In my blog My Way of Dealing With The Bear, I mentioned that provided the time horizon when you want to use your capital is not terribly near, then provided you hold quality stocks and jettison the dross, you can take a fairly laid-back approach to a bear market.
Just to explain, let’s go back in time to 12/12/2007 a date when the FTSE100 reached one of its three peaks of 2007. You could take another date or indeed another index but for the demonstration of concept, I will use 12/12/2007: after this date the FTSE100 slid steadily downhill at an increasing pace. The index reached a final low some 15 months later on 9/3/2009 having fallen some 46%: a nasty bear market. What I am doing is looking at what the outcome may have been for two groups of stocks if I were to do nothing from just before the start of the banking crisis and held on to them for the following eight years.
Now let’s say we cleaned our portfolio and only had stocks that were of good quality. Now to measure quality we could have used all sorts of ratios but for simplicity I have taken a look at a basket of quality stocks as having the following criteria in 2007: a Piotroski F-score of at least 6, an Altman-Z score of at least 1.8 and a free cash flow margin of at least 5%. The data I have used is from the excellent SharePad. I then back-tested to see how those shares have performed after holding them for eight years to 12/12/2015.
I then run the same filter over the same period but for shares of lower quality and certainly ones I would not wish to hold during a bear market: Criteria Piotroski F-score of 5 or less, an Altman-Z of less than 1.8 and a free cash flow margin of less than less than 2%. Once again, I back-tested the performance of this group of shares to see how they have performed after continuously holding from for the following eight years.
1. FTSE All Share
FTSE All Share Index over this period: zero % change i.e. been through the falls and over 8 years has crept back. Note this as indeed the examples I quote excluded dividends either taken or reinvested.
FTSE All Share quality stocks as given by the above criteria: 49 stocks met the quality criteria and gave a “basket” appreciation of 165%.
FTSE All Share low-quality stocks as given by the above criteria: 17 stocks met the low-quality criteria and gave a “basket” depreciation of -26% change i.e. been through the falls and over 8 years and has failed to reach the heights of the pre-banking crisis level.
2. AIM All Share
Aim All Share Index over this period: -30 % change i.e. been through the falls and over 8 years and has failed to reach the heights of the pre-banking crisis level.
AIM All Share: quality stocks as given by the above criteria: 24 stocks met the quality criteria and gave a “basket” appreciation of 115%. This included 6 of the 24 stocks appreciating by over 300%.
AIM All Share: low-quality stocks as given by the above criteria: 82 stocks met the low-quality criteria and gave a “basket” depreciation of -73%. Of this group of 82 poor quality stocks only 4 gave an appreciation over the eight-year period: something to think about in my view!
What can this data infer? Note as I scientist I don’t like the term prove because it’s just a sample of data over one bear market. However, it does suggest that if you hold a portfolio of good quality stocks and you are not in a rush, then you may well find that within a few years time, in this case, eight years, you may well have done rather well simply sitting on your hands. Note the above figures don’t include reinvested dividends and I am very keen on reinvested dividends.
This simple back-test also suggests that much more danger lurks for the unwary investor on the junior AIM market but this is surely not news to anybody apart from the idiots and fools that populate bulletin boards.
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