Stock Strategy Performance: Winners and Losers in 2002
by John Bajkowski
At the writing of this article, 2002 is drawing to a close, and it seems likely that as you read this the S&P 500 will have experienced its third consecutive calendar-year loss. Historically, this string of losses would be the first since the 1939-through-1941 period; the S&P 500 experienced four consecutive years of losses starting in 1929. While in the past few years investors could take some solace from gains in small-cap stocks, it appears likely that small, medium and large companies will finish down on average for the year. Overall, as indicated through the indexes at the bottom of Table 1, smaller-cap stock indexes did perform better than larger-cap indexes and value strategies faired better than growth strategies.
Screening Strategy Results
Table 1 summarizes the performance and variability of the stock screens built into AAIIs Stock Investor software program and presented on AAII.com. We have been developing, testing, and refining a wide range of screening strategies over the last five years. Many of the screens follow the approaches of popular investment professionals, while others are tied to basic principles of investing. These approaches run the full spectrum, from those that are value-based to those that focus primarily on growth, while most fall somewhere in the middle. Keep in mind that screens following the approach of an investment professional do not represent their actual stock picks. The rules of each screen are defined by our interpretations of their respective investment approaches. The results of the screening strategies, as well as the criteria for each screen, are programmed into the Stock Investor program and are also posted in the Stock Screens area of AAII.com.
Each month over 50 separate screens are performed using AAIIs Stock Investor Pro and the current companies passing each individual screen are reported. Stock Investor subscribers can perform the screens themselves, while AAII members can access the screening results by clicking on the All Screens link within the Stock Screens area of AAII.com. The results are posted to the site in the middle of each month using data from the previous months end.
The performance of the stocks passing each screen is tracked on a monthly basis. The month-to-month closing price is used to calculate the return and equal investments in each stock at the beginning of each month is assumed. The impact of factors such as commissions, bid-ask spreads, cash dividends, and time-slippage (time between the initial decision to buy a stock and the actual purchase) are not considered. This overstates the reported performance, but all approaches are subject to the same conditions and procedures. Higher turnover portfolios would typically benefit more from these simplified rules. Sell rules are the same as the buy rules. The screens are simply reapplied using each subsequent months data. Thus, a stock is sold (no longer included in the portfolio) if it ceases to meet the initial criteria, and new stocks are added if they qualify. Stocks that no longer qualify are dropped even if the strategist behind a particular approach suggests different sell rules versus buy rules.
Table 1 presents the price gains for the various investment strategies that are tracked, along with index performance data. The screening approaches listed in the table are grouped by growth versus value orientation, with additional specialty and sector screens broken out separately.
The Total Gain column in Table 1 represents the percentage amount each test portfolio has appreciated or lost from January 1, 2002, through December 15, 2002, along with the gains or losses during the prior four years and cumulatively over the whole period. It does not include dividends. For example, the High Relative Dividend Yield (value) approach gained 60.3% cumulatively over the last five years. During this time period, shareholders of these stocks would have also received stock dividends that would have increased their rate of return, but the performance figures do not consider the impact of this income. Large-cap value strategies, such as Dogs of the Dow, would be impacted the most by this type of exclusion. The current average dividend yield of the Dogs of the Dow is 4.2%; shareholders of these stocks would actually have a return that is higher by approximately this amount annually.
The Graham Enterprising screen, with a return of 48.1%, is leading the pack in 2002 with only half a month to go until the year end as of this writing. This value approach looks for dividend-paying stocks with low price-earnings ratios, low multiples of price to earnings and book value, positive earnings growth, and minimum levels of financial strength.
Of course, past performance is no guarantee of future success. The Joseph Piotroski screen was the best-performing strategy in 2001, but suffered a 19.1% loss in 2002 through December 15.
Cumulatively, the Martin Zweig approach has shown the strongest gain over the past five years, 392.9%. By way of comparison, the S&P 500 has lost 8.3% over the same period of time.
When measuring performance, the risk of the strategy should also be considered. The Monthly Variability columns report the greatest monthly percentage gain (High) and loss (Low) as an indication of the volatility that occurred over the last five years. For example, the Martin Zweig approach had a maximum loss of 24.2% in value during a single month, and has gained as much as 32.7% in one month. By way of comparison, the most that the S&P 500 index gained in a single month was 9.7%, and its largest single monthly loss was 14.6%.
The Monthly Variability columns also report the monthly standard deviation over the full study period. Standard deviation is a measure of total risk, expressed as a monthly change, that indicates the degree of variation in return experienced relative to the average for a strategy over the test period. The higher the standard deviation, the greater the total risk of the strategy. The 5.4% monthly standard deviation of the S&P 500 is well below the Martin Zwieg 9.4% figure.
The Monthly Holdings columns provide data on portfolio holdings over time—the total number of stocks that were in each portfolio over the last five years and the average holdover percentage from month to month as an indication of turnover. The Graham Enterprising Investor screen has averaged only seven passing companies per month. Its strong 2002 performance came from holding only a handful of companies.
The Percent Holdover column gives an indication of the turnover for a given strategy. Every month these portfolios are rebalanced and only those companies passing the screen for a given month are held. The higher the percentage holdover, the greater the chance that a company will pass a screen month after month. On average, 13 stocks have passing the Martin Zweig screen and on average only 54.4% would pass the same screen the next month.
As a general rule, approaches that focus on value tend to have less portfolio turnover than the pure growth approaches; they also tend to be less volatile and outperform other approaches during bear markets.
These strategies are based on relatively simple screens that are interpretations of the investment approaches advocated by prominent investment professionals. They do not replicate a buy-and-hold strategy, which is the optimal approach for an individual investor.
The strategies do, however, attempt to develop a practical set of rules for each approach, which is the first step in any disciplined investment approach. Examining their investment characteristics reveals many of the practical problems that you may run into when trying to develop your own disciplined approach to investing.
As you look at the performance of the screens, do not blindly follow the strategies with the highest performance. Instead, try to gain an understanding of the forces impacting performance and determine what kind of market environment might be expected in the future.
Most importantly, remember that screening is just a first step. There are qualitative elements that cannot be captured effectively by a quantitative screening process. For further information on these approaches, consult the Stock Screens area of AAII.com.
John Bajkowski is AAIIs financial analysis vice president and editor of Computerized Investing.