Simple Quantitative View of Goldman's VIP List Generates Some Other Long Ideas

For a pdf of this report, follow this link: Simple Quantitative Overview of Goldman Sach's VIP List.

An article by the contributor "Market Folly" on Goldman Sach's "VIP List" caught our attention on Seeking Alpha. What better way to test our simple quantitative model against a list of 50 stocks that Goldman believes "tracks the long exposure of hedge funds?"  We could even automate the implied strategies and essentially print money, allowing us to head off to some resort beach in the South Pacific for the rest of our days.

Unfortunately for us, it did not work out that way.  As we mention to our equity research consulting clients from time to time, as proud as we are of the financial models and equity research reports that we create for them, brain power and independent thought are still required in making prudent investment decisions.  While academic studies and models such as the Ascendere Long/Short Model Portfolio demonstrate the impressive value that may be generated from simple quantitative approaches, in this case it also demonstrated a few, though revealing, shortcomings.  

For example, we discovered that hedge funds that owned large-cap technology stocks like Apple Inc. (AAPL), Google Inc. (GOOG), Hewlett-Packard Company (HPQ), Cisco Systems, Inc. (CSCO), Oracle Corp. (ORCL), QUALCOMM Inc. (QCOM), Intel Corporation (INTC), EMC  Corporation (EMC), International Business Machines Corp. (IBM) might be interested in considering mid-cap technology names such as Seagate Technology (STX), Micron Technology Inc. (MU), Flextronics (FLEX), SanDisk Corp. (SNDK), Harris Corporation (HRS), Ingram Micro (IM) and CGI Group (GIB).  This is because these mid-cap stocks rank better than any of these large-cap companies on a vast majority of fundamental factors.  A more sanguine view might be that the quantitative factors such as operating momentum and analyst revisions are completely irrelevant.  We get to that later.

More interesting, there were a few standout stocks that had no peers which were ranked higher across the board for key factors such as relative value, operating momentum, analyst revision momentum and fundamental quality.  These included Microsoft Corp. (MSFT), Mastercard Incorporated (MA), Wells Fargo (WFC), DIRECTTV (DTV), WalMart (WMT), Mead Johnson Nutrition Company (MJN), Merck & Co. Inc. (MRK), Johnson & Johnson (JNJ), Philip Morris International (PM), and a few others.  

On the other hand, it compared CVS Caremark Corporation (CVS) to better ranked mid-cap stocks such as Del Monte Foods Co. (CLM), NBTY, Inc. (NTY) and large-cap Pepsico, Inc. (PEP).  Somewhat absurd, given that it is not the best idea to compare a large pharmacy benefit manager with a fish oil capsule manufacturer and food companies.  That is the nature of the quantitative model.  It only analyzes and provides the information exactly in the way you asked it to.  Powerful in some ways, simple and naive in others.  

One additional observation is that any key attribute scoring very low seemed to be offset by another attribute scoring considerably high, and that these managers seem to overweight a focus on quality over other key attributes.  This makes sense - if a portfolio manager is going to hold a stock for a long time, a company with basic solid fundamentals and good management can always make up for its other shortcomings later.

Whatever one's world view on basic quantitative models versus deep fundamental analysis, it seems that blending the two approaches could provide deeper insight than any one approach on its own. Some good examples of this may be found with our recent research on McKesson Corp. (MCK), Starbucks Corp. (SBUX) and Joy Global (JOYG).  Decide for yourself -- please see below for the Goldman Sach's VIP list of stocks and some alternatives suggested by a few simple quantitative models.