Yesterday, in the article 'VICL, DNDN, BKD, RINO, ASPM, IFLO, HITK, AFFX: Seven Bullish Healthcare Stocks' I wrote about seven bull stocks in the medical industry. In this article, we will pick seven bull stocks in the financial services industry. We will use a slightly modified strategy to pick those stocks. Still our focus remains one year target price appreciation, as we want to pick those stocks that are likely to deliver higher returns for us.
Our research universe
Our research universe initially comprises of 1,139 stocks in 21 sub sectors (for space constraint we are omitting the names of these sub sectors) which can be grouped into three super-sub sectors namely banks, finance, and insurance. As we progress, our universe becomes smaller ultimately reaching our desired state of seven picks.
Strategy similar to 130/30
We will follow a strategy similar to 130/30 employed by mutual funds. For those who are not familiar with the jargon - 130/30 means mutual funds investment portfolio is 130% long and 30% short, with net 100% long as compared to traditionally 100% long only strategy. Instead of long/short, we employ weighted alpha to pick our final seven. Since, our stock universe average weighted alpha (Alpha is a measure of how much a stock has risen or fallen over a one-year period.) is 20.03 we will construct a portfolio with a weighted average of 20.03. Excepting this deviation, our stock picking strategy is similar to the one employed in the healthcare article.
Penny stocks and less liquid stocks out
The first criterion is to eliminate penny stocks (stocks whose 52 week low price has been below $1 at least one time in 2009). Removing the penny stocks our stock universe reduces from 1,139 stocks to 1,055 stocks. The next criterion is to eliminate those stocks whose average trading volume was less than 500,000 shares (since our universe is bigger and also since financial stocks generally issue more number of stocks, we have raised the bar). Removing the less liquid stocks we arrive at a universe consisting of 49 stocks.
Narrowing down to twenty one
Our next criterion is relative strength index or popularly called RSI (A technical momentum indicator that compares the magnitude of recent gains to recent losses in an attempt to determine overbought and oversold conditions of an asset.). A stock is deemed to be overbought once the RSI approaches the 70 level, meaning that it may be getting overvalued and is a good candidate for a pullback. In our universe of stocks, two stocks namely Banco Bradesco (BBD, $7.02 - $21.37, 114.42%), and Ishares Msci Br (EWZ, $25.26 - $73.68, 110.19%) have RSI above 70% as on October 12. So, we eliminate these stocks.
