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Adapting the Kimmel Approach: AAII's Simple & Complex MAGNET Screens

by Wayne A. Thorp, CFA

Adapting The Kimmel Approach: AAII's Simple & Complex MAGNET Screens Splash image

The article starting here outlines Jordan Kimmel’s MAGNET investment philosophy. How can individual investors adapt the MAGNET investing approach?

As part of our AAII Stock Screens series, AAII developed two MAGNET screens—a Simple MAGNET screen, and a more stringent Complex MAGNET screen—using AAII’s Stock Investor Pro fundamental stock screening and research database program. Stock Investor Pro covers a universe of over 9,500 NYSE, Amex, and NASDAQ over-the-counter stocks.

In keeping with Kimmel’s approach, both of AAII’s MAGNET screens combine relative strength measures along with growth measures to find growth stocks that are “on the move,” but also use value measures to protect against overpaying for growth.

Figure 1 reports backtesting results for both the MAGNET Simple and MAGNET Complex screens, both of which have outperformed the various S&P market cap indexes by a wide margin since the start of 1998.

Despite some wild fluctuations over the period, the MAGNET Simple screen has generated a cumulative gain of 645.3%, and the MAGNET Complex screen an even more impressive 839.1% gain. By comparison, the S&P 500 index has lost 5.9% over the same period.

Profile of Passing Companies

Table 1 presents the characteristics of the companies passing the MAGNET Simple screen as of July 10, 2009. At this time, no companies pass the MAGNET Complex screen.

Kimmel is interested in finding high-growth companies, but he does not want to overpay for those growth prospects. Based on earnings for the last 12 months, the companies currently passing the MAGNET Simple screen have a median price-earnings value that slightly exceeds that of the typical exchange-listed stock. However, when comparing the price-earnings ratio based on estimated earnings for the current fiscal year to the estimated long-term growth rate in earnings (or estimated PEG ratio), we see a much different story. The median estimated PEG ratio for the MAGNET Simple stocks is a very reasonable 0.4 compared to 1.3 for the typical exchange-listed stock.

Kimmel’s MAGNET Simple screen calls for companies to have revenue growth of at least 15% over the last 12 months. Looking at a longer timeframe, we see that the MAGNET stocks are still strong performers. The median sales growth rate over the last five years for the MAGNET Simple stocks is 48.7%. By way of comparison, the typical exchange-listed stock has a five-year sales growth rate of 12.7%.

Lastly, MAGNET stocks must have strong and improving price performance. Over the last year, the median of the current group of companies passing the MAGNET Simple screen has outperformed the S&P 500 by 162%, while the typical exchange-listed stock has underperformed the S&P by 2%.

Table 1 includes monthly turnover data for both the Simple and Complex MAGNET screens, based on the backtesting results. Given the price momentum filters of both MAGNET screens, it does not come as a surprise that both strategies have high monthly turnover—on average, the MAGNET Simple screen turns over 66.7% of its portfolio each month and the MAGNET Complex 67.1%.

Portfolio Characteristics (Median) MAGNET
Simple
Stocks
MAGNET
Complex
Stocks
Exchange-
Listed
Stocks
Price-earnings ratio (X) 16.8 nmf 14.2
Price-to-book-value ratio (X) 3.7 nmf 1.2
Price-to-sales ratio (X) 2.5 nmf 1.0
PE-to-EPS-est.-growth ratio (PEG) (X) 0.4 nmf 1.3
Sales 5-yr. historical growth rate (%) 48.7 nmf 12.7
EPS 5-yr. historical growth rate (%) 21.2 nmf 2.9
EPS 3-5 yr. estimated growth rate (%) 33.5 nmf 12.0
Market cap. ($ million) 353.7 nmf 275.8
Relative strength vs. S&P (S&P=0) (%) 162 nmf -2
       
Monthly Observations      
Average no. of passing stocks 3 2  
Highest no. of passing stocks 16 9  
Lowest no. of passing stocks 0 0  
Monthly turnover (%) 66.7 67.1  

Also, historically, both MAGNET screens have generated few passing companies month-to-month. While this makes it extremely difficult to build a diversified portfolio based on the MAGNET approach, Kimmel admits there are very few companies that are attractive to growth, momentum, and value investors at the same time.

Since the beginning of 1998, three companies, on average, have passed the MAGNET Simple screen each month and two have passed the MAGNET Complex screen. Currently, eight companies are passing the MAGNET Simple screen and no companies pass the MAGNET Complex screen.

Passing Companies

Table 2 lists the eight companies passing the MAGNET Simple screen as of July 10, 2009 [no companies pass the MAGNET Complex screen at this time]. We ranked these companies in descending order by their 13-week relative strength value.

Fuqi International FUQI leads all MAGNET Simple stocks with a 12-month sales growth rate of 104.6%. The company designs and sells precious metal jewelry in China and has seen sales increase to $399.5 million for the last 12 months, as compared to sales of $195.2 million during the previous 12 months. The company has benefited from robust consumer spending in China despite the worldwide economic downturn. Surprisingly, however, the impressive 12-month growth rate for Fuqi exceeds that of the jewelry & silverware industry, which has seen sales decline 11.8% on a median basis over the last 12 months compared to the prior 12 months.

Based on estimated earnings for the next fiscal year, Electronic Game Card, Inc. EGMI has the lowest forward price-earnings ratio at 5.8. However, it can be misleading to view individual data points in isolation when analyzing a company. A company may appear to have a low valuation based on its price-earnings ratio, but can actually be overpriced when compared to some other variable. In this case, comparing EGMI’s price-earnings ratio to its estimated earnings growth rate for the next three to five years (30.0%), we arrive at a forward PEG value of 0.19 (5.8 ÷ 30.0).

