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Mar 2, 2015

Creating An Investment Process - Part 2

by Keith Richards

Keith Richards


In the last issue of Canadian MoneySaver, I covered the first two steps of a process that you can follow when creating your own systematic stock investing approach. The order of the steps that you will want to follow if you are creating your own buy/sell discipline should be:



1. Macro market technical analysis

2. Initial screening for technically favorable stocks

3. Screening for fundamental suitability

4. Position size

5. Sell discipline

In this article, I would like to cover the final three steps involved in the investment process. We’ll start with some thoughts on using fundamental analysis within your analysis approach, followed by suggestions on position sizing for individual stocks within your portfolio. Finally, we’ll cover the most difficult part of investing in stocks: the process of deciding when and if to sell. Let’s get started with step 3, fundamental screening for quality stocks:

3. Screening For Fundamental Suitability

ValueTrend’s resident fundamental analyst Craig Aucoin is responsible for reviewing stocks that have passed my initial technical screens (something I discussed in my last column). When reviewing a stock, Craig looks for qualitative factors, such as a sound and experienced management team who are working within an appealing sector. He also looks for quantitative factors—that is, the more measurable factors that cover the numerical side of a business. For example, Craig looks for EPS (earnings per share) growth. Such growth is preferable from a growing business model rather than cost cutting. Craig also focuses on revenue growth. There are two ways for a company to experience revenue growth: through increased volume sales or through higher margin sales (selling fewer widgets at a higher price). While not a hard and fast rule, Craig prefers the former over the latter. Cash flow generation must also be sustainable and growing.

Another factor that is part of our fundamental evaluation process is to look for margin expansion within the company in question. As Craig notes, falling margins may indicate the glory days are behind a company if their margins are shrinking. A strong balance sheet is also essential to pass our screens. A company we invest in must have enough cash on hand to meet liquidity—and not be overstretched due to leverage.

I’d like to briefly revisit our decision to purchase Enerplus back in early 2013. Around the time that the stock broke out technically, the company had sold some non-core assets and had purchased new assets that were expected to be more profitable. Craig paid a visit to the company's shareholders meeting and came away with even more conviction about this holding. He noted the company had an aggressive business plan to create efficiency and diversification within its operations. We also noted its healthy 6% + dividend at the time.

(Readers may be interested to know that, on average, Craig only passes about 10% of the stocks from my initial technical phase and trend identification list. In our way of doing things, one analytical discipline does not trump the other. A stock selection must pass both my technical screens, and Craig’s technical screens independently.)

4. The Final Buy Decision And Position Size

After passing my initial technical screens and Craig’s fundamental screens, the few companies that survive are placed on a “Live watch list.” Craig passes the ball back to me at this point. It is now my job to refine the entry point by watching daily and even intra-day chart patterns to pick a suitable entry point. You should refer to my Sideways book, or any good book on technical analysis, to understand how to use the shorter termed timing indicators such as momentum oscillators. You might choose not to refine your trading price-point timing by using such indicators, and that’s okay. The important part of this strategy is to find fundamentally sound stocks that are breaking out of a base, or testing an established trendline. By following such a systematic approach to stock selection, you will be ahead of the crowds in your investment success.

When fully invested, the ValueTrend equity platform holds, on average, 20 ETFs and common stocks. Position size is between 3%-7% per stock, and 3%-10% per ETF, with a typical position weighting at 5%. We will underweight (3%) or overweight (7% for a stock or 10% for an ETF) each position according to our confidence level in the technical and fundamental factors behind the security. You should create similar rules regarding your maximum, minimum and average position size.

Putting Our Buy Rules To Work

As an example of how our position sizing works, here are two ValueTrend Stocks that are in Phase 2 uptrends, along with their position sizes in our portfolio: 

Keyera (KEY-T): 6% position, above average confidence 

Disney (DIS-US): 5% position, average confidence

5. Selling Individual Stocks

The basic sell rule when analyzing an individual stock or sector is to sell upon a break of an established trend, or to sell if a stock has broken down from an obvious phase 2 topping pattern (also known as a consolidation pattern).

A simple example of a stock that has recently broken its uptrend is Onex Corp (OCX-T). Typically, a wellrun company like Onex can go too far up, too fast. If the stock breaks a trend line by taking out the last low after breaking its 40-week moving average, this is a sell signal. The break of a trend does not always signal doom and gloom for a stock. In fact, Onex is trading sideways at this time—it is not in a downtrend. But a moving average break usually does mean that the stock is in for a long period of underperformance before it becomes a factor again. Onex’s chart shows us that things have changed for this stock's uptrend, at least for now. There are better places to invest your money at this time.Enerplus Stock Graph

By the way, the beauty of technical analysis is that you can react and move with the times. Should Onex get back on trend, we can buy it again. At this point, however, the odds are not favourable towards this stock performing as well as the market.

Now let’s look at a stock that broke down from a phase 2 top. I’m going to reference Enerplus (ERF-T). I mentioned the steps that led us to buying this stock in 2013. Now I’d like to illustrate the decision process we used to sell the stock last summer. Enerplus, as you can see on the chart below, entered into an uptrend after we bought its breakout in early 2013. By mid-2014, the stock began a topping process. In September, Enerplus broke down by taking out its last trough low of around $23. It then cracked its 200-day moving average, as you will see on the chart. It was time to sell.

A final note about utilizing a buy/sell stock strategy such as ours. There is no known technique that will consistently enable you to buy at bottoms and sell at tops. Our buy-and-sell example of Enerplus illustrates this perfectly: we bought this stock well off of its bottom, and sold it well off of its top. Our process allowed us to buy the stock at a favourable time, and ride it for as long as it was in an uptrend. Our sell discipline allowed us to identify the end of that uptrend while taking a reasonable profit. Interestingly, if we had been the “buy and hold” types, we would be under water on this position right now. It is below our purchase price at the time of writing.

Our system saved us from that grief.

If you would like to learn more about technical and fundamental analysis techniques, I would encourage you to do one, or all of the following:

1. Follow my free technical analysis blogs at New postings are tweeted via @ValueTrend

2. Read my book Sideways: Using the Power of Technical Analysis to Profit in Uncertain Times.

3. Attend one of our free educational events at a local library.

4. My website at has updated dates for my upcoming BNN

MarketCall appearances.

Keith Richards, Portfolio Manager, can be contacted at He may hold positions in the securities mentioned. Worldsource Securities Inc. – Member: Canadian Investor Protection Fund, and sponsoring investment dealer of Keith Richards.

The opinions expressed are those solely of Keith Richards and may not necessarily reflect that of Worldsource Securities, its employees or affiliates. The contents are for information purposes only and do not represent investment advice.