Invest like the masters: James O'Shaughnessy

From MoneySense magazine, November 2006

Invest like the masters: James O'Shaughnessy

We've plumbed the minds of four great stock pickers to find your smartest investments.
Warren Buffett David Dreman Peter Lynch James O'Shaughnessy

James O'Shaughnessy

He looked back over decades to find the best stock-picking strategies of all time. We've taken one of his best methods and gone searching for values in the Canadian market.

James O'Shaughnessy is know to most investors as the author of What Works on Wall Street. In this ground-breaking work, published in 1996, O'Shaughnessy evaluated the record of many by-the-numbers investment strategies over decades. After writing his book, O'Shaughnessy put his results to work by launching several U.S. and Canadian mutual funds based on his findings.

Unfortunately, he ran smack into the Internet bubble. The dull, value-oriented stocks turned up by his methods performed poorly and he got roasted in the press. However, in more recent years his funds have performed very well. For instance, his U.S.-based Cornerstone Value Fund has bested the S&P 500 over the past five years by an average 2.19 percentage points a year and has done so with less volatility than the index.

We decided to focus on his Cornerstone Value approach because we're fond of dividends. Like all of O'Shaughnessy's methods, it's a by-the-numbers affair, without any deeper research into individual companies. The Cornerstone Value method starts with "marketleading" stocks, which are defined as those with large market capitalizations, an above-average number of shares, more than an average level of cash flow per share, and more than 1.5 times the average level of sales. From this market-leading group, O'Shaughnessy selects the highest yielding stocks — but he excludes utility companies, to ensure they don't dominate the list.

To apply the Cornerstone approach to the Canadian market, we decided to define market-leading stocks as those with annual revenues of at least $2 billion, market capitalizations of at least $1 billion and an annual net income of at least $500 million. We then sorted this list of big stocks by dividend yield and selected the top 10 for O'Shaughnessy's darlings. We did, however, add our own twist. In the U.S., O'Shaughnessy had trouble with too many utilities dominating his results; in Canada, we encountered a similar problem with banks and other financial institutions. To avoid too much concentration in the financial sector, we allowed a couple of utilities to slip through, but we also selected only the highest yielding stock from each industry sub-group. The result is a more diversified list, but one which still pays a generous average dividend yield of 2.9%.

In many ways, O'Shaughnessy's Cornerstone Value method is similar to the venerable Dogs of the Dow approach, but it ranges wider in its search for large dividend-paying stalwarts. As a believer in high-yield stocks, we expect that stocks with generous dividends will continue to do well over the long run. But remember that even the most successful methods will have off years, as the O'Shaughnessy funds demonstrated in their early days.

O'Shaughnessy's darlings


CompanyIndustry
Price DividendYield P/E ROE

BCE Inc.Telephone utility
$30.22 4.33% 15.3 14.9%
Bank of MontrealBank
$68.65 3.68% 13.2 18.7%
TransCanadaGas utility
$35.48 3.64% 13.3 17.6%
Teck ComincoMining
$71.31 2.85% 7.4 35.4%
Husky EnergyOil and gas
$72.20 2.83% 11.2 29.2%
Sun Life FinancialInsurance
$46.56 2.57% 14.2 12.6%
Power Corp.Conglomerate
$32.38 2.47% 13.5 16.4%
Thomson Corp.Business services
$45.20 2.25% 29.4 9.4%
Magna InternationalAuto parts
$81.99 2.17% 11.9 10.7%
George WestonFood stores
$72.39 2.00% 13.2 16.2%


Source: globeinvestor.com, Sept. 28, 2006

http://www.canadianbusiness.com/my_money/investing/article.jsp?content=20061128_104200_3896