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INVESTMENT PHILOSOPHY

High quality assets are worth more than low quality assets. This sounds like a simple truth, but it's a foundational concept that many investors forget when confronted with a complex and compelling narrative, or when the potential for profit or loss becomes emotional.

Evidence shows that many characteristics of high quality companies / assets are persistent, and that, counter to the principals of market efficiency, those quality investments can produce higher, long-run shareholder returns*.

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We understand that different objectives, require different tools. Split Creek utilizes a dynamic investment review process, customized to the clients' goals and asset in question, but we always evaluate: profitability, growth, and safety/risk.

Depending on the mandate, we emphasize factors that influence return within the broader categories of: balance sheet, governance & ESG; growth & profitability; valuation & timing; risk.

*See the work of Asness, Frazzini and Pedersen in their working paper "Quality Minus Junk", October 2013, where they find that high quality stocks remain high quality stocks up to 10 years later.

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EXAMPLE

Here we took a look at the S&P 500 and at each stage of the screen, we filtered out stocks that had numbers that were ‘worse’ than the benchmark average. Remember, there are no rules on how to define the filter cutoffs, “better than average” is a reasonable place to start.

While we did succeed in cutting down our investment universe, the screen also dropped some potentially compelling investments.  For instance: Alphabet (GOOGL – the parent company of Google and YouTube) has a P/S ratio of 5.65x vs the 4.27x average & cutoff, and a profit margin of 29.51% vs the average & cutoff 13.57%.

Some would say that it’s worth paying a slight sales premium given the superior margins. The point of this illustrative example is not to argue for or against GOOGL, but rather it is to highlight that one of the most common steps in the investment process, may be concealing ‘hidden’ opportunities.

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STOCK SCREENING

Many advisors use a screening process to find investments. You may be familiar with stock screening as many websites and investment platforms (like Schwab) make screening tools available for free.

Each ‘stage’ of the funnel screens out (removes from consideration) stocks that don’t meet the defined criteria. So if you set the price-to-earnings (P/E) ratio at 21x, you won’t see any stocks with a P/E ratio higher than 21x.

While this technique can help narrow the field of potential investments, it has two significant shortcomings: (1) There are no objectively ‘best’ practices for where to set the filter cut-offs. (2) Screening often hides potentially attractive investments that miss on a single criteria.

SECURITY SCORING

A scoring system is a little different. Here we standardize various data points, so that they can be compared to one another. Data that are good relative to the investment universe result in a positive + contribution to the final score.

Elements that are worse than the scored universe result in a negative – contribution. This allows us to better evaluate stocks with different potential return drivers (Example: a value stock with average growth vs a stock with impressive growth and a lofty valuation).

Scoring also allows us to weight important factors, rank the output, break-out the contribution components, control for outliers, and better compare opportunities from different industries. It’s a bit more work than a simple filter / screen, but gives us a much greater degree of investment insight.

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Split Creek Capital LLC ® is a Registered Investment Advisor CRD #319437. Proudly carbon neutral with the help of  carbonfund.org. Photo credit @gse_photography

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4917 Plank Rd, Suite #191
North Garden, VA 22959

(434) 414-1477

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