2010 Year-End Screening Review: Across the Board Gains
Wayne Thorp will speak at the 2015 AAII Investor Conference this fall; go to www.aaii.com/conference for more details.
Compared to the roller-coaster ride the market has been on the last few years, 2010 was a time for the markets and investors to catch their breath.
In this mid-term election year, the economy stood front and center for voters as well as investors. While the economy has managed to string together five consecutive quarters of growth, the erratic nature of the growth has done little to instill confidence in the market. That—combined with unemployment that remains the highest it has been in decades, the specter of future inflation stemming from government stimulus spending and uncertainty as to whether Bush-era tax cuts will expire at the end of the year—gave investors reason to be cautious.
Year-to-date, through December 10, 2010, the S&P 500 index has risen more than 11% (simple price return, excluding dividends). While that’s less than half the increase seen in 2009, it is still well above the index’s historical average capital appreciation of 7.2% between the beginning of 1950 and the end of 2009. Tempering two years of solid gains is the fact that the S&P 500 still is some 20% below its high of October 2007.
Looking at the 63 stock screens we currently track at AAII.com, 2010 was another successful year, with only three strategies currently down for the year. The median, or midpoint, return of all the screens was 23.0%, compared to a median return of 48.1% for the same group of screens in 2009. Out of the 63 AAII screens, one is having its best year ever—the Oberweis Octagon screen.
Ranking 2010 Performance
Table 1 on pages 26 and 27 provides summary performance and volatility statistics for the AAII stock screens we track on AAII.com. All of these screens have been created using AAII’s fundamental stock screening and research database program, Stock Investor Pro, and most of them are pre-built into the software (the exceptions are the Dogs of the Dow and Dogs of the Dow: Low-Priced 5 screens).
Table 1 presents the price change performance (excluding dividends and transactions costs, time and price slippage, etc.) for the various stock selection strategies. We have reconfigured the style groups we use to classify the different screening methodologies to more clearly identify their underlying premises. These style groups are: value, value with price momentum, growth, growth with price momentum, growth and value, growth and value with price momentum, earnings estimates, and specialty. The AAII stock screens are ranked in Table 1 in descending order within each of their style groups by their year-to-date price performance through December 10, 2010. At the bottom of the table you will also find performance data for several market indexes and averages.
Top Performer of 2010
A familiar approach finds itself back on top as the overall best-performing AAII stock screen for 2010: Piotroski: High F-Score (in the value category). This low price-to-book-value strategy developed by Joseph Piotroski, an accounting professor from the University of Chicago, has achieved an impressive 128.3% return this year through December 10.
The price-to-book-value ratio is calculated by dividing price per share by book value per share. Book value per share is determined by subtracting total liabilities from total assets and then dividing the result by the number of shares outstanding. It represents the value of the owners’ equity based upon historical accounting decisions. The price-to-book-value ratio essentially compares the market’s assessment of company value to an accountant’s assessment of a company’s net worth.
The AAII Piotroski screen starts with stocks with price-to-book-value ratios that rank in the lowest 20% of the entire Stock Investor Pro database. There are many studies indicating that a portfolio of low price-to-book-value stocks generally outperforms portfolios of stocks trading with high price-to-book-value ratios. Piotroski found that most of these stocks were neglected firms or financially troubled firms. He found that either situation can create buying opportunities—after checking on financial strength—especially when studying smaller-cap stocks.
