3 Asset Models to Power Up Your Portfolio

03/13/2012 6:30 am EST

Focus: STOCKS

Equity researcher and analyst Robert Gay shares his three models designed for retail investors, and explains how they can access his systems. He looks at fundamental metrics to determine investments across the risk spectrum.

Kate Stalter: I’m speaking today with Robert Gay of Global Equity and Analytics Research Services, also known as GEARS.

Bob, you analyze corporate data to get a better understanding of the company fundamentals. Describe for us some of the metrics that you are looking at.

Robert Gay: Well, they’re all very traditional metrics, Kate. We’re looking at growth metrics, financial condition metrics, earnings quality metrics, and valuation.

The growth metrics that we would look at are things that you would consider to be important contributors to the company’s growth rate: What the sales growth rate is, whether it’s rising or falling, whether their profit margins are improving, whether they’re building inventories…all kinds of things that give us a hint as to the direction of the growth rate.

What we can show with a very, very high degree of statistical confidence is that for companies that achieve a rising growth rate, shares go up, and for companies that suffer a falling growth rate, shares go down. So monitoring and analyzing and understanding the sources of the company’s growth is an incredibly important contributor to our decision.

Kate Stalter: You classify your findings into three different investment models. What are these?

Robert Gay: Well, they’re essentially distributed across the risk spectrum. Once you’ve got a clear measurement of whether the company’s growth rate is rising or falling, then you make a decision about what kind of risk you want to take on in building your portfolio.

If you want to produce a higher rate of return, then you ramp the portfolio up to more rapidly accelerating companies. If you want to produce a stable rate of return, then you’ve got more stable growth companies—companies that are achieving an improvement, because improvement is always important, but improvement, possibly, at a more stable kind of history or at a relatively slower rate.

The other distinction between what I call the Speedboat model—which is my high-return model—and earnings surprise, which is my other high-return model, is that earnings surprise is looking for a specific kind of pattern in the numbers. It’s looking for a clearly accelerating company, whether it appears to be an inconsistency between the evidence acceleration and the depressed share price.

So we’re looking for a depressed price with improvement. What that tends to do is, that if the improvement is repeated in the upcoming quarter and the market is surprised by that, then the share price performs very well.

Alternatively, if the improvement is a disappointment—in other words, if the improvement is not sustained in the upcoming quarter—then the fact that the shares are depressed when we bought them protects us on the downside. We’re able to observe the deterioration and make the decision.

So the distinction between those two is a function of the pattern in the numbers.

Whereas Luxury Liner, which is my hedged portfolio, is designed to produce a stable return. In other words, designed to float along like a luxury liner, independently of what storms might be going on in the market. Whereas the speedboat is not going to stand a storm very well.

So the distinction is one of risk. How much risk the investor wants to incorporate into their portfolio.

Kate Stalter: Is there any market-cap distinction among these portfolios?

Robert Gay: I don’t apply a market-cap constraint, because it’s important to understand that if you impose a bias—it doesn’t matter what the bias is, it could be a market capital bias, it could be a sector bias, it could be some kind of a personal bias like, “I like to buy companies that have certain value characteristics.”—those biases are designed and have the affect of moderating returns. In other words, they produce lower risk.

So it’s important to understand, that bias imposed has a cost. So what I’m trying to do is to create portfolios that are independent of those biases, and bias instead strictly towards risk, and not modify that risk with some kind of a bias overlay.

Kate Stalter: Now these models, Bob, sound like something that institutional managers would use. But these are also things that individuals can participate in. Tell us how that works.

Robert Gay: Well that’s the exciting thing about Covestor, is that it provides access to investment processes that might be, and increasingly are, more and more difficult for the personal investor to get access to.

Many, many of the products now available to personal investors are either strictly market-oriented. In other words, strictly oriented toward focusing on a specific benchmark, an ETF…and even a lot of professional managed portfolios that are available to personal investors track very close to their index benchmark.

If you want to diverge from that, if you want to move into a higher-return kind of portfolio strategy, Covestor provides an excellent platform to do that on.

Kate Stalter: Well Bob, thank you very much for taking the time to explain some of these processes today. It’s been great speaking with you.

Robert Gay: Thanks very much Kate, it’s my pleasure. Let me get a plug in here, particularly for the personal investors. Covestor is hosting an online investor seminar on March 21 and 22, 2012, called Next Invest. It’s an excellent way to meet the model managers, get involved with the process, and understand more about what Covestor is up to.

Related Reading:

Related Articles on STOCKS