Driehaus Screen for Growth and Momentum Stocks
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.
Momentum investors seek rapidly growing companies with prices to match.
Their hope is that continued growth will attract additional investors who will continue to drive up the stock price.
That investment philosophy, centered on earnings growth, underlies the approach used by Richard Driehaus, who was named to the Barron’s All-Century Team of All-Stars in 2000. He and his Chicago-based firm, Driehaus Capital Management, look for companies with strong and accelerating earnings growth. Their belief is that earnings growth is the primary driver of stock prices, as sustained earnings growth allows a company to increase cash flows and dividends. In his book, “Investment Gurus” (Prentice Hall, 1999), Peter J. Tanous outlines Driehaus’ momentum strategy.
The AAII Driehaus Screen
Based on Tanous’ book, AAII developed a Driehaus screen, which we have built into our Stock Investor Pro fundamental stock screening and research database program and track at AAII.com. The AAII Driehaus screen isolates small and mid-cap companies with:
- Sufficient liquidity (daily trading volume);
- Year-over-year growth in earnings per share from continuing operations;
- Strong, positive earnings surprises; and
- Short-term price strength on an absolute basis as well as relative to a company’s respective industry.
- The exact screening criteria used for this screen are detailed in the box on page 30.
Each month, AAII.com lists the companies passing the Driehaus screen and tracks the performance of these stocks in a hypothetical portfolio.
Figure 1 shows that the AAII Driehaus screen generated an average annual price gain of 14.8% from the beginning of 1999 through the end of April 2011. The screen significantly outperformed the various S&P indexes as well as the typical exchange-listed stock during that time.
However, underlying this performance is high volatility. The screen has a risk index of 2.31, compared to 1.00 for the S&P 500. This means that this methodology has been 2.31 times more volatile than the large-cap index over the last 36 months. During the last bear market, the Driehaus approach lost 53.4%, which was on par with the S&P indexes and the typical exchange-listed stock. However, since the end of the last bear market, the screen has returned an amazing 324.3%, compared to an 85.5% gain for the S&P 500 and a 165.6% gain for the typical exchange-listed stock.
Looking at the annual returns over the last five years, the Driehaus screen lost 42.7% in 2008 and rebounded with a 106.0% gain in 2009 and a 65.7% gain in 2010. It is up 11.6% this year, through April 30.
Profile of Passing Companies
Table 1 highlights the characteristics of the stocks currently meeting the AAII Driehaus screen criteria. Momentum investors are willing to accept higher price multiples such as price-earnings ratio and price-to-book-value ratio, as they are more concerned with growth (earnings, dividends, cash flow, etc.) than buying cheap assets. The companies passing the AAII Driehaus screen as of May 6, 2011, have a median price-earnings ratio of 19.4, which is slightly higher than the 17.7 median price-earnings ratio for the typical exchange-listed stock. These passing companies also carry with them a high median price-to-book-value ratio relative to the typical exchange-listed stock (2.7 versus 1.7).
|Portfolio Characteristics (Median)||
|Price-earnings ratio (X)||19.4||17.7|
|Price-to-book-value ratio (X)||2.7||1.7|
|EPS 5-yr. historical growth rate (%)||18.3||3.5|
|EPS 3-5 yr. estimated growth rate (%)||15.0||12.6|
|Latest quarterly EPS surprise (%)||28.5||3.9|
|Market cap ($ million)||1,052.5||551.6|
|Relative strength vs. S&P* (%)||26||-2|
|Average no. of passing stocks||14|
|Highest no. of passing stocks||40|
|Lowest no. of passing stocks||1|
|Monthly turnover (%)||63.3|
|Data as of May 6, 2011.|
In order to pass the AAII Driehaus screen, a company must have annual earnings per share growth that is better than that of the previous year for each of the last two fiscal years. (Note that this does not necessarily mean that the earnings growth rate itself is positive, but only that the rate of change is.) This requirement has translated into a median average earnings growth rate of 18.3% over the last five years, compared to 3.5% average annual earnings growth over the same period for the typical exchange-listed stock.
Looking forward, the median estimated annualized growth in earnings per share for the current Driehaus companies is 15.0%, compared to 12.6% for exchange-listed stocks.
Rapidly growing firms such as those sought by Driehaus tend to be small in nature, as measured by market capitalization. Looking at the companies currently passing the AAII Driehaus screen, we find that they have a median market cap of roughly $1.05 billion, which places them at the upper end of the small-cap spectrum. In comparison, the median market capitalization for exchange-listed stocks is slightly over $551 million.
The current Driehaus stocks have outperformed the S&P 500 index by 26% over the last 52 weeks. In contrast, the typical exchange-listed stock has underperformed the S&P 500 by 2% over the same period.
There are currently 28 companies satisfying the criteria of the AAII Driehaus screen. This is above the monthly average of 14 passing companies the approach has seen since the start of 1999. Over this period, the screen has generated at least one passing company each month and as many as 40 stocks in one month.