Price Gain (%)
Avg Ann’l Price Gain (%)
Risk & Return
Price Gain (%)
|YTD*||2009||2008||2007||Gain||Loss||Avg #||Turnover %|
|Piotroski: High F-Score||128.3||34.6||-35.3||1.8||21.1||16.9||33.7||28.4||2.00||16.2||294.8||-53.6||43.1||-42.0||25||23.1|
|Graham—Defensive Investor (Non-Util)||29.4||57.9||-32.0||20.6||10.1||16.2||20.8||17.8||1.37||14.1||156.4||-52.1||25.8||-17.3||20||20.9|
|Weiss Blue Chip Div Yield||25.0||27.9||-26.2||4.5||2.6||7.1||10.6||10.1||1.22||9.0||92.4||-43.1||14.3||-16.8||13||25.1|
|Dogs of the Dow||17.3||8.1||-45.4||-1.8||-13.9||-2.9||-1.9||-0.1||1.26||-1.1||101.3||-69.0||17.1||-23.4||10||7.2|
|Cash Rich Firms||15.4||56.9||-38.0||7.7||3.5||7.2||11.3||13.9||1.36||11.3||100.7||-45.6||17.6||-20.7||32||25.1|
|Dogs of the Dow: Low Priced 5||15.4||-7.7||-58.7||-2.7||-26.4||-10.4||-4.4||-1.7||1.64||-5.3||117.0||-82.9||27.6||-34.8||5||15.8|
|Fundamental Rule of Thumb||13.3||92.1||-41.5||4.1||6.6||11.7||22.2||19.1||1.67||13.0||165.2||-57.0||33.8||-19.2||50||22.2|
|Graham—Defensive Investor (Util)||3.4||7.9||-18.4||1.8||-3.4||3.7||5.5||8.0||0.91||8.3||30.1||-31.4||12.0||-13.4||18||14.4|
|Value Screens With Price Momentum|
|O’Shaughnessy: All Cap||34.2||23.3||-40.9||12.5||-4.3||6.4||17.2||12.9||1.31||10.8||99.3||-52.1||17.4||-21.5||25||34.8|
|O’Shaughnessy: Sm Cap Grth & Val||27.7||-3.3||-32.4||29.6||-8.2||8.0||18.1||19.1||1.51||14.0||56.9||-50.6||18.5||-18.2||25||48.9|
|O’Shaughnessy: Tiny Titans||18.3||71.1||-56.4||2.2||-5.5||4.1||29.8||28.9||1.91||17.0||137.7||-67.3||37.4||-21.0||25||42.2|
|O’Shaughnessy: Grth Mkt Leaders||16.0||12.6||-44.5||15.5||-11.3||-1.7||3.5||5.6||1.19||5.4||48.1||-50.5||13.6||-18.6||10||43.1|
|Return on Equity||32.2||40.0||-33.8||7.2||5.8||7.4||13.2||14.0||1.26||11.9||122.4||-47.2||14.6||-22.2||33||20.8|
|Dual Cash Flow||30.0||76.0||-46.8||-7.3||4.5||6.3||12.8||16.9||1.56||12.3||174.4||-61.0||34.7||-23.6||69||31.2|
|IBD Stable 70||19.5||56.0||-37.2||-10.6||2.4||2.3||7.8||9.7||1.18||8.8||110.8||-50.6||18.4||-21.9||46||11.9|
|Inve$tWare Quality Growth||16.4||39.6||-24.1||-10.9||2.8||2.1||5.0||6.0||1.23||5.7||91.6||-44.7||18.2||-22.0||23||12.1|
|Growth Screens With Price Momentum|
|O’Neil’s CAN SLIM Revised 3rd Ed||45.5||16.8||-26.3||31.4||7.2||9.3||12.1||19.9||1.86||12.5||70.0||-27.8||52.7||-26.7||9||64.7|
|Foolish Small Cap 8||24.6||48.1||-53.5||-2.8||-6.0||-1.8||6.6||13.2||2.06||8.4||136.2||-67.7||38.8||-22.5||20||36.4|
|O’Neil’s CAN SLIM||-9.6||97.3||-10.5||30.4||19.3||21.9||26.8||28.4||1.82||17.4||78.3||-10.1||69.6||-23.1||7||56.9|
|Growth & Value Screens|
|Rule #1 Investing||37.7||99.8||-43.2||-11.7||16.3||7.2||8.0||10.8||1.75||7.9||208.0||-54.0||27.0||-26.8||15||26.2|
|Dividend Screen: Non-DRPs||24.0||25.4||-31.7||-7.6||0.5||2.8||15.5||12.8||0.92||13.5||86.8||-48.1||17.6||-15.3||30||28.9|
|Buffettology: EPS Growth||19.8||57.5||-36.9||5.8||4.6||6.5||10.0||9.8||1.23||8.7||114.5||-48.4||15.1||-20.8||45||11.8|
|Dividend (High Relative Yield)||17.9||16.4||-21.4||-9.6||-0.6||2.2||7.7||7.9||0.95||8.1||67.7||-40.4||12.5||-14.2||42||19.8|
|Buffettology: Sustainable Grth||17.6||68.0||-28.9||3.9||9.9||9.7||12.4||11.4||1.29||9.8||122.8||-41.9||16.5||-20.4||33||13.2|
|Dividend Screen: DRPs||16.4||29.4||-24.2||-21.2||1.5||1.7||8.3||7.9||1.12||7.5||104.7||-50.4||20.5||-18.2||30||26.2|
