Stock Screening – Weed Out The The Losers

Stock Screening – Weed Out The The Losers

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Big performance from market caps below $50 million.

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I was impressed with what Charles Kirk had to say regarding AAII and Stock Screening. I’m a lifetime member of AAII, and I’ve used their stock screening software for years, long before I was a professional. I was also impressed to note in the recent issue that two of my four buys in the fourth quarter were buys in the shadow stock portfolio, which has done very well over the years.

Back to Charles Kirk, if I can quote a small part of his piece:

When looking over the information, among many things I noticed include the fact that 7 stock screens have posted gains for every year over the past 10 years. Screens with this amazing consistency include Graham’s Defensive Investor, Price-To-Sales, Zweig, PEG with Estimated Growth, PEG With Historical Growth, and two of O’Shaughnessy’s screens - Small Cap Growth & Value and Growth. Few screening strategies can produce gains year after year as these have and there’s something to be learned from them.

Looking through and comparing the criteria between all of these screens, in essence they were seeking four simple things: 1) growing earnings per share over various time frames, 2) strong sales growth, 3) an attractive valuation (often using price-to-sales), and 4) relative strength.

Though I may quibble with O’Shaughnessy’s methodology, this is consistent with what he found in his book What Works on Wall Street. That said, though I am more agnostic about market capitalization, as I looked across the shadow stock portfolio, which is a small cap deep value portfolio, it confirmed to me that there are a lot of cheap stocks to buy in this environment. There are good gains to be had in the future, even if past performance has suffered.

Now to approach it from a different angle. I mentioned how much I like the CXO Advisory blog. One page to visit is the Big Ideas page, if you like academic finance papers. I want to give you my short synopsis of what seems to work:

  • Cheap valuation, particularly low price-to-book (though I like cheap price-to-everything… book, earnings, sales, dividends, EBITDA)
  • Price momentum
  • Low accrual accounting entries as a fraction of earnings or assets
  • Piotroski’s accounting criteria
  • Low net stock issuance
  • Positive earnings surprises
  • Low historical return volatility
  • Illiquidity, which is a proxy for size and neglect

There are other prizes on that page, including mean-reversion, an improved Fed Model, Dollar-weighted vs. Time-weighted returns, limitations on academic financial research, demography, etc.

I would simply tell the fundamental investors in my audience to think about these issues. Let me summarize them one more time:

  • Look for a cheap valuation.
  • Look for mean reversion, but don’t try to catch a falling knife.
  • Grab positive price momentum and earnings surprises.
  • Look for sound accounting, and management that is loath to dilute shareholders.
  • Avoid volatile stocks
  • Look for neglected stocks

That’s my quick summary for what seems to work in stock selection. I invite commentary on this. I downloaded a lot of the papers cited, and will be reading them over the next few months.

About the author: David Merkel

David J. Merkel, CFA, FSA — From 2003-2007, I was a leading commentator at the excellent investment website RealMoney.com (http://www.RealMoney.com). Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and now I write for RealMoney on equity and... More

I was impressed with what Charles Kirk had to say regarding AAII and Stock Screening. I’m a lifetime member of AAII, and I’ve used their stock screening software for years, long before I was a professional. I was also impressed to note in the recent issue that two of my four buys in the fourth quarter were buys in the shadow stock portfolio, which has done very well over the years.

Back to Charles Kirk, if I can quote a small part of his piece:

When looking over the information, among many things I noticed include the fact that 7 stock screens have posted gains for every year over the past 10 years. Screens with this amazing consistency include Graham’s Defensive Investor, Price-To-Sales, Zweig, PEG With Est Growth, PEG With Hist Growth, and two of O’Shaughnessy’s screens - Small Cap Growth & Value and Growth. Few screening strategies can produce gains year after year as these have and there’s something to be learned from them.

Looking through and comparing the criteria between all of these screens, in essence they were seeking four simple things: 1) growing earnings per share over various time frames, 2) strong sales growth, 3) an attractive valuation (often using price-to-sales), and 4) relative strength.

Though I may quibble with O’Shaughnessy’s methodology, this is consistent with what he found in his book What Works on Wall Street. That said, though I am more agnostic about market capitalization, as I looked across the shadow stock portfolio, which is a small cap deep value portfolio, it confirmed to me that there are a lot of cheap stocks to buy in this environment. There are good gains to be had in the future, even if past performance has suffered.

