Like the power output of a petrol engine (a direct consequence of how fast it rotates and how much twisting force it produces, hence power = revolutions per minute x torque), the power output of a stock-picking engine (aka outperformance) is a direct consequence of how fundamentally attractive the selected stocks are and how much controversy is associated to them (hence expected outperformance = fundamentals x controversy).
Viewed under this lens, the power output expected from the shares of speciality chemical company 3M has been comprehensively underwhelming since January 2018, and it is in large part driven by its lack of “torque”. In this note, we compare and interpret the signals provided by Butterwire since January 2018 on a “meh” stock like 3M vs. an “interesting” one like Facebook, and in doing so illustrate one of the three aspects of active investing supported by the Butterwire engine: stock selection (the other two being portfolio construction and tactical allocation). If you would like more details on the inner workings of the engine and the terms used, please go to www.butterwire.com and sign up for a free 30-day trial (no credit card required) which will give you access to the app’s user guide.
A quick look at each stock snapshot as of April 24, 2019 (see extract below) confirms that Facebook’s fundamentals x controversy combination made it an “interesting” stock to consider, whereas Butterwire saw “better odds elsewhere” for 3M. Looking closer, both companies stood out for their ability to generate high returns on capital, but Facebook scored much higher on overall “Fitness”. Further, for a company with no growth, 3M’s poor fundamental momentum and average value looked worrisome, certainly compared to Facebook’s exceptional growth prospects. Lastly and unlike Facebook with its very publicly controversial digital ad model, 3M had an extremely low Controversy score, belying a share price behaviour that (too) closely tracked that of the market index: such a low controversy score is like a loaded spring, ready to snap and trigger an eruption of volatility as the shares take a sudden dive (at the other extreme, stocks with very high controversy scores like Twitter are liable to consuming a disproportionate amount of a portfolio risk budget).
Looking back 2 years (see table below), 3M in fact looked the better bet for a while, delivering similar outperformance to Facebook with only half the volatility between Apr-17 and Jan-18. But in Jan-18, the engine triggered a “Take Profit?” alert shortly after assigning a “Yellow Flag” to the stock, meaning that after a strong run it looked increasingly poor value and unlikely to continue outperforming. Since then, 3M’s fundamentals have been steadily deteriorating along with the price of its shares. And then suddenly yesterday, profit warning, 13% price drop, 30-day volatility rises to 45%. The spring sprung.
As of 24-Apr, there were 6 large-cap stocks globally with very similar fundamentals x controversy characteristics to 3M….
...likewise for Facebook