|Foolish Small Cap 8 Revised||15.4||161.0||-60.6||13.5||8.6||14.3||19.1||22.0||2.08||12.7||219.0||-64.0||28.1||-24.2||7||31.0|
|T. Rowe Price||7.5||40.1||-47.8||-7.1||3.6||5.4||7.4||5.3||1.53||4.8||85.6||-40.0||28.2||-20.0||10||31.0|
|Growth & Value Screens With Price Momentum|
|Stock Market Winners||123.1||-9.0||-34.7||13||9.6||7.2||23.8||20.7||1.52||15.0||173.8||-51.3||22.0||-23.4||12||62.2|
|Value on the Move—PEG w/Hist Grth||32.6||23.9||-38.3||20.7||-0.7||5.9||15.6||14.9||1.04||14.5||96.7||-50.1||12.7||-19.1||88||36.2|
|Value on the Move—PEG w/Est Grth||31.0||24.2||-37.2||29.5||-1.3||9.4||23.2||20.5||1.32||16.5||99.8||-50.2||15.7||-23.1||44||44.1|
|Earnings Estimates Screens|
|Est Rev: Up 5%||36.4||86.3||-18.4||25.7||27.0||29.6||26.4||30.5||1.78||18.9||161.7||-23.4||30.8||-21.7||45||91.9|
|Est Rev: Up||28.3||53.9||-31.2||13.7||8.7||13.5||15.5||17.1||1.26||14.4||117.0||-40.1||13.8||-18.6||175||80.6|
|Dreman With Est Revisions||26.9||62.9||-37.1||4.3||6.6||13.7||14.5||15.3||1.34||12.4||106.7||-39.9||15.2||-26.2||13||82.1|
|Est Rev: Down 5%||24.5||76.0||-47.8||-24.7||1.1||1.6||0.1||1.4||1.96||-1.1||181.1||-63.8||33.5||-30.5||78||88.7|
|Est Rev: Down||22.6||57.6||-42.6||-20||-0.2||0.0||2.0||1.3||1.60||-0.4||142.7||-59.9||25.0||-25.3||211||79.2|
|Insider Net Purchases||2.1||59.0||-51.7||-10.9||-7.9||-6.0||4.2||0.0||1.82||-3.3||109.6||-65.5||27.8||-27.2||28||29.1|
|S&P 500 Growth (w/divs)||14.2||31.6||-33.9||9.1||-1.6||3.8||0.0||3.3||1.12||3.3||72.7||-44.4||10.8||-16.5|
|S&P 500 Value (w/divs)||14.1||21.2||-38.5||2||-8.0||0.9||2.7||3.4||0.99||3.4||81.1||-56.0||11.0||-17.1|
|S&P MidCap 400||23.7||35.0||-37.3||6.7||-0.3||4.0||5.7||7.9||1.19||7.3||100.0||-50.5||14.8||-21.8|
|S&P MidCap 400 Growth (w/divs)||28.7||38.1||-36.9||13.5||1.4||5.9||6.7||11.6||1.32||9.8||103.4||-47.7||19.0||-22.2|
|S&P MidCap 400 Value (w/divs)||18.6||33.7||-33.4||2.7||0.3||4.4||7.1||6.9||1.09||6.6||95.6||-49.4||15.7||-21.8|
|S&P SmallCap 600||23.8||23.8||-32.0||-1.2||-1.0||3.3||6.5||6.5||1.27||6.0||99.9||-52.2||17.3||-20.2|
|S&P SmallCap 600 Growth (w/divs)||27.7||30.7||-32.2||5.6||2.0||5.7||7.7||7.9||1.32||7.0||112.0||-51.1||17.0||-21.7|
|S&P SmallCap 600 Value (w/divs)||24.4||20.6||-28.9||-5.5||-0.9||3.8||7.7||7.3||1.21||6.7||100.1||-51.0||18.4||-19.6|
|Dow Jones 30||9.4||18.8||-33.8||6.4||-6.3||1.3||0.6||2.9||0.98||2.9||61.6||-49.3||11.8||-15.1|
|All Exchange-Listed Stocks||23.1||65.8||-46.3||-4.5||0.9||4.2||11.6||10.5||1.39||8.7||139.2||-58.6||23.9||-22.1|
|Unless otherwise stated, figures do not include dividends or transaction costs.|
|Screen results are not realistic as to what an investor could achieve in the real world.|
|*Through December 10, 2010.|
|**Bull market period is March 1, 2009, through December 10, 2010. Bear market period is November 1, 2007, through February 28, 2009.|
Piotroski developed a nine-point scale that helps to identify stocks with solid and improving financials. Profitability, financial leverage, liquidity and operating efficiency are examined using popular ratios and basic financial elements that are easy to use and interpret. In implementing his work, we initially required stocks passing the Piotroski screen to have a perfect score of nine. This was stricter than Piotroski’s original study and often created a situation where very few, if any, stocks passed the Piotroski 9 screen.
