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Charles Kirkpatrick’s Approach to Value and Momentum Investing

 November 20, 2012 10:55 AM


In brief 

Charles Kirkpatrick is a US investment strategist whose mechanical stock selection techniques – blending value, growth and momentum – have earned him a following among technical investors. Kirkpatrick has won awards for his stockmarket analysis and academic writing and he continues to publish a weekly technical stock market letter, The Market Strategist. 

Background 

Kirkpatrick is president of technical research publisher Kirkpatrick amp; Co., which has been producing The Market Strategist since 1976. He has written three books, among which the 2008 publication of Beat the Market: Invest by Knowing What Stocks to Buy and What Stocks to Sell won huge acclaim. Kirkpatrick believes that investors face an impossible task in predicting the market or the economy. His approach is to look for fundamental and technical indicators as a signal to buy and sell stocks. Central to this philosophy is a focus on relative strength – the performance of a stock price versus the rest of the market. Beyond that, he looks for value and growth drivers to hone the strategy. 

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Kirkpatrick's focus on relative strength dates back to research he carried out in the 1960s with Robert Levy, who wrote a paper claiming that relative strength could be used successfully in stock selection. While Levy's views were largely ignored by investors and analysts at the time (who tended to favour the efficient market hypothesis) Kirkpatrick stuck with Levy's theories. In 1982 he began tracking them in real time on a weekly basis. He revisited the story 17½ years later in an award-winning paper that reflected on how the strategy had gone on to perform. It wasn't exactly a secret – Kirkpatrick has earned guru status for performing exceptionally well against the market using a strategy that is basically devoted to relative strength. 

Investment strategy 

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Kirkpatrick's approach is mechanical – he relies less on what the company actually does and more on ‘relative' indicators connected to the stock price and fundamental data. He is a strong believer in behavioural biases, so his strategy seeks to strip out potential frailties like investor impatience, lack of discipline and fear of being wrong. 

He employs a three-step process called STRACT – setup, trigger, and action – which he uses to react to individual price share price movements. His buy and sell indicators include price-to-sales, reported earnings growth, and share price strength. He also point amp; figure charts to help in the buy and sell decision process. Using those factors he developed three investment models – Growth, Value and Bargain. 

  • With Growth, he looks for stocks in the top 10% of the market for relative price strength over the previous 130 days. In addition, he screens for stocks in the top 10% of the market for relative reported earnings growth over the previous four quarters. 
  • With Value, the relative price and reported earnings growth once again apply. This time, he also wants to see a relative price-to-sales ratio that ranks among the lowest 30% of the market. 
  • In the Bargain model, the demands are even more precise. Stocks ideally need to be displaying relative strength in the top 3% of the market, while the relative price-to-sales ratio has to rank in the 17th to 42nd percentiles. 

The only restrictions on the models are that the minimum share price for a stock has to be $10. Value model stocks must have a minimum market cap of $500 million, while growth and bargain stocks need to be valued by the market at $1 billion+. 

When to sell 

As a technician, Kirkpatrick had very fixed views on when to sell stocks in each of his three models. In varying degrees, all sale triggers involved a substantial negative change in the relative strength of the price, the reported earnings growth rank and the price-to-sales ratio rank. 

  • With Growth, stock are sold when the relative price strength rank falls to below 30% in the market; relative reported earnings growth rank falls below 70% and the stock price falls below two previous notable lows. 
  • In Value, the sell drivers are when the relative price strength rank falls to below 30% in the market are when the relative reported earnings growth rank drops below 50% against the market. Kirkpatrick didn't use the price-to-sales ratio as a sell indicator in this model. 
  • In the Bargain model, Kirkpatrick's precision screening involved selling stocks when the relative price strength ranked below 52% in the market and when the relative price-to-sales ratio ranked below 7% or above 67%. 

Does it work?

In Beat the Market (2008), Kirkpatrick claimed that his stock-picking technique based on the relative strength of prices had outperformed the Samp;P 500's performance by an impressive 7.7x over 25 years. 

At Stockopedia, we have modelled Kirkpatrick's three investment approaches – and they are currently delivering mixed results based on the year to date. The best performer is the Value model (albeit with just one company in it), which screens for stocks with a minimum market cap of £100m. Each stock must be in the top 20% of the market on a 130-day moving average basis; in top 30% on a price-to-sales rank and the top 10% on an operating profit growth basis.  On those filters the screen has produced a return of 29.1% versus a 5.8% for the FTSE 100 in the year to date. Meanwhile, the Bargain screen has produced a year-to-date return of 9.9% while the Growth screen is in negative territory at -2.2%. 

One possible criticism of Kirkpatrick's approach is that the screening parameters used, particularly the 17% and 42% used in his Bargain model, may simply be a function of data mining historical results, as there doesn't seem to be an obvious investment / commercial logic behind those numbers to suggest that the exact parameters will hold in the future. Another implementation issue is that the Value parameters are very restrictive, with just one UK stock appearing in the Value screen at present, which doesn't exactly make for a diversified portfolio, but then again having high standards is no bad thing!

From the source 

Kirkpatrick's best known (and highly recommended) book is Beat the Market, but he has also written Technical Analysis: The Complete Resource for Financial Market Technicians and Time the Markets: Using Technical Analysis to Interpret Economic Data. He continues to publish the weekly Market Strategist too. 

Other sources 

 

Stockopedia

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