Chasing the Wind

The Mechanical Investing strategy I’ve been following since 1998 is in the news at the Motley Fool today. Here are some excerpts, part 1 of 2:

Want 50% Annual Returns?
By Jim Fink (TMF Hamp)
January 30, 2006

In my years of reading The Motley Fool, I’ve been particularly interested in the Fool boards on “mechanical investing,” which discuss stock-picking strategies based on quantitative computer screens. This type of investing is “mechanical” because it requires the investor to pick stocks based on an objective set of fundamental (e.g., annual sales above $500 million) and/or technical (e.g., stock price above the 200-day moving average) criteria. Furthermore, there is literally no discretion on the part of the investor; if the screen spits out Altria (NYSE: MO), you buy the stock regardless of whether you morally oppose tobacco companies, or think that litigation will bankrupt the company. So goes the strategy, anyway.

Some might argue that it’s a form of brain-dead investing, but what’s wrong with that? I’ll take money however it comes to me. As Fool contributor Tim Beyers also recently pointed out, it’s not uncommon for individual investors to have a difficult time deciding how many stocks to own. It’s similarly difficult to endure the emotional roller coaster of a high-volatility portfolio. While Tim was advocating the Motley Fool Champion Funds newsletter as a solution, mechanical investing is another way to save us from our more irrational, emotional selves.

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There are a few simple rules of thumb for developing a logical stock screen. Fool member moebruin wrote an article to help us determine which stock-screen criteria probably have purely coincidental superior investment returns (and thus should be avoided), and which criteria have a logical underpinning that gives us confidence in their continued superior investing returns. His five criteria for a “good” stock screen are:

1. The strategy must follow a simple and logical protocol;
2. The rationale must make sense and be easily explainable;
3. The screen must work with good but diminishing returns for lower-ranked stocks;
4. There must be at least 10 years of historic returns (for purposes of backtesting, to confirm validity);
5. There should be peripheral data that supports the contention that the screens should work.