When we loosened the Piotroski Financial Score (F-Score) requirement to that of the original study (F-Score of eight or more), we still observed strong performance, but also larger, more meaningful portfolios.
At the far right of Table 1, under Monthly Holdings, we report portfolio holdings over time—the average number of stocks passing a screen each month since testing began in 1998. Since May of 2006, the original Piotroski 9 screen has generated no passing companies a full one-third of the time. In contrast, the Piotroski 8 screen (now called the Piotroski: High F-Score screen) has averaged 25 passing companies since the start of 1998.
The Turnover % column under Monthly Holdings in Table 1 gives you an idea of how many stocks “fall out” of a given screening strategy portfolio from month to month. At the end of each month, the hypothetical portfolios of the stocks passing each screen are rebalanced. Only those stocks passing a screen from one month to the next are held. If a stock fails to pass the screen in a subsequent month, we assume it is sold from the portfolio. The lower the percentage turnover, the greater the likelihood that the same company will pass a screen from month to month. The performance figures we quote for all of the screens we track at the Stock Screens area of AAII.com do not take into account, among other things, transactions costs such as commissions (and bid-ask spreads). While commissions on stock transactions, especially when using an online discount broker, are negligible, higher turnover strategies will still incur greater overall transactions costs, which will adversely impact your investment performance.
The Piotroski: High F-Score screen has averaged monthly turnover of 23.1% since the start of 1998, which means that slightly less than one-quarter of the stocks in the hypothetical portfolio are new each month. For all screening strategies tracked by AAII, the median monthly turnover is 32.6% over the testing period.
Generally speaking, value-oriented methodologies tend to have less portfolio turnover compared to those focused on growth. Adding a price momentum element to a strategy also tends to increase the overall turnover. The Piotroski screen has no price momentum elements in it. It focuses on the price-to-book-value ratio as well as the financial strength scoring system. While the price-to-book-value ratio fluctuates, the financial scoring system relies on financial statement data that changes quarterly.
Screens for All Markets: Bull and Bear Market Performers
When selecting a stock screening strategy, there are a number of factors to consider, including your time horizon and risk tolerance, as well as how closely you are able to monitor your stock portfolio.
While historical performance is an important component of the selection process, the market has reminded us over the last few years that it can undergo some wild gyrations. As a result, it is also useful to see how various strategies perform over different market conditions. This, in my opinion, is one of the true values of the AAII stock screens—members have access to a variety of strategies and can compare their year-to-year performance against broad market indexes and other strategies.
