If you intend to pick the best shares to buy it helps to have some sort of system to sort the wheat from the chaff. Amateurs and professionals alike usually need their system so they can justify their final picks to themselves or their intended audience.
The more complicated a system, the better it will seem because it will be more exclusionary and lend more weight to those shares that made the cut. And when share picks are akin to driving on a dark night without your headlights on, you really need that extra credibility.
The drive into the darkness is because most shares never behave the way we expect them. They’re subject to random external factors that can render most systems embarrassingly wrong.
No matter because the Australian Financial Review’s Smart Investor magazine has a system. They’ve filtered the ASX 300 to look for the best and most reliable prospects the market can offer. And only eight companies made it through their filter.
Filtering 300 companies down to eight? It sounds impressive considering you’re left with a very exclusive club. The companies were MACA Limited, Decmil Group, Folkestone Education, Arena Reit, Spark New Zealand, JB Hi-Fi, McMillan Shakespeare and Reckon.
The basis for filtering was a combination of previous dividend yields, previous return on equity and the ability of earnings to cover interest on debt to ensure dividend yields could remain strong.
These picks were obviously forward looking, but the combined performance of these companies at the time of writing had been mixed. Year to date combined returns show a decline of 11%, while at the same time the wider ASX 300 had declined less than 1% for the year.
Which brings us to the key point on share filtering – no matter how robust your system is, it often leaves you with only a handful of companies making the grade based on their past performance. And if you’re placing your fortunes in a handful of companies, you’re leaving a portfolio significantly undiversified.
Five out of the eight companies filtered are in negative territory for the year and their impact on the portfolio’s performance is clear. Meanwhile hundreds of ASX companies are in the red every year, yet they have a significantly lesser impact on the broader ASX.
Asset allocation and diversification across local and world indices have long shown their resilience in providing returns. Unfortunately there’s still not a filter to find a reliable share picking system.
This represents general information only. Before making any financial or investment decisions, we recommend you consult a financial planner to take into account your personal investment objectives, financial situation and individual needs.
