We’ve used this analytical process for four years to buy and sell options, in particular to write options premium. The returns have been excellent. If I told you how good, you probably wouldn’t believe me, but it is more a business than passive investing. Nevertheless, financial statement risk analysis has been an important driver of returns, the other components being premium offered, stock price channels or trends and violation of weekly moving averages.
As far as work we’ve done for clients, it has been successfully used in a variety of market segments:
- High-yield bonds
- Investment grade bonds
- High-yielding common stocks, REITs, MLPs, royalty trusts.
- Nanocap stocks
- High quality companies (high return on capital, low debt, growing companies)
- Undervalued companies with minimal debt and improving although still substandard profit performance
- High revenue growth companies not yet earning money consistently, but showing stead free cash flow improvement.
- Short sales.
Since we are studying financial statement trends, the analytical process has applicability to any security that performs, at least in part, based on how well the underlying business performs.
Around the turn of each year, we calculate the return if the positions we took were in common stock and held indefinitely in the belief that this most accurately reflects the ability of the software to detect emerging financial statement trends. It probably also should be noted that we are continually, and by that I mean daily or weekly, tweaking the software to improve it and improve its usability for clients who want to extract its value quickly. Much of the tweaking involves outliers and anomalies — companies that lose money and have negative shareholder equity is common. These skew the averages or otherwise throw the program off, which relies fairly heavily on changes in return on fixed capital and changes in debt versus equity.
Performance Update January 4, 2018
Overall performance 28% annualized. See chart below. Performance by year:
- 2014: 19%
- 2015: 62%
- 2016: 20%
- 2017: 16%
So far, 2018 has been a particularly strong year.
- When positions were accumulated over time, I’ve used the average cost.
- This record doesn’t include bearish trades (selling naked calls — HEDGED naked calls, buying puts, HEDGED puts) of which there have been many. Three immediately come to mind: Royal Bank of Scotland at $11, Amira Nature Foods at $15 and CGG at $290 per share.
- Clarification: I recently mentioned to a new client that I had taken a position in Micron Technology (MU) late in 2017. It does not appear on this list because I actually took the position January 23, 2018. I mis-remembered.
- We’ve tested this software trading small cap stocks, in particular nanocap stocks, on the theory that there was an absence of research in this area. It has worked fine, but returns have been lower than selling option premium in higher cap stocks.