|Top Performers: Overall Risk-Adjusted||Price||
|EPS Grth (%)||
|Est Rev: Up 5% (Earnings Estimates)||30.5||18.9||24.4||2.1||1.7||0.0||1.2||-2.3||15.5||808.2||23|
|O’Neil’s CAN SLIM (Growth w/Price Mom)||28.4||17.4||No companies currently pass this screen.|
|O’Shaughnessy: Tiny Titans (Value w/Price Mom)||28.9||17.0||20.9||2.0||0.5||0.0||1.3||-22.9||5.0||130.3||140|
|P/E Relative (Earnings Estimates)||17.8||16.6||13.5||1.5||0.7||0.4||1.2||9.2||10.3||9175.3||1|
|Value on the Move—PEG w/Est Grth (Grth&Val w/Pr Mom)||20.5||16.5||16.2||2.7||2.1||0.0||0.8||11.6||18.5||1623.3||34|
|Bottom Performers: Overall Risk-Adjusted|
|Murphy Technology (Growth & Value)||-4.7||-20.7||7.2||2.3||2.2||0.0||0.7||29.2||13.5||310.5||-16|
|Dogs of the Dow: Low Priced 5 (Value)||-1.7||-5.3||16.6||1.6||1.4||3.8||1.8||-3.2||8.6||136329.4||-3|
|Insider Net Purchases (Specialty)||0.0||-3.3||20.8||1.4||1.6||0.0||1.9||-18.9||11.5||138.5||-18|
|Est Rev: Down 5% (Earnings Estimates)||1.4||-1.1||18.0||1.6||1.0||0.0||1.4||-1.3||10.8||605.9||-16|
|Dogs of the Dow (Value)||-0.1||-1.1||13.7||1.9||1.4||3.7||1.8||-0.7||7.6||129271.7||-4|
|All Exchange-Listed Stocks||10.6||8.7||17.9||1.7||1.6||0.0||1.5||1.0||12.5||513.8||5|
|Top Performers: Bull Market||
|EPS Grth (%)||
|MAGNET Simple (Growth & Value w/Price Mom)||48.6||664.7||18.7||1.9||1.8||0.0||0.5||33.3||29.5||371.0||179|
|Piotroski: High F-Score (Value)||128.3||294.8||11.2||0.6||0.5||0.0||3.2||-7.2||10.0||59.1||-5|
|Driehaus (Growth w/Price Mom)||67.0||283.3||29.0||2.3||1.7||0.0||1.4||2.6||20.0||819.3||36|
|Foolish Small Cap 8 Revised (Growth & Value)||15.4||219.0||33.8||9.4||6.9||0.0||1.8||90.9||18.8||2829.5||75|
|Bottom Performers: Bull Market||2010*||Bull Mkt**|
|MAGNET Complex (Growth & Value w/Price Mom)||-27.1||-35.5||11.8||1.8||0.8||0.0||nmf||-8.0||na||254.3||85|
|Kirkpatrick Value (Growth & Value)||-25.2||-19.1||19.6||1.7||0.6||0.7||0.7||-8.2||32.4||35835.2||84|
|Graham—Defensive Investor (Utility) (Value)||3.4||30.1||12.8||1.5||1.2||4.6||2.8||5.4||4.7||10821.6||-8|
|Zweig (Growth & Value)||14.1||42.5||21.2||3.0||1.5||0.0||1.0||56.5||17.7||832.6||49|
|O’Shaughnessy: Grth Mrkt Leaders (Value w/Price Mom)||16.0||48.1||21.9||3.9||1.3||0.8||1.4||-7.8||13.4||10794.4||43|
|All Exchange-Listed Stocks||23.1||139.2||17.9||1.7||1.6||0.0||1.5||1.0||12.5||513.8||5|
|Top Performers: Bear Market||2010*||Bear Mkt***|
|O’Neil’s CAN SLIM (Growth w/Price Mom)||-9.6||-10.1||No companies currently pass this screen.|
|Kirkpatrick Value (Growth & Value)||-25.2||-23.3||19.6||1.7||0.6||0.7||0.7||-8.2||32.4||35835.2||84.0|
|Est Rev: Up 5% (Earnings Estimates)||36.4||-23.4||24.4||2.1||1.7||0.0||1.2||-2.3||15.5||808.2||23.0|
|P/E Relative (Earnings Estimates)||28.3||-27.6||13.5||1.5||0.7||0.4||1.2||9.2||10.3||9175.3||1.0|
|O’Neil’s CAN SLIM Rev 3rd Ed (Growth w/Price Mom)||45.5||-27.8||52.7||6.0||5.0||0.0||1.3||-6.8||25.0||723.1||127.0|
|Bottom Performers: Bear Market||2010*||Bear Mkt***|
|Dogs of the Dow: Low Priced 5 (Value)||15.4||-82.9||16.6||1.6||1.4||3.8||1.8||-3.2||8.6||136329.4||-3|
|MAGNET Simple (Growth & Value w/Price Mom)||48.6||-75.9||18.7||1.9||1.8||0.0||0.5||33.3||29.5||371.0||179|
|Oberweis Octagon (Growth & Value w/Price Mom)||76.2||-70.6||13.2||2.3||1.0||0.0||0.9||-22.0||17.8||831.9||72|
|O’Shaughnessy: Value (Value)||5.6||-69.1||13.4||2.4||1.5||4.2||1.6||5.8||7.9||39773.8||-3|
|Dogs of the Dow (Value)||17.3||-69.0||13.7||1.9||1.4||3.7||1.8||-0.7||7.6||129271.7||-4|
|All Exchange-Listed Stocks||23.1||-58.6||17.9||1.7||1.6||0.0||1.5||1.0||12.5||513.8||5|
|*Through December 10, 2010.|
|**The latest bull market period began on March 1, 2009, and continues as of December 10, 2010.|
|***The latest bear market period began on November 1, 2007, and ended on February 28, 2009.|
