Fundamental Approach workbook: Fundamental-Approach

The following paragraphs detail the seven steps involved (as used in the above excel workbook) to run a fundamental approach to investing in US stocks.

Step 1

Each month (around the 10th business day), I go to Vanguard’s “Custom Reports” tool to download to excel the following data for 10 US Sector ETFs:

• Earnings growth rate (G)
• Return on equity (ROE)
• Price/earnings (PE)

Step 2

To utilize the factors I need, I then develop two numbers for each sector:

• PE/G (PEG) : Price/earnings (P/E) divided by Earnings growth rate (G)
• Earnings Yield (EY) : Invert Price/earnings (P/E)

Step 3

Then in excel, rank each sector among all 10 sectors across three factors:

1. PEG
2. ROE
3. EY

Step 4

For the growth sectors (consumer discretionary, healthcare, info. tech.), then use the PEG ranks to develop:

• “GROWTH SUM” of the growth sectors ranks
• “GROWTH AVERAGE” of the growth sectors ranks
• For each growth sector: “WEIGHT as a % of the GROWTH SUM”

For the core sectors (consumer staples, industrials, materials, telecomm) use the PEG, ROE, and EY ranks to develop:

• “CORE SUM” of the core sectors ranks
• “CORE AVERAGE” of the core sectors ranks
• For each core sector: “WEIGHT as a % of the CORE SUM”

For the value sectors (energy, financials, utilities), use the ROE and EY ranks to develop:

• “VALUE SUM” of the value sectors ranks
• “VALUE AVERAGE” of the value sectors ranks
• For each value sector: “WEIGHT as a % of the VALUE SUM”  

Step 5

For each style (growth, core, value), develop a % of total style averages:

• “Growth as a % of Total Averages”: GROWTH AVERAGE divided by the sum of the GROWTH AVERAGE, CORE AVERAGE, VALUE AVERAGE
• “Core as a % of Total Averages”: CORE AVERAGE divided by the sum of the GROWTH AVERAGE, CORE AVERAGE, VALUE AVERAGE
• “Value as a % of Total Averages”: VALUE AVERAGE divided by the sum of the GROWTH AVERAGE, CORE AVERAGE, VALUE AVERAGE

Step 6

To develop the allocations, complete the following calculation for each sector:

• Growth Sectors Allocation %:  “Growth as a % of Total Averages” times “WEIGHT as a % of the GROWTH SUM” 
• Core Sectors Allocation %:  “Core as a % of Total Averages” times “WEIGHT as a % of the CORE SUM” 
• Value Sectors Allocation %:  “Value as a % of Total Averages” times “WEIGHT as a % of the VALUE SUM” 

Step 7 (optional)

To develop a more concentrated strategy, drop all sector allocations with less than a 10% allocation.

Performance Comparison

The following chart illustrates the advantage of the fundamental approach vs. a traditional index approach.

Note: the Vanguard funds utilized in the illustration of the fundamental vs. traditional approach are for proxy purposes only. They are not a recommendation to buy or sell the funds.

More background on the approach factors

To read more about the rationale behind the use of PEG, ROE, and EY, open … A Fundamental Approach to Investing in US Stocks