The Difference Between Stock Screens and Portfolios
Thursday, May 29, 2014

Many of the more common questions I get asked pertain to our stock screens. Specifically, members ask about the performance of the screens and how replicable it is. Often, the screens are initially mistaken for being portfolios, which they are not.

I’ll use the O’Shaughnessy: Tiny Titans screen and our Model Shadow Stock Portfolio to explain the difference between a screen and a portfolio. Both target micro-cap stocks, but with different approaches. The performance figures for both also have important differences to be aware of.

A stock screen is essentially a database filter. It seeks out stocks matching a specific set of criteria. For example, the Tiny Titans screen identifies U.S. exchange-listed stocks with market capitalizations between $25 million and $250 million, a price-to-sales (P/S) ratio below 1.0 and a 52-week relative strength price rank of 85% or higher. (The last criterion restricts the screen to only those stocks whose price appreciation is better than at least 85% of all other stocks.) Any stock matching these criteria passes the screen, regardless of how positive or negative any of its other characteristics are. This is why it is important to conduct analysis beyond what the screen is designed to look for and not simply buy a stock because it passes a good screen.

The performance reported for each of the more than 60 stock screens on AAII.com is calculated based on the month-end list of passing companies. We determine what stocks pass, group them into a hypothetical portfolio, hold the portfolio for a month and then restart from scratch the next month. This monthly reconstitution works fine for giving you an idea of the type of performance of the screen has produced, but your actual real-world returns may differ. The performance calculations exclude any transaction costs—such as commissions, bid-ask spreads and taxes. They also use prices that may differ from what you would actually be able to trade it at.

(The AAII.com version of the Tiny Titans screen restricts the list of passing companies to the 25 with the strongest relative price strength rank. Our Stock Investor Pro program says 47 companies qualified to pass the screen as of the end of last week.)

The Model Shadow Stock portfolio, in contrast, is an actual portfolio run through an online discount broker. Our founder and chairman Jim Cloonan handpicks the stocks that go into the portfolio, based on the results of a Shadow Stock screen. Since this is a real portfolio, stocks are held until they either violate a sell rule or a company-specific event (e.g., an acquisition offer) occurs. New stocks are only added if others are sold. The return information incorporates all of our transaction costs. Most importantly, stocks can be held in a portfolio after they no longer meet the exact purchase rules and no longer pass the Shadow Stock screen, reducing transaction costs. (Stocks no longer matching a screen’s results, in contrast, are merely dropped from list of passing companies with no explanation.)

Comparing and Contrasting the Micro-Cap Stock Strategies

The Shadow Stock portfolio seeks out exchange-listed stocks whose market capitalizations are equivalent to the smallest 10% of companies listed on the New York Stock Exchange. (The portfolio does consider stocks traded on both the NYSE and the NASDAQ.) The list of portfolio candidates is then further restricted to those whose price-to-book (P/B) ratios are equivalent to the bottom 10% of NYSE-listed stock P/B ratios, are profitable, have share prices in excess of $4 per share, have a price-to-sales ratio below 1.2 and are current with their Securities and Exchange Commission (SEC) filings. All ADR stocks are excluded.

In addition to being more restrictive than the Tiny Titans screen, the Model Shadow Stock Portfolio excludes any momentum criteria. Rather, it is a pure micro-cap value strategy. While momentum pairs well with low valuation, it can lead to more frequent transaction costs. While the Tiny Titans screen does not consider transaction costs (nor does any other screen, though a real-life implementation of the strategy would), the Model Shadow Stock portfolio is designed to limit the adverse impact of transaction costs. Due to their reduced levels of liquidity, micro-cap stocks have higher transaction costs then their large-cap peers. So while momentum indicators could be used for analyzing micro-cap stocks, they should be used with caution.

Note that both the Tiny Titans screen and the Model Shadow Stock Portfolio both require stocks to be exchange-listed. Over-the-counter stocks are excluded from both. Over-the-counter stocks have less regulatory oversight, trustworthy information about them is often more difficult to find and their trading volume is often very low. This combination of factors makes over-the-counter stocks targets of hucksters and fraudsters.

