How I use Compound Income Scores to help construct a portfolio.

​Having had a question from a subscriber about how I pick the the constituents of the Compound income Portfolio by using the scores. i thought the response might be of interest to others too, so I set out the answers below.

I aim to select new investments from the top decile (90 and above) of the Scores to replace stocks which have seen their Score fall below the top quartile (75 and less), although on occasions I will give some stocks that fall into this sell category the benefit of the doubt if there has not been much news flow or it is quite marginal, as over trading can detract from performance.

In terms of the new positions I do also take into account existing holdings as I like to try and get diversification by sector and type of business. So for example while Redrow & Barratt Developments both Score well at present, the portfolio has held Bellway for a long time and I have not felt that I want more than  one house builder, although that's not a hard and fast rule across all sectors as some are more varied by business type. So they would be excluded on that basis, although other may feel comfortable with having several house builders  in their portfolio or if they felt particularly bullish on the sector or the theme, each to their own I guess.

I also like to apply some value discipline when buying new positions, in the same way that Terry Smith tries to buy quality companies at reasonable prices. I tend to use a maximum of 20x PE and a minimum dividend yield of at least 2%. I also look at the earnings yield (EBIT/EV Yield) & would like this to be 5% or more ideally. These metrics are all readily available alongside the Scores. Thus again in terms of current highly rated stocks that has tended to rule out (rightly or wrongly), two examples are currently high Scoring stocks like dotDigital & Rightmove. Again others may choose to be more relaxed about this and pay up for quality.

In the past I also used these value metrics as guides for selling too, but I have chosen to relax this for current holdings as long as they continue to Score sufficiently well and updates etc. don't give cause for concern so as to "run the winners" which is often a common behavioural failing of investors in not doing this. Having said that I'm not averse to some top slicing if the valuation gets quite high (say closer to 30x & yield well below 2%) & the % of the portfolio gets large (towards 10%), with Avon Rubber being a current example of one that I am considering for that. 

I would also not tend to buy anything less than £50m market cap. as a new position for liquidity / lack of investor interest reasons, although again others may see this as an opportunity.  I  also pay some attention to 12 month price momentum which might well put me off buying if it is negative, unless I think there is a strong enough contrarian value case for example with the purchase of Investec this month. This was in preference to Caledonia Mining (probably due to my personal aversion to / bias against mining stocks). It also reflected that fact that the portfolio already had one smaller precious metals miner as well as a diversified major so again the diversification / sector thoughts came into play there. While the negative price momentum also directed me away from NMC Health (amongst other things), Central Asia Metals and AA (plus debt concerns here) for example at the moment. 

Beyond that I do some due diligence on the other high Scoring stocks not ruled out by the above factors to choose any new holdings. So there may be some of my own knowledge & biases creeping in there, which otherwise I try to keep to a minimum. On occasions I have forced myself to buy high Scoring stocks even though it felt like I was getting in late having ruled them out previously due to my own biases. Examples of these would be Games Workshop (GAW) which was first bought in October 2017 at nearly £20 having dismissed it at around £10 previously. This felt horrible at the time but turned out fine as did an uncomfortable purchase of Sylvania Platinum more recently, again a lot later than I could have bought it, having dismissed it much lower down too at under 20p, as I didn't have a strong feel for them and my  natural aversion to miners personally mentioned earlier.

Equally on occasions a position that I force myself to buy based on the Scores, despite my own reservation, won't always work out as trades in PLUS 500 some time ago proved, although I have vowed to never buy that one again, which again may or mat not be right. Sometimes it does force me to buy things which I don't feel that strongly about personally which go onto pleasantly surprise on the upside, with Avon Rubber and Dunelm being two current examples of that, although they required some patience before they delivered.

Hopefully this has given you a feel for how I go about selecting positions for the Compound Income portfolio. Overall it was set up to demonstrate how one could use the Scores to help construct a portfolio and also to see if the Scores had any merit in this regard. Thus far it has proven to be pretty good at selecting more winners than losers in the nearly 5 years that it has been running, although as all investment marketing says the past is no guide to the future & I can't offer any guarantees or provide any personal investment advice.

I wouldn't expect subscribers to follow the portfolio fully (although they can if they want) but for it to act as a guide to what might be attractive stocks and help people in selecting their own portfolio after doing their own research. Indeed I use them everyday myself to help run my own portfolio in addition to the Scores portfolio, so I'm definitely eating my own cooking as it were, as I believe it is a recipe for success. The current Compound income portfolio has a weighted average PE of 15.7x with prospective dividend yield of 3.5% based on the forecast dividend growth of 15%.

If that has whetted your appetite you can find out more about the Scores and how to access them by clicking here or in the Scores section in the site menu. You can also see the full performance history of the Scores Portfolio by clicking here, but as the standard disclaimer goes the past is no guide to the future, thanks for reading and good luck for the future with your own investing, however you choose to do it.