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Factor Investing

What Are Factors?
A factor is simply an attribute or characteristic that a stock possesses. The factor typically plays an important role in explaining the stock’s return or risk profile. We want to know why some stocks perform better than others, or why some stocks are less risky (i.e., volatile) than others. Intuitively, certain attributes emerge as being obvious. A stock that has a high yield probably has a different risk/return profile than a stock that does not pay a dividend.

Types of Factors
All factors can be organized into three categories: macroeconomic, statistical, or fundamental. At tickrz, we’re focused on fundamental factors. We encourage you to explore the other two categories.

As you can imagine, there are many fundamental factors that an investor could consider. In fact, there are an infinite number of combinations. This huge list needs to be narrowed down into a manageable list to focus our efforts. Berkin and Swedroe use the following criteria:

Persistency does the factor hold over a long period of time?
Pervasive the factor shows up in multiple markets, asset classes, and sectors.
Robust sufficiently broad with multiple approaches showing similar results.
Investable it can be turned into an investment strategy, not just a theoretical exercise.
Intuitive we can make a reasonable argument for why the factor may exist.

Factors We Focus On
After applying the above criteria, we focus on the following factors:

Value stocks with low valuations, captured by low price-to-earnings, price-to-book, price-to-sales, price-to-cash flow, and enterprise value-to-EBITDA ratios, tend to have excess returns.
Momentum stocks that perform well in the past tend to perform well in the future.
Volatility stocks with lower standard deviation and/or beta exhibit excess returns.
Dividend Yield excess returns shown for stocks with higher dividend yields.
Quality companies with low debt, high operating margins, consistent earnings, tend to generate excess returns.

There are many other fundamental factors such as size, beta, and carry. Again, we encourage you to explore these to see if they appeal to you.

Do Factors ‘Work’?
So how do we know these factors ‘work’? In other words, how do we know that we’ll be able to generate excess returns by uncovering stocks with these factors? Fortunately, there is a huge body of academic and practitioner work that we can point to. We highlight some of these papers and books below.

Our Screens
Our stock screens give you the ability to sort the investment universe using the above factors. Some of our screens, like our tickrz Rank Screener, Dividend Screener and Warren Buffett Screener combine multiple factors.

ETFs a Viable Option
Find picking individual stocks too overwhelming but still want to embrace factor investing? There are many ‘smart beta’ ETFs out there that are designed to exploit the above factors—and others!

Factors Are Cyclical and Can Go Out of Favor
It’s very important to keep in mind that even though academics and practitioners have found these factors to be powerful there’s not guarantee they’ll work in the future. Plus factors tend to be cyclical. Value can stay out of favor for very long periods of time. Tough to predict macroeconomic forces can greatly influence the performance of stocks with specific attributes. For example, rising interest rates may lead to under performance for high yielding stocks.

Books We Recommend

Sources & Suggested Reading
Berkin, Andrew L. and Larry E. Swedroe. Your Complete Guide to Factor-based Investing: The Way Smart Money Invests Today. St. Louis, MO: BAM ALLIANCE, 2016. Print.
Blitz, David. 2015. “Factor Investing Revisited.” Journal of Index Investing, vol. 6, no.2 (Fall): 7-17.
Connor, Gregory. 1995. “The Three Types of Factor Models: A Comparison of Their Explanatory Power.” Financial Analysts Journal, vol. 51, no. 3 (May/June): 42-46.
Fama, Eugene F. and Kenneth R. French. 1992. “The Cross-Section of Expected Stock Returns.” Journal of Finance, vol. 47, no. 2 (June): 427-465.
Fama, Eugene F. and Kenneth R. French. 1996. “Multifactor Explanations of Asset Pricing Anomolies.” Journal of Finance, vol. 51, no. 1 (March): 55-84.
Gray, Wesley R., and Tobias E. Carlisle. Quantitative Value: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors Website. Hoboken, NJ: Wiley, 2013. Print.
Jagadeesh, Narasimhan, and Sheridan Titman. 1993. “Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency.” Journal of Finance, vol. 48, no. 1 (March): 65-91.
Novy-Marx, Robert. 2013. “The Other Side of Value: The Gross Profitability Premium.” Journal of Financial Economics, vol. 108, no. 1 (April): 1-28.
Zhang, Lu. 2005. “The value premium.” Journal of Finance, no. 60: 67–103.

Learn


Factor Investing

What Are Factors?
A factor is simply an attribute or characteristic that a stock possesses. The factor typically plays an important role in explaining the stock’s return or risk profile. We want to know why some stocks perform better than others, or why some stocks are less risky (i.e., volatile) than others. Intuitively, certain attributes emerge as being obvious. A stock that has a high yield probably has a different risk/return profile than a stock that does not pay a dividend.

Types of Factors
All factors can be organized into three categories: macroeconomic, statistical, or fundamental. At tickrz, we’re focused on fundamental factors. We encourage you to explore the other two categories.

As you can imagine, there are many fundamental factors that an investor could consider. In fact, there are an infinite number of combinations. This huge list needs to be narrowed down into a manageable list to focus our efforts. Berkin and Swedroe use the following criteria:

Persistency
does the factor hold over a long period of time?

Pervasive
the factor shows up in multiple markets, asset classes, and sectors.

Robust
sufficiently broad with multiple approaches showing similar results.

Investable
it can be turned into an investment strategy, not just a theoretical exercise.

Intuitive
we can make a reasonable argument for why the factor may exist.

Factors We Focus On
After applying the above criteria, we focus on the following factors:

Value
stocks with low valuations, captured by low price-to-earnings, price-to-book, price-to-sales, price-to-cash flow, and enterprise value-to-EBITDA ratios, tend to have excess returns.

Momentum
stocks that perform well in the past tend to perform well in the future.

Volatility
stocks with lower standard deviation and/or beta exhibit excess returns.

Dividend Yield
excess returns shown for stocks with higher dividend yields.

Quality
companies with low debt, high operating margins, consistent earnings, tend to generate excess returns.

There are many other fundamental factors such as size, beta, and carry. Again, we encourage you to explore these to see if they appeal to you.

Do Factors ‘Work’?
So how do we know these factors ‘work’? In other words, how do we know that we’ll be able to generate excess returns by uncovering stocks with these factors? Fortunately, there is a huge body of academic and practitioner work that we can point to. We highlight some of these papers and books below.

Our Screens
Our stock screens give you the ability to sort the investment universe using the above factors. Some of our screens, like our tickrz Rank Screener, Dividend Screener and Warren Buffett Screener combine multiple factors.

ETFs a Viable Option
Find picking individual stocks too overwhelming but still want to embrace factor investing? There are many ‘smart beta’ ETFs out there that are designed to exploit the above factors—and others!

Factors Are Cyclical and Can Go Out of Favor
It’s very important to keep in mind that even though academics and practitioners have found these factors to be powerful there’s not guarantee they’ll work in the future. Plus factors tend to be cyclical. Value can stay out of favor for very long periods of time. Tough to predict macroeconomic forces can greatly influence the performance of stocks with specific attributes. For example, rising interest rates may lead to under performance for high yielding stocks.


Books We Recommend

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About tickrz
Key Concepts
Great Investors