Patrick O’Shaughnessy’s Millennial Investor Strategy

Patrick O’Shaughnessy gives five traits millennial investors should look for in a stock in his book, “Millennial Money: How Young Investors Can Build a Fortune” (Palgrave Macmillan, 2014). Those traits are value, earnings quality, shareholder orientation, return on invested capital (ROIC) and momentum. He says owning stocks with these characteristics will lead to a portfolio that is both unique and performs well over time. He gives a summary of his approach in this issue’s Stock Strategies article.

Rather than requiring absolute values for each criteria (e.g., return on invested capital of at least X%), Patrick uses composite rank scores. A ranking is assigned to each criterion to determine how favorable or unfavorable a company is relative to all other stocks for that characteristic. A composite score is then calculated based on the rankings for each criterion.

Three of the criteria, price-to-free cash flow (a measure of value), 26-week relative price strength (a measure of momentum) and return on invested capital, are built into AAII’s stock screening and fundamental database, Stock Investor Pro. Rankings for price-to-free cash flow and relative price strength are also calculated by the program. Cash from operations less net income divided by market capitalization (earnings quality) and cash from financing divided by market capitalization (shareholder orientation) require the use of custom fields.

Calculating the rankings and the composite scores requires the use of a spreadsheet. The list of passing companies was exported to Microsoft Excel. The inverse of price-to-free-cash-flow ranking was calculated to assign higher rankings to the stocks with the lowest valuations for purposes of determining the composite score. Rankings were calculated in Excel for earnings quality, shareholder orientation and return on invested capital. The individual ranks for each criterion were then added together to create a stock’s composite score. Higher scores are better.

The universe of stocks was restricted to exchange-listed stocks. Stocks within the financial sector were excluded because of the structure of their financial statements. Passing stocks were required to have the data necessary for calculating all five criteria and the composite score. These restrictions narrowed the set of available stocks to 1,660. The 25 stocks with the highest composite scores make this issue’s First Cut.

Fields for use in SI Pro are shown below the table. You can download instructions for creating the screen and a spreadsheet of the Excel ranking formulas here.

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