More on AAII.com

The Week Ahead

Five S&P 500 members are reporting next week: Dollar General (DG) on Tuesday; Brown-Forman (BF.B) and PVH Corp. (PVH) on Wednesday; and J.M. Smucker Company (SJM) and Joy Global (JOY) on Thursday.

The first economic reports of note are the May ISM manufacturing survey, the May PMI manufacturing index and April construction spending, which will be released on Monday. Tuesday will feature April factory orders. The May ADP Employment Reports, April international trade data, revised first-quarter productivity, the May ISM non-manufacturing index and the periodic Federal Reserve Beige Book will be released on Wednesday. Friday will feature May jobs data, including the change in nonfarm payrolls and the unemployment rate.

Three Federal Reserve officials will speak: Chicago president Charles Evans on Monday, Kansas City president Esther George on Tuesday and Minneapolis Federal Reserve Bank President Narayana Kocherlakota on Wednesday.

Local Chapter Meetings

AAII Local Chapter Meetings offer you a variety of presentations from expert speakers who will give you their view on the world of investing. A bonus of attending a Chapter Meeting near you is the opportunity to meet other AAII members who share your interest and enthusiasm for investing. You can even share the Chapter experience with your family and friends by inviting them to attend Chapter Meetings with you!


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AAII Sentiment Survey

Optimism among individual investors hit a two-month high in the latest AAII Sentiment Survey. Neutral sentiment, meanwhile, stayed above 40% for a fifth consecutive week.

Bullish sentiment, expectations that stock prices will rise over the next six months, rebounded by 6.0 percentage points to 36.5%. This is the highest level of optimism registered by our survey since March 20, 2014 (36.8%). The improvement was not big enough to keep bullish sentiment below its historical average of 39.0% for the 11th consecutive week, however.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, fell 2.8 percentage points to 40.3%. Even with the drop, neutral sentiment remains above its historical average of 30.5% for the 21st consecutive week.

Bearish sentiment, expectations that stock prices will fall over the next six months, fell 3.2 percentage points to 23.2%. The drop keeps pessimism below its historical average of 30.5% for the sixth straight week.

The spread between bullish and bearish sentiment (the “bull-bear spread”) is now at 13.3 percentage points, the widest it has been since March 13, 2014.

The ongoing streak of +40% neutral sentiment readings is unusual. The last time neutral sentiment stayed above 40% for five consecutive weeks or longer was the six-week period of July 2, 1993 through August 20, 1993. Throughout the entire history of the survey, there appear to have only been six occasions—five occurring before 1990—when neutral sentiment stayed above 40% on consecutive weeks for longer periods.

The new record highs set by the S&P 500 as well as the rebound in technology, biotech and small-cap stocks likely contributed to the higher level of optimism. Also contributing to individual investor optimism are continued signs of economic expansion, the Federal Reserve’s tapering of bond purchases and low interest rates. Offsetting this optimism are the rate of economic expansion, Federal Reserve tapering, the events in Ukraine and frustration with Washington politics. The unusually high level of neutral sentiment suggests many individual investors remain uncertain about the short-term direction of stock prices or expect stocks to remain essentially unchanged over the next six months.

This week’s special question asked AAII members how first-quarter earnings impacted their six-month outlook for stock prices. Nearly half of all respondents said the profit reports did not impact their outlook. Approximately 15% said the earnings reports made them more optimistic. A smaller group, 9% of all respondents, said they are more pessimistic about the short-term outlook for stock prices.

Here is a sampling of the responses:

  • No, I think an improving economic outlook will be more of a favorable driver of stock prices.”
  • “Earnings have not influenced my outlook.”
  • “First-quarter results were dampened by the weather. I expect that we will continue now with the old, slow growth.”
  • “Positively, as good companies have maintained solid results despite the weather’s hit.”
  • “I have not been impressed!”

This week’s Sentiment Survey results:

Bullish: 36.5%, up 6.0 points
Neutral: 40.3%, down 2.8 points
Bearish: 23.2%, down 3.2 points

Historical averages:

Bullish: 39.0%
Neutral: 30.5%
Bearish: 30.5%

Take the Sentiment Survey.
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