Simple Strategy Delivers 18% a Year Investment Return

As you all know, my primary investment vehicles of choice are index funds. That's not to say I don't buy individual stocks, but I'm very picky on the ones I select. Yet I'm always on the lookout for a stock-picking "system" that can do better. Well, maybe I've found one.

This piece from Money Central on a simple investment strategy that delivers an 18% annual return starts off as follows:

It sounds too good to be true. But I have tested the Cornerstone Growth method for two years, and the returns have been remarkable.

Here's how to do it:

• O’Shaughnessy first identifies a universe of stocks with price-to-sales ratios (P/S) of 1.5 or less, adding the hurdle that they also had to record at least some earnings growth over the prior year.

• From that list, O’Shaughnessy picks the 50 stocks with the highest relative strength for his Cornerstone Growth portfolio.

A few other comments I thought were interesting:

Many value investors use low P/S ratios to identify value-priced stocks. So the name is misleading. Cornerstone Growth is really a value strategy.

According to O’Shaughnessy, Cornerstone Growth returned 18% on average, annually, compared to 13% for the S&P 500, over his 43-year test period.

Unlike many strategies that fail once they’ve been publicized, Cornerstone Growth hasn’t lost its mojo. The Hennessey Cornerstone Growth (HFCGX) mutual fund, which uses O’Shaughnessy’s selection formula, has averaged an 18% annual return since its November 1996 inception.

There is nothing magic about 50 stocks. In his book, O’Shaughnessy said he chose 50 because it was a common portfolio minimum for professional and institutional money managers. But he also mentioned research showing that most of the benefits of diversification come from “as few as 16 stocks.”

Hmmmmm. Very interesting. Still, even if you bought only 100 shares of 16 stocks and each stock sold for $30 average, that would mean dedicating $48,000 to this strategy -- not an inexpensive proposition to test.

Anyone out there heard of/been using this method? Any comments/thoughts?

Comments

[Dave]

This guy is promising more than he can really deliver. For reasons why, check out "Winning the Loser's Game" by Charles Ellis. If it was this simple, why isn't everyone doing it?

[ob1]

I use FOLIOfn for my stock portfolio. You are able to buy fractional shares of stock with them. So you can still hold 16 stocks priced at whatever and still have the same diversification.

[My Personal Finance Blogger]

Wouldn't it be easier to just buy the fund? I wonder if there is an ETF out there with the same stocks...

[Martin]

The easiest way to get exposure to this strategy is to buy the mutual fund that implements it (HFCGX). It has had an 18.26%/year average return since in ception in 96. There are many other funds with similar strategies. An example is Numeric's NISVX (closed) with very similar performance. Bridgeway Funds also have various offerings in this space. And we also run a strategy that evolved from O'Shaughnessey's research, but it has only about 2 years of track record so far.

[Angelo]

Charles Ellis is basically recommending index funds.Nothing new there.For the last 10 years Vanguard index 500 has returned about 8% a year,whereas hfcgx has returned about 15% a year even including this year's flat performance.The reason everybody is not "doing it" is because many people are looking for spectacular returns,instead of better than average ones.