Finally, given the strict earnings growth and price momentum requirements of the Driehaus methodology, it is probably not surprising that it has one of the highest monthly turnover rates among the screening strategies AAII tracks. In a given month, over 63% of the stocks that pass the Driehaus screen did not pass the month before. This monthly turnover rate is the second-highest among the growth with price momentum strategies followed at AAII.com.
Strong, accelerating earnings growth serves as the cornerstone of the Driehaus philosophy. Table 2 shows the 25 companies with the highest four-week price increase out of the 28 that currently passing the Driehaus screen.
|Kulicke & Soffa Indus (KLIC)||11.98||498.0||297.1||-121.7||-248.4||50.0||36||66||3||855.5||tools for semiconds|
|SunPower Corp. (SPWRA)||21.41||394.3||383.3||123.2||-518.9||29.0||27||37||3||2108.5||solar electric power|
|Coleman Cable (CCIX)||11.37||305.6||105.5||-137.5||-288.8||76.2||24||58||0||196.6||wire & cable prods|
|BJ’s Restaurants (BJRI)||47.61||88.2||75.5||25.6||-13.3||28.9||23||26||0||1311.8||restaurant chain|
|ExlService Holdings (EXLS)||23.44||68.5||65.5||41.0||-37.1||29.9||16||6||-1||695.2||outsourcing servs|
|Crocs, Inc. (CROX)||21.00||664.7||259.2||78.1||-207.7||23.1||15||33||-3||1858.9||footwear & accessories|
|Columbia Sportswear (COLM)||68.53||16.6||15.2||-28.0||-31.3||28.0||14||16||12||2323.2||outdoor apparel|
|ABIOMED, Inc. (ABMD)||16.94||69.2||42.9||27.8||-22.3||77.8||12||31||5||641.2||medical devices|
|Buffalo Wild Wings (BWLD)||61.05||29.3||24.1||24.1||22.3||10.8||11||14||0||1118.5||restaurant chain|
|Ultra Clean Holdings (UCTT)||10.90||332.6||197.9||61.3||-424.0||19.0||9||23||3||247.6||subsys for semiconds|
|U-Store-It Trust (YSI)||10.92||76.5||57.1||37.8||-12.5||100.0||9||9||-8||1085.8||self-storage facilities|
|Immersion Corp. (IMMR)||8.02||92.1||78.6||39.4||-140.6||350.0||8||36||-5||228.7||digital device touch tech|
|Newport Corp. (NEWP)||17.87||833.3||333.3||88.3||-499.0||26.4||7||11||0||665.8||photonics tech prods|
|Saia Inc. (SAIA)||16.73||192.5||117.9||54.7||-219.4||197.6||7||2||2||266.4||truck transport|
|FEI Company (FEIC)||34.28||248.1||135.0||22.4||-62.0||16.9||6||35||3||1326.4||nanoscale instruments|
|Salix Pharmaceut’ls (SLXP)||38.84||96.2||46.6||11.1||-682.4||98.8||6||-6||-6||2267.1||pharmaceuticals|
|Cadence Design Sys (CDNS)||10.36||247.4||184.5||92.1||-788.7||20.0||5||10||0||2786.2||electronic prod devlp|
|MWI Veterinary Sply (MWIV)||81.20||34.1||32.5||24.8||15.4||10.7||5||27||-6||1019.2||animal health prods|
|Post Properties, Inc. (PPS)||39.87||86.4||85.7||10.6||-207.3||84.1||4||10||-8||1974.1||equity REIT|
|PrivateBancorp, Inc. (PVTB)||15.26||122.2||82.1||69.9||-719.6||143.9||4||17||-6||1090.0||bank holding co.|
|Morton’s Restaurant Grp (MRT)||7.41||105.9||105.9||-27.1||-574.1||23.1||3||29||0||125.4||restaurant chain|
|NIC Inc. (EGOV)||12.81||40.9||27.3||15.8||0.0||11.1||3||30||-1||819.5||e-government servs|
|Portland General Electric (POR)||24.90||83.5||26.7||-5.8||-40.1||63.7||3||6||-4||1875.6||electric utility|
|TriMas Corp. (TRS)||21.64||246.3||226.3||110.2||34.6||12.2||3||22||2||741.3||pkg & energy prods|
|Valley National Bancorp (VLY)||13.56||49.1||27.9||0.0||-41.9||10.5||3||-5||-6||2300.7||bank holding co.|
|*Versus the S&P 500 index.|
|Source: AAII’s Stock Investor Pro/Reuters Research, Inc. Data as of May 6, 2011.|
In order to pass the AAII Driehaus screen, a company must have increased the annual growth rate in earnings per share from continuing operations over each of the last two fiscal years. In addition, the growth rate for earnings per share from continuing operations over the last four quarters (trailing 12 months) must be positive.
