Building Stock Screens Using the Kirkpatrick "Relative" Approach
Wayne Thorp recently spoke at the 2015 AAII Investor Conference. For information on how to subscribe to recordings of the presentations, go to www.aaii.com/conferenceaudio for more details.
In “Beat the Market,” Kirkpatrick outlines three different selection strategies he has been testing—Growth Model, Value Model, and Bargain Model.
AAII has developed three new screens based on Kirkpatrick’s research. If you are interested in a detailed discussion of how these screens were developed using AAII’s Stock Investor Pro fundamental screening and research database program, you may wish to read the September 2009 Computerized Investing On-Line Exclusive available at www.computerizedinvesting.com.
In 1982, Kirkpatrick began testing a hypothetical portfolio of stocks using relative earnings growth, relative price strength, and chart pattern analysis.
What It Takes: Kirkpatrick Criteria
- Relative price strength (as defined by current weekly closing price divided by the six-month average closing price) ranks in the 90th percentile or higher
- Relative reported earnings growth (as defined by the last four quarters of operating earnings divided by the four-quarter total of operating earnings one quarter prior) ranks in the 90th percentile or higher
- Share price of at least $10
- Market capitalization of at least $1 billion
- Relative price strength ranks in the 90th percentile or higher
- Relative reported earnings growth ranks in the 90th percentile or higher
- Relative price-to-sales ranks in the 30th percentile or lower
- Share price of at least $10
- Market capitalization of at least $500 million
- Relative price strength ranks in the 97th percentile or higher (lower to 90th percentile to increase total number of passing companies unless 20 companies pass)
- Relative price-to-sales ratio ranks in the 17th to 42nd percentiles
- Share price of at least $10
- Market capitalization of at least $1 billion
In “Beat the Market,” Kirkpatrick calculates relative strength by dividing the current weekly closing price by the 26-week moving average of closing prices. To replicate Kirkpatrick’s measure, we created a custom field in Stock Investor Pro that is the ratio of the current stock price to the average of the last six monthly closing prices. For our Kirkpatrick Growth screen, we then isolated those companies with a relative price strength value that placed it in the top 10% of the stock universe.
As of October 9, 2009, a relative price strength of 150% isolated 916 of the 9,101 companies with valid relative price strength values. This approximates the top 10% of the companies.
Reported Earnings Growth
Kirkpatrick uses a non-standard calculation for earnings growth, which compares operating earnings over the last four fiscal quarters to the four-quarter total in operating earnings one quarter earlier. His goal is to eliminate the impact of seasonality on a company’s earnings.
Once again, we created a custom field to capture Kirkpatrick’s screening methodology. Our custom field uses operating income, just as Kirkpatrick does, to avoid the special charges or adjustments to earnings.
Furthermore, since Kirkpatrick only considers companies with positive earnings, our custom field eliminates those firms with negative operating earnings over either four-quarter period.
As of October 9, 2009, 4,111 companies in the database had non-null relative earnings growth values. A growth rate of 27% isolated 413 of those companies—approximately the top 10%.
Price and Market Cap
Lastly, Kirkpatrick looked for growth companies with market capitalizations of at least $1 billion and share prices of at least $10.
As of October 9, 2009, 3,273 companies had a share price of $10 or more and 1,889 companies had a market capitalization of at least $1 billion.
Kirkpatrick analyzed point & figure charts of potential Growth Model stocks to confirm whether the stock price was actually rising. During periods of steep market declines, a stock with strong price strength relative to the market can still be falling, just not as quickly as the overall market.
Since Stock Investor is a fundamental screening database, we are not able to screen for stocks with rising chart patterns. However, as a proxy, we require that companies passing our Kirkpatrick Growth screen have a relative strength of at least 100%. This means the current stock price is at least as high as the average of the last six monthly closing prices. While this does not guarantee the price has been rising over the last six months, the hope is that it will allow you to avoid stocks in freefall.
Kirkpatrick’s Value Model mimics the Growth Model, except that it uses the relative price-to-sales ratio as a means of reducing risk instead of using a chart pattern stop. To begin our Kirkpatrick Value screen, we use the same screening criteria we used for the Kirkpatrick Growth screen regarding relative price strength and relative earnings growth.
For his Value Model, Kirkpatrick chooses stocks with relative price-to-sales ratios that are in the 30th percentile or lower. Therefore, for our Kirkpatrick Value screen, stocks must have a price-to-sales percentile rank than is less than or equal to 30.
As of October 9, 2009, 2,270 companies ranked in the bottom 30% of the stock universe based on their price-to-sales ratio.
