The Stock Picking Robots Are Coming


The use of robots in the workplace has allowed companies to lower production costs, increase efficiency, and fatten margins. Although it’s unlikely that machines will completely displace humans—at least in our lifetime–the conversation is gaining momentum in the world of investing. Money managers are allocating more resources to quantitative model-building and the bot-versus-human narrative has amplified as firms are turning to stock-picking algorithms to entice clients seeking low-cost alpha.

According to PricewaterhouseCoopers, robotic process automation (RPA) concepts–logic-driven robots that execute pre-programmed rules—”have been around for nearly a decade, and they’ve advanced quickly. In financial services, insurance carriers have used RPA in claims processing for quite a while. Capital markets firms are now turning to ‘automation’ to reduce costs, provide better service, and even make complex regulatory implementations work more efficiently.”

In the realm of investment and fund management, the use of robo-based investment strategies is also on the rise, using “rules” based strategies and quantitative metrics to select stocks. The robo trend is resulting in efficiencies and lower fees, which are huge draws for clients, especially since many of these strategies are earning better returns than many actively managed funds.

BlackRock, the largest asset manager in the world (overseeing more than $5 trillion), announced last month that it will consolidate some of its actively managed mutual funds with computer-centric peers. In a recent interview, Laurence Fink (one of the firm’s founders), explained, “We have to change the ecosystem—that means relying more on big data, artificial intelligence, factors and models within quant and traditional investment strategies.” This belief in algorithm-based investing strategies runs counter to Fink’s long-standing mantra, “let the client choose.” But that’s not to say the firm is abandoning actively managed funds by any stretch–they still account for 16% of total revenue (although Morningstar data shows that only 11% have beaten their benchmarks since 2009).

Last summer, JPMorgan Chase CEO Jamie Dimon said his firm would offer clients a free, automated investment service. According to a CNBC article posted in March, Goldman Sachs is in the process of building a robo-adviser platform to “broaden its customer base outside the super wealthy” (the article says the firm’s U.S. private wealth business typically advises clients with an account size of around $50 million).

A recent New York Times article described BlackRock’s new plan as a “direct attack on the cult of the brainy mutual fund manager, popularized in the 1980s and 1990s by Peter Lynch, a stock-picking wizard at Fidelity.” Nir Kaissar, in his Bloomberg Gadfly column, extends the discussion further; “In fact, had smart beta existed 30 years ago, it most likely would have kept pace with—or even beaten—the most revered stock pickers” (he names Lynch as one).

As an investor in today’s market, there are ways that individuals can combine sound stock picking methodologies with a quantitative investment process. For instance, at Validea I have studied the most successful investors of all time, including Peter Lynch and Warren Buffett, and have created stock screening models that allow investors to combine proven strategies into a quantitatively-based investing system.

My models scores stocks using more than 300 distinct investment criteria, ranging from valuation metrics to income statement and balance sheet measures, profitability and quality factors and price action. The models I run score and rank stocks based solely on their investment fundamentals. Using these multi-factor based approaches, I’ve identified the following four high-scoring stocks for investors who still want to uncover individual stock ideas:

Biogen (BIIB) is a biopharmaceutical company that focuses on discovering, developing, manufacturing and delivering therapies for serious neurological and autoimmune diseases. The company earns high marks from my Peter Lynch-inspired stock screening model based on the relationship between price-earnings and growth in earnings-per-share (PEG ratio, a hallmark of the Lynch strategy) which, at 0.55, easily passes the test (must be under 1.0). My Warren Buffett-based investment strategy likes the predictability in earnings-per-share as well as the company’s ability to pay of all debt with earnings in under two years.

NetEase (NTES) is a technology company that operates an online community in China and is a provider of Chinese language content and services. The company earns a perfect score under our Warrant Buffett-based screen given its debt-free balance sheet and ten-year average return-on-equity of 25.4% (versus the minimum requirement of 15%). Management’s use of retained earnings reflects a favorable return of 25.1%. My Lynch-based methodology likes NetEase’s PEG ratio of 0.63 as well as average growth in earnings-per-share (based on 3-, 4-, and 5-year averages) of 33.1%, which falls comfortably within the preferred range of between 20% and 50%.

Credicorp Ltd. (USA) (BAP) is a financial services holding company in Peru that offers services including banking, insurance, pension funds and investment banking. The PEG ratio of 0.55 satisfies my Lynch-based screen, and my Buffett-based model favors the predictable and consistently expanding earnings-per-share. Average return-on-equity over the past ten years of 19.0% is well above the required minimum of 15%.

Banco Macro SA (BMA) is an Argentina-based financial institution offering traditional banking products and services. My Buffett-inspired screening model likes the free cash flow-per-share of $12.72, which indicates that Banco Macro is generating more cash than it is using. Management’s use of retained earnings reflects a favorable return of 30.6%.

My Martin Zweig-based strategy gives high marks to the price-earnings ratio of 11.46 compared to the market P/E of 17.00. Our Lynch-based model finds the PEG ratio of 0.28 to be exceptional, and average growth in earnings-per-share of 41.3% (based on 3-, 4- and 5-year averages) falls within the preferred range of between 20% and 50%.

Disclosure: At the time of publication, John Reese and/or his private clients are long all four stocks mentioned in the article. 

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