By Todd Beaird (TMF Synchronicity)
June 20, 2000

Last week we ran through a list of questions to determine if Mechanical Investing is right for you. Assuming you're still interested in our mechanical Workshop strategies (that is why you're back, right?), we'll show you some of the historical returns of our screens, and give you some tips on choosing the screens that are right for you.

Below are some (yes, just some) of the backtested returns of many of our strategies. The results below are for strategies that held five stocks, selected mechanically, for one full year. Except where indicated below, 12 portfolios per year (one starting each month) were included.

Screen     CAGR     GSD 
Key100#    30.9%   33.9%
KeyEPS     28.6%   25.8%
Keystone#  28.0%   26.1%
PEG26      28.7%   32.6%
PEG13      27.8%   33.9%
Plow       28.8%   28.3%
RS13*      21.1%   35.4%
RS26*      22.5%   40.6%
Spark      25.9%   26.3%
S&P500     16.9%   12.4%

The RS strategies have been tested all the way back to 1969 using 12 portfolios per year. The screens marked with a (#) have been tested back to 1969 for January, April, July, and October starts, and back to 1986 for all months. All other screens have been tested back to 1986, and the S&P 500 results also date back only to 1986. (Note: The S&P return since 1969 is lower, around 14%. Returns that include the period prior to 1986 will show a lower return due to market conditions at that time.)

The results above are for annual holding periods. Many of our strategies have worked even better when the stocks are switched semiannually, quarterly, or even monthly. Of course, more frequent trading entails higher costs. You can use Jamie Gritton's trading simulator to estimate the impact that frequent trading will have on your returns.

A note of caution is in order. The fact that these strategies have backtested well does not guarantee that they will continue to outperform. The market is a dynamic entity. Also, it is possible that some of the strategies' outperformance has been due solely to random chance.

Now, what do the numbers above represent? Compound annual growth rate (CAGR) is the rate of return the strategy had during the backtest period. For more information on how to calculate CAGR, see our Workshop Math primer, Part I.

Geometric standard deviation (GSD) is a measure of how volatile a screen is. You can find out more about calculating GSD in the Workshop Math Primer, Part II. As a general rule, the smaller the GSD, the better (less volatile) a strategy is.

Usually, people focus solely on the returns of a strategy when choosing a screen. This can be a big mistake. As we've mentioned numerous times before, any investment in stocks requires you to honestly assess your tolerance for risk. If you don't, you're unlikely to stick with a strategy long enough to reap the rewards. Bailing out of an otherwise good strategy just because it has hit a bad stretch is a great way to lose money.

One of the advantages of following a Workshop strategy is that you can get an idea of how volatile it is before investing. A quick glance at the strategies listed above shows that many of them have returned 25-30% per year, compared to only ("only"?) 16% for the S&P from 1986 on. However, during that time the S&P has had a GSD of 12%, while many of our strategies have had GSDs well over 30%! Think about that for a minute. If you think the stock market can be a little wild, then our stock strategies can be positively crazy at times. Again, we can't emphasize how important it is to understand volatility and manage your risk.

So, what screens should you use? Well, first you should understand how the screens select their stocks. Don't invest in any screen unless you feel comfortable with the underlying rationale.

Next, choose screens that conform to your needs as an investor. Last year Moe Chernick wrote a three-part series that gave a brief overview of some of our screens and the rationales for choosing them. Be aware that a lot has happened since then (our Workshop strategies are constantly evolving), but I still recommend looking at Parts One, Two, and Three.

The last suggestion I'll mention today is to attempt to choose a mix of strategies that do not overlap. If you have chosen a volatile momentum strategy like one of our Relative Strength screens, you might want to put some of your funds in a more value-oriented strategy, such as PEG. On a mathematical level, you would want to know how closely correlated are the various Workshop screens. In a perfect world, one could use a mix of strategies, each of which outperforms the market, but have very little volatility when combined. We're still looking for such a mix!

Next week we'll present some numbers showing the correlation of returns between our various screens. Until then, feel free to experiment with various blends on Jamie Gritton's backtest tool.

I hope you all enjoy the summer solstice today in the Northern Hemisphere (winter solstice if you're reading this from Down Under), and Fool on!