Price and Market Cap
For his Value Model, Kirkpatrick relaxed his market-cap requirements to include companies whose market capitalization is $500 million or higher. He did, however, maintain the $10 share price minimum.
As of October 9, 2009, 3,273 companies had a share price of $10 or more and 2,551 companies had a market capitalization of at least $500 million.
The Bargain Model uses the “best” triggers found in his analyses.
While his Value Model selects stocks with relative price-to-sales in the 30th percentile or lower, Kirkpatrick’s testing of relative price-to-sales ratio percentile rankings indicated optimal performance in percentiles greater than 17 but not higher than the 42nd percentile.
Therefore, for our own Kirkpatrick Bargain screen, we required companies to have a price-to-sales percent rank that is greater than or equal to 17 and less than or equal to 42.
As of October 9, 2009, 1,917 companies ranked between the 17th and 42nd percentiles within the entire stock universe based on relative price-to-sales ratio.
Kirkpatrick’s analysis of earnings growth and future price performance indicated only a weak correlation between the two. As a result, he decided to omit relative earnings growth as a selection criterion for his Bargain Model.
Relative Price Strength
For both the Growth Model and Value Model, Kirkpatrick had been selecting stocks with relative price strength in the 90th percentile or higher. When he started the Bargain Model, Kirkpatrick upped the requirement to include only companies in the 97th percentile or higher, to reduce the number of passing companies.
However, when we backtested our Bargain screen, restricting the relative price strength to the top 3% led to a very small number of passing companies, if any at all. For our testing, we relaxed the relative price strength to include companies in the 90th percentile or higher unless 20 companies passed at a higher percentile.
As of October 9, 2009, isolating the top 3% of the 9,101 of the companies in the database with a valid (non-null) value for the relative price strength field resulted in 266 companies with a relative price strength of at least 200.1%.
However, adding this filter to the rest of the criteria Kirkpatrick uses for the Bargain Model results in only one passing company. Using the 150.1% minimum relative price strength value from the Growth Model and Value Model screens to capture roughly the top 10% of companies based on relative price strength nets us 15 passing companies.
Price and Market Cap
Lastly, Kirkpatrick looked for Bargain Model companies with market capitalizations of at least $1 billion and share prices of at least $10, just as he did for his Growth Model.
AAII Kirkpatrick Screen Results
Figure 1 represents the backtesting results for AAII’s new Kirkpatrick Growth, Value, and Bargain screens.
Our backtesting assumed buying the month-end passing companies in equal dollars amounts and then rebalancing each subsequent month. Unlike the sell rules outlined on page 25, our backtesting assumes that a stock is sold if it did not pass the screen the following month.
The Kirkpatrick screens have all outperformed the broad market indexes over the backtesting period. [Note that we were not able to backtest the screens in 1998.] Between 1999 and the end of September 2009, the Bargain screen gained 157.3%, the Growth screen gained 821.6% and the Value screen gain 465.1%.
Profile of Passing Companies
Table 1 presents the characteristics of the companies passing the Kirkpatrick Growth, Value, and Bargain screens as of October 9, 2009.
The Bargain and Value screens use the price-to-sales ratio to find “value-oriented” stocks. As a result, we see that the companies passing the Bargain screen have a median price-to-sales ratio—0.5—that is much lower than the 1.3 median for all exchange-listed stocks. [No companies currently pass the Kirkpatrick Value screen.]
However, since all three screens look for stocks with strong recent price action, it is not surprising that the median price-earnings ratios for the Bargain screen (37.0) and Growth screen (108.0) are significantly higher than the median price-earnings ratio for exchange-listed stocks (18.1).
|Portfolio Characteristics (Median)||
|Price-earnings ratio (X)||37.0||108.0||na||18.1|
|Price-to-book-value ratio (X)||1.4||4.1||na||1.5|
|Price-to-sales ratio (X)||0.5||4.0||na||1.3|
|EPS 5-yr. historical growth rate (%)||-11.5||111.2||na||1.9|
|EPS 3-5 yr. estimated growth rate (%)||7.2||88.6||na||12.0|
|Market cap. ($ million)||2091.1||1323.2||na||362.4|
|Relative strength vs. S&P (S&P=0) (%)||24||142||na||3|
|Average no. of passing stocks||14||12||2|
|Highest no. of passing stocks||21||41||15|
|Lowest no. of passing stocks||0||0||0|
|Monthly turnover (%)||66.3||61.2||74.9|
|Data as of October 9, 2009.|
The Kirkpatrick Growth and Value screens look at earnings growth over the last year, but we see that this does not translate into long-term earnings strength for the Value companies. The companies passing the Growth screen have an impressive median five-year earnings per share growth rate of 111.2%. However, this is tempered by the fact that only one of the three companies passing the Kirkpatrick Growth screen has a valid five-year earnings growth rate (Table 2). Meanwhile, the Bargain companies have seen earnings decline, on average, of 11.5% over the last five years. By comparison, the typical exchange-listed stock has seen earnings increase an average of 1.9% over the last five years.