Company (Exchange: Ticker) Sales
Growth
PE-Fwd
EPS
Est
Y1
(X)
EPS
Grth
Est
(%)
Price to
Sales
Gross
Margin
Relative
Strength
Percentile
Rank
 
 
 
Co
12 Mo
(%)
Indus
12 Mo
(%)
 
Co
(X)
Indus
(X)
Co
(X)
Indus
(X)
13-Wk
(%)
52-Wk
(%)
 
Description
MAGNET Simple Screen
Fuqi International (M: FUQI) 104.6 -11.8 8.5 31.0 0.9 0.6 13.6 31.7 98 98 jewelry in China
STEC, Inc. (M: STEC) 25.1 -2.2 13.8 43.8 4.7 0.6 32.3 23.4 97 99 flash drives; memory cards
American Dairy (N: ADY) 57.4 5.5 8.0 115.0 2.3 0.5 50.1 24.1 95 100 milk powder in China
Intellon Corp. (M: ITLN) 26.7 -7.5 12.2 40.0 1.8 1.2 44.0 37.5 94 92 integrated circuits
Harbin Electric (M: HRBN) 74.0 -2.9 9.5 28.0 2.6 0.6 36.9 27.8 93 90 electric motors
Perfect World (ADR) (M: PWRD) 72.2 5.0 10.1 28.9 6.8 1.0 87.6 49.1 91 90 on-line games in China
SciClone Pharma’ls (M: SCLN) 50.0 7.9 15.9 36.0 2.2 3.0 82.2 51.8 91 98 biopharmaceuticals
Electronic Game Card (O: EGMI) 54.8 -0.9 5.8 30.0 6.1 1.0 77.0 43.9 90 97 pocket gaming device
Median for all MAGNET
  Simple Companies










 
56.1 -1.6 9.8 33.5 2.5 0.8 47.1 34.6 94 98  
                       
MAGNET Complex Screen
 

No Passing Companies.

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Furthermore, when analyzing the data of companies in disparate industries such as those passing the MAGNET Simple screen, it is difficult to draw conclusions about a company without making an “apples-to-apples” comparison. Historically, many industries have been considered “low price-earnings ratio” or “high margin.” Therefore, when we see that SciClone Pharmaceuticals SCLN has the highest forward price-earnings ratio at 15.9, we cannot automatically assume it is overvalued relative to the other passing companies. Again, comparing SciClone’s forward price-earnings ratio of 15.9 to its estimated earnings growth rate of 36.0%, we arrive at a forward PEG value 0.44. As a rule, PEG values below 1.0 are considered undervalued, and the MAGNET Simple screen looks for companies with a forward PEG ratio of less than or equal to 0.5.

The final element of the MAGNET Simple screen is price momentum. In order to pass the MAGNET Simple screen, a company needs to rank in the top 10% of all companies in terms of relative price strength over the last 13 and 52 weeks. Fuqi International again leads the pack by ranking in the 98th percentile for relative price strength over the last 13 weeks. During that time, FUQI shares have skyrocketed by 223%. Electronic Game Card, Inc. EGMI, a designer and manufacturer of personal gaming devices, just cleared the hurdle, ranking in the 90th percentile over the last 13 weeks.

Conclusion

Jordan Kimmel’s MAGNET stock selection process isolates companies that will attract value, growth and momentum investors alike. By identifying these rare companies that are sought by different types of investors, Kimmel believes there is a much greater pool of buying power to push stock prices higher.

For now, remember that stock screening is not about generating a “buy” or “recommended” list. Quantitative filters such as the two MAGNET screens we have presented here can help you identify companies with similar characteristics. It is still up to you to perform additional due diligence to decide whether a stock matches your risk tolerance and time horizon before adding it to your investment portfolio.

What It Takes: MAGNET Stock Selection Process Criteria

Simple Screen

  • The price-earnings ratio based on forecasted earnings for the next fiscal year is no more than one-half the projected long-term growth rate in earnings per share
  • The growth in sales over the last 12 months (the last four quarters compared to the prior four quarters) is greater than or equal to 15%
  • The price strength relative to the S&P 500 over the last 13 weeks ranks in the top 10% of the entire stock universe
  • The price strength relative to the S&P 500 over the last 52 weeks ranks in the top 10% of the entire stock universe

Complex Screen

  • The current share price is at least $8
  • The percentage ownership by institutions is less than the median institutional ownership percentage for the industry
  • The institutional ownership percentage is at least 5%
  • The current ratio for the most recent fiscal quarter is at least 1.5
  • The long-term debt-to-equity ratio for the most recent fiscal quarter is less than or equal to 40%
  • The current price-to-sales ratio is less than the industry median price-to-sales ratio
  • The price strength relative to the S&P 500 over the last 13 weeks ranks in the top 25% of the entire stock universe
  • The price strength relative to the S&P 500 over the last 52 weeks ranks in the top 25% of the entire stock universe
  • The growth in sales over the last 12 months (the last four quarters compared to the prior four quarters) is greater than or equal to 25%
  • The growth in earnings per share from continuing operations over the last 12 months (the last four quarters compared to the prior four quarters) is greater than or equal to 25%
Wayne A. Thorp, CFA is a vice president and senior financial analyst at AAII and editor of Computerized Investing. Follow him on Twitter at @WayneTAAII.


Discussion

Anthony from DE posted over 3 years ago:

how do I get the current companies that are in this portfolio?


Anthony from DE posted over 3 years ago:

how do I get the current companies that are in this portfolio?


Wayne from IL posted over 3 years ago:

We update the passing company lists every month for all the stock screens we track at the Stock Screens area of AAII.com: http://www.aaii.com/stock-screens/. Wayne A. Thorp, CFA


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