One way to analyze the performance of an individual security or an investment approach is to see how it performs over bull and bear market cycles. For the first time, we have tracked the performance of the AAII stock screens over the most recent bull and bear market periods.
Bull Market Performance
After bottoming out in February 2009, the market has been in the midst of a bull run. Over this period, 61 of the 63 AAII stock screens have posted gains, with the median gain for the period being 111.5%.
Looking at Table 2, the top five performers over the current bull market (along with their respective style categories) are as follows:
- MAGNET Simple (growth & value with price momentum), +664.7%
- Price-to-Free-Cash-Flow , +364.4%
- Piotroski High F-Score (Piotroski 8) ( , +294.8%
- Driehaus (growth with price momentum), +283.3%
- Foolish Small Cap 8 Revised (growth & value), +219.0%
By way of comparison, the S&P 500 has gained 68.7% from the end of February 2009 through December 10, 2010, while the typical exchange-listed stock has gained 139.2% over the same period.
The MAGNET Simple screen is adapted from Jordan Kimmel’s book, “MAGNET Investing.” This screen targets reasonably priced sales growth and price momentum. Kimmel’s MAGNET system of investing attempts to identify stocks that will be attractive to growth, momentum and value investors alike.
The growth aspect of the MAGNET Simple screen looks for companies that have increased sales by at least 15% over the trailing 12 months (the last four fiscal quarters).
For momentum investors, the MAGNET Simple screen looks for high price momentum over the last three months and 12 months. Specifically, companies must rank in the top 10% of the stock universe based on relative price strength over the last 13 and 52 weeks.
Lastly, Kimmel uses the price-earnings-to-earnings-growthratio, to find undervalued stocks. In order to pass the AAII MAGNET Simple screen, a company’s current valuation (price-earnings ratio) cannot be more than 50% of its estimated annualized growth rate in earnings for the next three to five years.
Bear Market Performance
While, as investors, we would presumably want the market to be always moving upward, this isn’t the reality. However, it is difficult to consistently time the market so that you are fully invested when the market is rising or can move some or all of your portfolio into cash during a market downturn. The best way to insulate your portfolio during a bear market is through diversification across asset classes and investment styles. Investing in strategies that fare better during bear markets is one way to diversify your stock portfolio.
For our testing, we used the bear market that began in November 2007 and ran through the end of February 2009.
Of the 63 AAII stock screens, none managed to escape the last market downturn without a loss. The one that fared the best was the CAN SLIM approach of William O’Neil, which lost 10.1% between November 1, 2007, and February 28, 2009. William O’Neil is publisher of Investor’s Business Daily. The AAII CAN SLIM screen is based on the second edition of O’Neil’s book, “How to Make Money in Stocks: A Winning System in Good Times or Bad.” In the book, O’Neil outlines a stock selection approach developed by studying 500 of the biggest stock market winners from 1953 to 1993. The CAN SLIM approach is based upon the characteristics that these winning stocks possessed prior to their big price run-ups. In general, the CAN SLIM approach combines fundamental and technical factors to seek companies with strong earnings and price momentum, and it tends to isolate smaller-cap growth stocks.