Lastly, all three Kirkpatrick screens look for strong relative price strength over the last six months. As we can see, this has carried over to the last year as well. On a median basis, the stocks passing the Growth screen have outperformed the S&P 500 by 142% over the last year, while the Bargain stocks have outperformed the S&P by 24%. The typical exchange-listed stock has outperformed the S&P 500 by 3% over the last 52 weeks.
Table 2 lists the companies passing the Kirkpatrick screens as of October 9, 2009. Fifteen companies pass the Bargain screen, three companies pass the Growth screen, and no companies currently pass the Value screen. We ranked these companies in descending order by their relative price strength.
Among all three groups, Gannett Co. (GCI), which passed the Bargain screen, has the highest relative price strength at 202%. The company is probably best known as the publisher of the daily newspaper USA Today, in addition to over 90 other dailies in the U.S., Guam, and the U.K. Its digital segment also operates the employment Web site CareerBuilder. The stock has been on a steady upward march since July 15 when the company announced it had swung to a second-quarter profit and an indication that declines in ad revenue had begun to stabilize.
|Company (Exchange: Ticker)||
|Gannett Co., Inc. (N: GCI)||nmf||-53.8||202.0||95||28||news & information|
|Domtar Corp. (USA) (N: UFS)||nmf||na||174.3||93||18||paper & pulp mfg|
|Hartford Financial Servs (N: HIG)||nmf||-93.7||167.8||91||36||insurance & financial servs|
|Brunswick Corp. (N: BC)||nmf||-51.7||165.7||92||18||recreation products|
|Liberty Media Corp. (M: LINTA)||0.4||-75.3||164.5||94||42||media & entertain hold’g co.|
|Continental AG (O: CTTAY)||nmf||-37.4||161.8||na||19||auto supplier in Germany|
|Braskem SA (N: BAK)||na||-40.9||160.7||91||18||petrochemicals|
|Genworth Financial (N: GNW)||nmf||-21.7||159.3||97||30||insurance & financial servs|
|Oshkosh Corp. (N: OSK)||nmf||-1.3||157.5||95||24||specialty vehicles|
|W.R. Grace & Co. (N: GRA)||-55.1||32.0||157.1||93||29||specialty chemicals|
|Solutia Inc. (N: SOA)||23.0||22.3||156.1||96||34||chemical materials|
|Patriot Coal Corp. (N: PCX)||9.3||22.9||154.6||93||28||coal producer|
|Ulta Salon, Cos & Fragra (M: ULTA)||6.4||37.4||154.1||89||42||retail beauty prods|
|Manitowoc Company (N: MTW)||nmf||50.1||153.8||88||17||cranes & foodservice equip|
|Armstrong World Indus (N: AWI)||-28.6||29.0||150.8||88||35||flooring & ceilings|
|Home Inns & Hotels Mgmt. (M: HMIN)||43.1||111.2||174.5||90||81||economy hotel chain|
|SXC Health Solutions Corp. (M: SXCI)||48.6||na||164.3||87||47||health benefit mgmt servs|
|Warner Chilcott PLC (M: WCRX)||69.0||na||151.4||86||86||specialty pharmaceuticals|
|No companies currently pass the Kirkpatrick Value screen|
Exchange Key: M = NASDAQ; N = New York Stock Exchange; O = over the counter.
Source: AAII’s Stock Investor Pro/Thomson Reuters/I/B/E/S. Data as of 10/9/2009.
Warner Chilcott PLC (WCRX), a Bermuda-based pharmaceutical company focused on women’s healthcare and dermatology, has the highest relative earnings growth of all the companies in Table 2 at 69.0%. The company’s five-year earnings growth rate is “na” because it has not been in business long enough to calculate it.
Finally, only the Kirkpatrick Bargain and Value screens look for stocks with relatively low price-to-sales ratios. Among these two groups, Manitowoc Company (MTW) has the lowest price-to-sales percentile ranking of 17. Based in Wisconsin, the company operates two segments—cranes and related products, and foodservice equipment.
James Kirkpatrick believes that following a highly mechanical approach to stock picking will help investors to keep their emotions in check. To him, the stocks passing his screens are merely symbols.
Kirkpatrick feels that his analysis has uncovered methodologies that will perform well in both bull and bear markets. Furthermore, he believes that these same methodologies, along with disciplined money management, will help you steer clear of large capital losses during market downturns.