Friday, September 26, 2014

Back-testing value investing

I have been recently playing with a fundamental stock scanner designed for the Polish market - GieldowyRadar.

This scanner offers a number of predefined strategies based on some gurus stock selection criteria and allows to back-test them over 7 years.

The best back-test results are currently produced by "the Warren Buffett" strategy.

The average annual return of this strategy is 29.3% vs. -1.85% for WIG index.

The strategy takes into consideration indebtness, EBIT profitability, cash/free cash flow ratio, return on equity and market capitalization.

The scanner makes possible to back-test your own strategies. Unfortunatelly, some more complex conditions - including some used in the pre-programmed guru strategies - are currently not available.

Still, I was wondering whether it is possible to beat the best guru strategy using the limited scanner's back-test functionality while keeping the criteria fundamentally reasonable.

The answer is - YES! :)

"Buy Cheap" strategy: 1014% over 7 years

The strategy I have designed - let's call it "Buy Cheap" strategy, returns on average 41.12% annually over 7 years.

Not unlike "the Warren Buffett" strategy, it is rather selective, giving seldom signals. Hence, it is not for day traders :)

There are two interesting things about both strategies:

1, they do not produce any signals before the second half of 2009 (the back-testing starts at the end of 2007)

It is also worth to mention, that the Polish stock market was raising from the beginning of 2009.

2. the back-testing assumes monthly portfolio re-balancing using re-balancing dates set in relation to the current date (i,e. if you back-test your strategy on September 26th, the previous re-balancing date is August 26th and so on) - this does not allow for entry points optimization based on the temporary relative prices

WIG performance in the back-test period: 154% from the through

"Warren Buffett" strategy: 504% over 7 years

"Buy Cheap" strategy: 1014% over 7 years