It is reasonable to expect a non-hedged stock investing strategy to lose money when broad market indexes are down 50% or more, but we would, ideally, like to minimize our losses. While the typical AAII stock screen was down almost 51% over the last bear market, the worst five all lost 69% or more from November 2007 through February 2009, as shown in Table 2. During this same period, the S&P 500 lost a total of 52.6% on a price-change basis, while the typical exchange-listed stock lost almost 59%.
—Wayne A. Thorp, CFA
Characteristics of Top Strategies
Table 2 presents the current characteristics of the top- and bottom-performing strategies for 2010 and for the most recent bull and bear markets.
No matter what time period you are examining, basic investment principles do not change. Looking at the underlying characteristics of the five best-performing stock screens for this year and over the last bull and bear markets, we find prominent investment themes once again rising to the top:
- Low multiples, typically on a relative basis (price-to-book value, price-earnings-to-earnings growth, etc.);
- An emphasis on consistent sales and/or earnings growth;
- Strong financials;
- Price momentum; and
- Upward earnings revisions and/or positive earnings surprises.
When measuring the appropriateness of an investment strategy, you should consider risk as well as performance. The Monthly Variability columns in Table 1 report the greatest monthly percentage increase and loss since the beginning of 1998 as one indication of volatility.
The Piotroski: High F-Score screen’s best single-month gain has been 43.1%, while its worst single-month loss has been –42%. In comparison, the most the S&P 500 has gained in a single month since the start of 1998 has been 9.7%, and its largest single monthly loss was –16.8%.
The Historical Annual Risk & Return columns offer additional measures of portfolio volatility and risk/return profiles over the study period from the start of 1998 through December 10, 2010. Risk Index compares the variability of returns, as measured by the standard deviation of return, for a given stock screening strategy to that of a benchmark, in this case the S&P 500. Standard deviation is a measure of return volatility computed using monthly returns since the beginning of 1998. The risk index divides the standard deviation of a strategy’s return by the standard deviation of the S&P 500 return. The risk index of the S&P 500 is 1.00; methodologies with a risk index below 1.00 are below average in risk. For example, the Graham—Defensive Investor (Utility) screen (in the value category) has a total risk index of 0.91, meaning the approach is only 91% as volatile as the S&P 500 historically.
The 2.00 risk index value for the Piotroski: High F-Score approach indicates that, since the beginning of 1998, the monthly variability of returns for the stocks held in this portfolio has been twice that of the S&P 500 index. This makes the Piotroski: High F-Score screen the tenth-riskiest screen among the 63 approaches that AAII tracks. It also has the highest risk index among all value strategies. Among all AAII stock screens, the median risk index value is 1.5. This means that the typical stock screen tracked by AAII has 50% more volatility than the S&P 500 index.
Overall, only three AAII stock screens have a risk index less than 1.00, meaning their risk or volatility is lower than that of the S&P 500. These screens are:
- Graham—Defensive Investor (Utility) (in the value category)
- Dividend Screen: Non-DRPs (in the growth & value category)
- Dividend (High Relative Yield) (in the growth & value category)
Impact of Dividends
The Price Gain and Average Annual Price Gain columns in Table 1 represent the percentage amount the hypothetical portfolio invested in the stocks passing a given screen has gained or lost on an annualized basis over varying time periods between January 1, 1998, and December 10, 2010.
However, these performance numbers do not include dividend payments or dividend reinvestment. Therefore, return characteristics for large-cap strategies, such as the Dogs of the Dow (in the value category), do not benefit from dividend payments or reinvestment.
Currently, the 10 stocks that make up the Dogs of the Dow have a dividend yield of 3.7%; investors holdings shares in these stocks would, therefore, have a higher annual return by approximately this amount.
While performance is an important consideration when selecting an investment approach, you also need to consider the risk of the stocks passing a given screen. By considering both the risk and return of an investment methodology, you are ensuring that you are being properly compensated for the level of risk you are assuming.
One way of considering the risk of a strategy is to calculate a risk-adjusted return. Strategies with high returns that have above-benchmark standard deviations will have their returns proportionally lowered, and strategies with below-benchmark standard deviations will have their returns proportionally raised.
