Patience Investing

We develop a simple approach for making stock selection decisions. The philosophical underpinning of the Otuteye-Siddiquee (O-S) checklist approach is that it is possible to create a simple value investing decision making tool using criteria based on earnings potential, financial stability, and fair valuation. Furthermore, application of this tool will help the user to develop a consistent and disciplined approach to value investing decision making that will yield very satisfactory results.

We hypothesize that portfolios that are created from this approach will yield returns above the market average. The market return is the average returns from two sets of portfolios: those with above average returns and those with below average returns. We reason that if the stock selection criteria of the O-S approach are carefully applied, the resulting portfolios should be among the group with above average returns.

The way the O-S approach works is that prospective stocks that an investor is interested in will be subjected to a set of screening criteria. At the end, the investor will make one of three decisions: (i) reject the stock, (ii) put it on a watch list, or (iii) buy it. If a company is not investment worthy then the decision to reject it will be made immediately at the stage that the screening criteria point to that. A company will be put on the watch list if all the financial metrics are sound as revealed by the screening criteria but the stock price fails to meet the margin of safety criterion. Failing the margin of safety criterion means either the stock is selling above the intrinsic value or there is not sufficient margin of safety to classify it as a safe investment. A recommendation to buy a stock means that all the financial metrics are sound and the “price is right” (i.e. it is selling at a price that gives a good margin safety, as explained below).

There are two main parts to executing the approach: the preliminary stock selection criteria (referred to as the “5-Minute QuickScan”) and the full set of value investing criteria. The two parts are presented in Tables 1 and 2 respectively.

The 5-Minute QuickScan is a preliminary screening tool to determine if a company is worth taking through the entire screening criteria. It is essentially a device for narrowing down the number and types of companies that we will process through the full set of value investing screening criteria. Needless to say, an investor is only interested in good quality stocks. The 5-Minute QuickScan is the tool by which we focus our analysis only on companies that meet some minimum quality standards.

Table 1: Preliminary Stock Screening Criteria (The “5-Minute QuickScan” Screening Criteria)

Companies that fulfill all these preliminary screening criteria will now be subjected to the full set of value investing criteria in Table 2. There is one point we need to make specifically about criterion number 2 in the 5-Minute QuickScan: that the market capitalization must be greater than $500 million. The O-S approach is designed with what Benjamin Graham (1949) calls the “defensive investor” in mind. Specifically, Benjamin Graham’s (1949) recommendation to the defensive investor is that “each company selected should be large, prominent, and conservatively financed.” (p. 65). Limiting our set to companies with market capitalization greater than $500 million satisfies the condition of excluding small companies.

Table 2: Value Investing Screening Criteria[i]