The fourth part of my review of trades will be focusing on fundamentals. To recap, you can find the first 3 parts of my trade reviews here: ...

Review of My Analysis in 1H 2016 Part Four: Fundamentals

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The fourth part of my review of trades will be focusing on fundamentals. To recap, you can find the first 3 parts of my trade reviews here:
Part 3: Exits




In my weekly scan, I could scan though the universe of US and Singapore stocks in less than an hour thanks to the screeners available. Checking out the fundamentals for the few stock that I shortlisted take way more time as I have to go through the earnings, press release, transcripts and the SEC filings. With a disproportional amount of time spent on researching fundamentals, I am curious to find out if the effort is indeed worth it.

My main research questions are:
1) Do the potential superstocks report good results in the upcoming quarter?
2) Does having more consecutive quarters of year on year EPS growth improve the chances of EPS growth in the upcoming quarter?
3) How does stock price move in the earnings announcement week?

And of course, the most important question is how does good fundamentals of the stocks affect my bottom line?

Firstly, we can take a look at the summary of the trailing 12 months(TTM) EPS when I blog on the stock versus the earnings reported in the next quarter. An improvement in EPS (TTM) will also means a year-on-year (yoy) growth in the quarterly EPS.

Since I blog about the stock at different points of time, to normalise the date, I would define the latest quarter earnings at time of posting as T. Therefore, the result of the upcoming quarter (unknown at time of post) would be T+1. In the table below, I have included only companies that have posted at least one additional quarter of results after I blogged about the company. Note that DRD is not included as they have suspended quarterly reporting after I blogged about it.



Out of the 15 companies, 11 reported improving EPS (TTM), 1 reported flat flat EPS (TTM) and the remaining 3 reported decreasing EPS (TTM). There are some companies that reported very strong growth, for example AVHI with 628% increase in EPS (TTM) and GDEN with 164% increase in EPS (TTM).

A quick check using Finviz, as at end August 2016, the number of companies reporting positive EPS growth stands at 2243 versus 2179 companies reporting negative EPS growth. The shortlisted superstocks do perform fundamentally better than the universe of US stocks.

The next question is, does better earnings reported in the next quarter translate to better returns using the entry and exit strategies that I developed in the first three parts of the review?

I did a simple regression of returns on EPS growth. The coefficients on the slope is insignificant. This implies that EPS growth does not lead to better returns based on my strategy.



On closer examination of the reason, I note that in some instances, I exited the trade before the next earning release. Resurfacing the earlier table, the cells highlighted in orange mean that I am still in the stock when the T+1 earnings are released. I exited 6 out of 15 trades before the T+1 earnings are released. I ran a regression among the remaining 9 companies and once again, there is no correlation between EPS (TTM) growth and returns.



If EPS growth has no effect on my returns, how about price earnings ratio? On of my screening criteria is the PE ratio need to be between 0.2 and 30 based on the most recent quarter. For the analysis below, I am using EPS (TTM) instead to account for seasonality. Note that GDEN and Best World has been removed from the analysis as they are obvious outliers. Once again, there is no correlation between PE ratio and returns.



The above shows that changes in EPS growth and PE ratio have no impact among the potential superstocks. The comparison is restricted to potential superstocks with PE ratio between 0.2 to 30, therefore it is not conclusive that PE ratio does not affect stock performance in general. For example, if a stock has a strong technical breakout, strong fundamental but have a high PE ratio of about 70, the above research does not test if stocks like this will perform worse off than superstock with a lower PE ratio.

Performance During and Before Earnings Week


The next question that I will answer is if you should hold a stock on the week of earning release. For completeness, I will also look at how stocks behave one week before the earning release. The table below summarises the stock performance one week before earning release and during the earning release week.



The average return during the earning week is 1.2%, while the average return one week before earning release is -1.5%. Statistically there should be no evidence that the average return during earning week or one week before is different from zero, i.e. holding your stock through earnings week will not give you better returns on average. The reason to stay out during earnings week will be to avoid the volatility that is heightened during this period of time.

Another finding is that the quarter on quarter TTM EPS has no impact on the stock performance during earnings release. For example, we have AVHI that posted a 628% increase in TTM EPS and yet the stock was down for the week.  On the other hand, VRA had a fall in TTM EPS and yet post a gain both during earning week and aweek before. This may be because the earnings have been priced into the stock and it is the surprise component that moves the stock during earnings week or a week before.


Inconclusive Section


Compared to the first three parts on fundamentals, this part is not as conclusive. What I can conclude from this part of the review is:

* The potential superstocks have higher earnings growth than the market on average.
* I exited a good proportion of my trade before the next earning release, so long term earnings may not be too important.
* Exiting a trade during earnings release will not lead to better stock return.


What the part cannot conclude and yet is the most important question is, when two stocks have the same strong technical breakout, will a stock with better fundamentals produce better returns? In order to answer this question, I will need to keep track of the fundamentals of every single stock that passes through the technical screen. Next I will need to find out the returns of these stocks if I were to trade them based on my strategy developed in part one to three of the review. Thereafter I can compare the performance of those stock that passed through the fundamental list and those that did not to see if there are any significant differences in the stock return.

This will be a large scale project that I can only aim to complete in mid-2017 since I will need a relatively large sample for my findings to be robust. Till then, I will continue my weekly post on potential superstocks though I am not intending to trade them till I complete my research.

For now, I am glad that I have finally completed this part of my review. Stay tune for the last part of the review where I will summarise my findings from this review.










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All information in The Trader Diaries (TTD) does not constitute to investment advice or recommendation to buy, sell or hold. Readers are advised to consult their financial advisors prior to making any investment or pursuing any investment strategy. TTD will not be liable for any losses resulted from information published or shared from the blog.