Calculating Risk-Adjusted Return
The formula for calculating the risk-adjusted return is as follows:
Margin Rate + (Benchmark Std Dev ÷ Portfolio Std Dev) × (Portfolio Return – Margin Rate)
Margin Rate = margin rate (the rate at which you borrow funds); we use 4% for our calculations
Benchmark Std Dev = standard deviation of the benchmark, in this case the S&P 500
Portfolio Std Dev = standard deviation of the portfolio of stocks passing a given stock screen
Portfolio Return = return of the portfolio invested in the stocks passing a given stock screen
This calculation assumes that the portfolio return for a given stock screen is higher than the margin rate. If it isn’t, the risk-adjusted return calculation would be as follows:
Margin Rate + (Portfolio Std Dev ÷ Benchmark Std Dev) × (Portfolio Return – Margin Rate)
Following this methodology, we calculated the risk-adjusted returns since inception for all the AAII stock screens.
When ranked by risk-adjusted return since inception, the Estimate Revisions: Up 5% screen (in the earnings estimates category) is the top-performing strategy over the period from January 1, 1998, through December 10, 2010.
This screen looks for companies tracked by more than four analysts that have not had any downward revisions over the last month in their earnings estimates for the current and next fiscal year and have had at least one upward revision. Furthermore, the revisions to the average estimate must be significant enough to increase the consensus estimates for both the current and next fiscal years by at least 5% over the last month.
The strategy has an annualized risk-adjusted return of 18.9%, versus its non-risk-adjusted return of 30.5% a year since the beginning of 1998. The Estimate Revisions: Up 5% screen has a annual standard deviation of 29.4% versus 16.6% for the S&P 500, giving it a risk index of 1.78.
One approach whose risk-adjusted return benefited greatly from its low risk relative to the other AAII stock screens is the P/E Relative screen (in the earnings estimates category). This screen ranks 17th in annualized return since the beginning of 1998. However, with a risk index of 1.09 (meaning it is only 9% more volatile than the S&P 500), its risk-adjusted return does not suffer as much as the typical AAII stock screen, which has a risk index of 1.5. In fact, 15 of the 16 screens that ranked higher in return than the P/E Relative screen had a risk index value greater than 1.5. As a result, many of these screens saw their risk-adjusted returns drop significantly, while the risk-adjusted return of the P/E Relative screen fell only slightly.
The AAII stock screens are not intended to be “buy” or recommended lists. Instead, they allow investors to see how different investment strategies perform over varying market conditions. Since market conditions change, it is important to be adequately diversified to weather the ups and downs of the market.
One way to achieve sufficient diversification is to use multiple stock screening methodologies to help you in selecting stocks. However, it is not enough to simply choose those strategies that have the best long-term performance. Instead, it is useful to understand the forces influencing both the overall market and a strategy’s performance. Furthermore, you should also consider how changing economic conditions can impact both the market and individual stocks. Examining the characteristics of an investment methodology may reveal some practical problems you can face when trying to translate quantitative stock screening into real-world portfolio building.
Something else to keep in mind is that once you decide on which methodologies to follow, you cannot just let the quantitative screens choose your stocks. Screening is a multi-step process. The first step is to apply the quantitative filters to the stock universe to help you arrive at a set of candidates that all share the same base set of characteristics. This doesn’t necessarily mean they are all good investments. It is important to take your list of passing companies and, at a minimum, perform cursory qualitative analysis to decide whether or not they are right for your stock portfolio.
The AAII Stock Screens
AAII has been developing, testing and refining a wide range of screening strategies over the 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.
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 Pro program and are also posted monthly in the Stock Screens area of AAII.com.
Each month over 60 separate screens are performed using AAII’s Stock Investor Pro and the current companies passing each individual screen are reported. Stock Investor Pro subscribers can perform the screens themselves, while AAII members can access the screening results by going to the Stock Screens area of AAII.com. The results are usually posted to the website in the middle of each month using data from the previous month’s 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, with equal investments in each stock at the beginning of each month assumed. The impact of factors such as commissions, bid-ask spreads, cash dividends, time-slippage (the time between the initial decision to buy a stock and the actual purchase) and taxes 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.
The sell rules are the same as the buy rules: the screens are simply reapplied using each subsequent month’s 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.