Now to approach it from a different angle. I mentioned how much I like the CXO Advisory blog. One page to visit is the Big Ideas page, if you like academic finance papers. I want to give you my short synopsis of what seems to work:

  • Cheap valuation, particularly low price-to-book (though I like cheap price-to-everything… book, earnings, sales, dividends, EBITDA)
  • Price momentum
  • Low accrual accounting entries as a fraction of earnings or assets
  • Piotroski’s accounting criteria
  • Low net stock issuance
  • Positive earnings surprises
  • Low historical return volatility
  • Illiquidity, which is a proxy for size and neglect

There are other prizes on that page, including mean-reversion, an improved Fed Model, Dollar-weighted vs. Time-weighted returns, limitations on academic financial research, demography, etc.

I would simply tell the fundamental investors in my audience to think about these issues. Let me summarize them one more time:

  • Look for a cheap valuation.
  • Look for mean reversion, but don’t try to catch a falling knife.
  • Grab positive price momentum and earnings surprises.
  • Look for sound accounting, and management that is loath to dilute shareholders.
  • Avoid volatile stocks
  • Look for neglected stocks

That’s my quick summary for what seems to work in stock selection. I invite commentary on this. I downloaded a lot of the papers cited, and will be reading them over the next few months.

About the author: David Merkel

David J. Merkel, CFA, FSA — From 2003-2007, I was a leading commentator at the excellent investment website RealMoney.com (http://www.RealMoney.com). Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and now I write for RealMoney on equity and... More

I was impressed with what Charles Kirk had to say regarding AAII and Stock Screening. I’m a lifetime member of AAII, and I’ve used their stock screening software for years, long before I was a professional. I was also impressed to note in the recent issue that two of my four buys in the fourth quarter were buys in the shadow stock portfolio, which has done very well over the years.

Back to Charles Kirk, if I can quote a small part of his piece:

When looking over the information, among many things I noticed include the fact that 7 stock screens have posted gains for every year over the past 10 years. Screens with this amazing consistency include Graham’s Defensive Investor, Price-To-Sales, Zweig, PEG With Est Growth, PEG With Hist Growth, and two of O’Shaughnessy’s screens - Small Cap Growth & Value and Growth. Few screening strategies can produce gains year after year as these have and there’s something to be learned from them.

Looking through and comparing the criteria between all of these screens, in essence they were seeking four simple things: 1) growing earnings per share over various time frames, 2) strong sales growth, 3) an attractive valuation (often using price-to-sales), and 4) relative strength.

Though I may quibble with O’Shaughnessy’s methodology, this is consistent with what he found in his book What Works on Wall Street. That said, though I am more agnostic about market capitalization, as I looked across the shadow stock portfolio, which is a small cap deep value portfolio, it confirmed to me that there are a lot of cheap stocks to buy in this environment. There are good gains to be had in the future, even if past performance has suffered.

Now to approach it from a different angle. I mentioned how much I like the CXO Advisory blog. One page to visit is the Big Ideas page, if you like academic finance papers. I want to give you my short synopsis of what seems to work:

  • Cheap valuation, particularly low price-to-book (though I like cheap price-to-everything… book, earnings, sales, dividends, EBITDA)
  • Price momentum
  • Low accrual accounting entries as a fraction of earnings or assets
  • Piotroski’s accounting criteria
  • Low net stock issuance
  • Positive earnings surprises
  • Low historical return volatility
  • Illiquidity, which is a proxy for size and neglect

There are other prizes on that page, including mean-reversion, an improved Fed Model, Dollar-weighted vs. Time-weighted returns, limitations on academic financial research, demography, etc.

I would simply tell the fundamental investors in my audience to think about these issues. Let me summarize them one more time:

  • Look for a cheap valuation.
  • Look for mean reversion, but don’t try to catch a falling knife.
  • Grab positive price momentum and earnings surprises.
  • Look for sound accounting, and management that is loath to dilute shareholders.
  • Avoid volatile stocks
  • Look for neglected stocks

That’s my quick summary for what seems to work in stock selection. I invite commentary on this. I downloaded a lot of the papers cited, and will be reading them over the next few months.

About the author: David Merkel

David J. Merkel, CFA, FSA — From 2003-2007, I was a leading commentator at the excellent investment website RealMoney.com (http://www.RealMoney.com). Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and now I write for RealMoney on equity and... More

Stock Screening - Weed Out The The Losers by David Merkel, CFA

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David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.