Looking at this value for companies in Table 2, we see that Newport Corp. (NEWP) leads all other companies with an astronomical 833.3% growth rate over the last 12 months. The company, which supplies advanced technology products and systems related to scientific research, aerospace and defense, earned $1.54 per share over the last four fiscal quarters, compared to a loss of $0.21 per share for the four quarters prior.
Columbia Sportswear Co. (COLM) has the lowest 12-month earnings growth rate of 16.6%.
Driehaus believes that one way to identify companies with strong earnings growth that are apt to continue that trend is by locating those with “significant” positive earnings surprises—when the company’s actual announced earnings beat the consensus analyst estimate. The AAII Driehaus screen deems a “significant” surprise to be at least 10%.
Among the current passing companies, Immersion Corp. (IMMR) had the highest percentage earnings surprise of 350.0%. On March 31, 2011, the company announced earnings per share of $0.05, whereas the four analysts tracking it had predicted a loss of $0.02 per share. Among the companies listed in Table 2, Valley National Bancorp (VLY) had the lowest percentage earnings surprise of 10.5%.
Given that many rapidly growing small- and mid-cap companies are usually not yet profitable, it was a pleasant surprise to see that only two of the 28 passing companies in Table 2 reported negative “normalized” earnings per share for the latest completed fiscal quarter—ABIOMED, Inc. (ABMD) and Post Properties, Inc. .
The number of analysts tracking a company is an important factor. Coverage by only one analyst limits the usefulness of an earnings estimate; as the number of analysts covering a company increases, the consensus estimate becomes more credible. Therefore, the AAII Driehaus screen requires that at least three analysts offer estimates for the current fiscal quarter. SunPower Corp. (SPWRA) has the broadest analyst coverage, with 28 analysts providing earnings estimates for the current fiscal quarter.
Beyond earnings growth and positive earnings surprises, Driehaus also monitors price momentum. The AAII Driehaus screen looks for stocks with an increase in price over the last four weeks. We rank the companies in Table 2 in descending order by four-week price change.
Among the 28 companies currently passing the AAII Driehaus screen, Kulicke & Soffa Industries (KLIC) has seen the largest price increase over the last four weeks, rising 36%. After the market close on May 2, 2011, the designer and manufacturer of equipment and tools used in the assembly of integrated circuits, light-emitting diodes and power modules, reported earnings that exceeded analyst estimates by 50%. It also issued revenue guidance for the next fiscal quarter that exceeded prior estimates by roughly 25%. From the close on May 2 to May 6, KLIC shares rose almost 33%.
Another measure of momentum is relative price strength, which indicates how well a stock has performed compared to some benchmark—usually a market or industry index. Driehaus tries to invest in industry leaders, both in terms of earnings growth and as price performance. Therefore, the AAII Driehaus criteria also require that a company have a 26-week relative strength value that is equal to or above the median relative strength for all the companies in its industry over the same period. KLIC shares have outperformed the S&P 500 index by 66% over the last 26 weeks, while the companies in its industry have outperformed the index by just 3%, on average.
What It Takes: Driehaus Criteria
- The year-to-year growth rate in earnings per share from continuing operations has increased over each of the last four fiscal years (Y4 to Y3, Y3 to Y2, etc.)
- Growth in earnings per share from continuing operations over the last 12 months has been positive
- The percentage difference between the actual announced earnings and the consensus earnings estimate for the same period—quarterly surprise—is greater than or equal to 10%
- At least three analysts have provided earnings estimates for the current fiscal quarter (Q0)
- The percentage change in stock price over the last four weeks is positive
The 26-week relative price strength is greater than or equal to the industry’s 26-week relative price strength
- As a manual screen, users may wish to eliminate those companies that have underperformed the S&P 500 over the last 26 weeks (26-week relative strength less than zero)
- This criterion is not used to generate the list of passing companies that appears on the AAII website
- The market capitalization for the latest fiscal quarter (Q1) is greater than $50 million and less than $3 billion
- Those companies that trade as American depositary receipts are excluded
- The average daily volume for the last 10 days is in the top 50% of the database (percent rank is greater than or equal to 50)
The momentum approach to stock selection developed by Richard Driehaus seeks to hit the “home run” that will provide above-normal returns. When investing in such potentially volatile stocks, it is very important to have a system in place that gets you out of a trade with only a minimal loss, while allowing the winners to ride until their momentum burns out. As the tech bubble of the late 1990s and the financial crisis of 2008–2009 showed, momentum strategies can crash back to earth very quickly, with potentially devastating consequences for investors.
As always, keep in mind that screening is only the first step in the investment process. The stocks passing this or any other screen do not represent a “recommended” or “buy” list. Before making any investment decisions, it is important to perform sufficient due diligence to identify those stocks that match your investing tolerances and constraints.