an experience that will do the job perfectly.” You’re creating experiences that, in effect, make up the product’s résumé: “Here’s why you should hire me.” Rowland’s unsatisfactory experience while shopping for a Christmas present for her nieces triggered the idea. At the time, the most popular options were either hyper-sexualised Barbies or Cabbage Patch Kids, neither of which would help her connect with her beloved nieces. Her vision for the company was born almost entirely out of her own childhood memories.
 
The dolls were never sold in traditional toy stores. They were available only through a catalogue first, then later at American Girl stores, in a few major cities. This added to the experience, turning a trip to the American Girl store into a special day out with mom (or dad). American Girl stores also have doll hospitals that can repair tangled hair or fix broken parts. Some of the stores have restaurants in which parents, children, and their dolls can happily sit and be served from a kid-friendly menu, or host birthday parties. The dolls become the catalyst for experiences with mom and dad that will be remembered forever. 
 
Many decades ago. Harvard marketing management guru Ted Levitt had said, “People don’t buy a quarter-inch drill. They want a quarter-inch hole.” In other words, people don’t want products; they want solutions—some jobs to done. Christensen notes that alone is the bedrock of competitive advantage. He writes, “I have found that creating the right set of experiences around a clearly defined job—and then organizing the company around delivering those experiences (which we’ll discuss in the next chapter)—almost inoculates you against disruption. Disruptive competitors almost never come with a better sense of the job. They don’t see beyond the product.”
 
Christensen is one of the world’s foremost management thinkers today. Anyone who is building a business will gain from the new perspective he provides to age-old ideas of customer-orientation.
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Vivek Naik

2 years ago

great article :)

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