Mid-Cap and Growth Pull Ahead in Mid-Year Review

    by Wayne A. Thorp

    Investors who hoped for a continuation of the late-year run-up in the markets that closed 2004 have no doubt been disappointed thus far with 2005.

    After John Kerry conceded defeat to President George W. Bush in the presidential election on November 3, 2004, the S&P 500 gained 6.0% to end the year. However, the fabled January effect turned into a 2.5% loss for the first month of 2005, as the New Year gave way to realizations of continued violence in Iraq and Afghanistan, rising oil price and interest rates, and erratic economic growth. Its lowest close for the year was on April 20, when the S&P 500 was down 6.0% for the year.

    There are some encouraging signs for the second half of 2005, as the S&P has gained 5.3% since its April low. However, as we go to press, oil has reached new all-time highs, and only time will tell its impact on the market.

    Twenty-three of the 54 stock screens tracked onAAII.com have generated positive returns for the first half of 2005.

    Thus far, 2005 has been a rough year for value-oriented strategies relative to growth approaches. Strategies investing in smaller-cap companies have outperformed strategies that focus on larger companies, while mid-cap indexes have fared the best thus far for 2005.

    Stock Screen Results

    Table 1 summarizes the performance and variability of the stock screens built into AAII’s Stock Investor Pro fundamental stock screening and research database program and presented within the Stock Screens area of AAII.com.

    We have been developing, testing, and refining a wide range of screening methodologies over the last eight years. Many of the screens follow the approaches of popular investment professionals—as interpreted by AAII through the study of works by and about the individuals, while others are tied to basic investment principles. Most of the strategies aim to be complete investment approaches that examine both primary selection factors to identify potential prospects and conditioning or secondary filters to exclude troubled or weaker companies. There are, however, some screens that focus solely on a single factor—such as earnings estimate revisions or insider transactions—to examine if these factors are predictors of stock prospects.

    Table 1 presents the price gains for the various investment strategies tracked by AAII, along with index performance data. The screening methodologies listed in the table are grouped by a growth versus value orientation, with additional specialty and sector screens broken out separately. Within each grouping, the strategies are ranked by year-to-date performance for 2005 (through June 10).

    Mid-Year Leaders

    Figure 1.
    Mid-Year Performance
    Winners: O’Neil’s
    CAN SLIM and Zweig

    The small-cap growth screen that follows the popular CAN SLIM philosophy of William O’Neil led all strategies during the first half of 2005 with a 23.9% gain, while the growth-and-value Martin Zweig approach continued its long-term dominance with a 1,432.2% cumulative gain since 1998. Figure 1 traces their performances compared to benchmark indexes.

    The CAN SLIM approach identifies companies with a relatively low float (shares outstanding less those shares held by insiders) exhibiting strong quarter-on-quarter growth in earnings as well as positive annual earnings growth over each of the last five fiscal years, and strong price momentum over the last 52 weeks.

    The CAN SLIM approach, with its 23.9% gain for the first half of 2005, appears to be rebounding from its 3.8% decline in 2004, its first and only annual decline since we began tracking it in 1998. The approach performed very well during both the run-up of the technology bubble and following the bursting of the bubble. This has led the CAN SLIM methodology to be one of the top-performing approaches tracked by AAII, with an 859.0% cumulative gain since 1998.

    The Zweig approach continued its long-term superiority with a solid 11.3% gain in the first half of 2005. The approach seeks companies with positive growth in quarter-over-quarter earnings, positive year-to-year growth in annual earnings and strong price movement over the last 26 weeks, but trading with price-earnings ratios that are not too high above the market norm. The screen currently favors mid-caps in the construction and financial industries.

    Value Winner
    Value-oriented screening approaches have had a difficult time thus far in 2005, with only six of the 18 value strategies producing a positive return for the first half of 2005.

    The Dreman Screen with Earnings Estimate Revisions led all the value approaches for the first half of 2005 with its 5.2% gain. The screen seeks stocks with the following characteristics: low price-earnings ratios, high market capitalizations, a total-liabilities-to-total-assets ratio that is below industry norms, and consensus earnings estimates for the current fiscal year and next fiscal year that have been raised over the last month. This screen has been turning up homebuilding and oil and gas companies, which have been performing well of late.

    The long-term value leader is the Piotroski screen, with a cumulative gain of 933.1% since 1998. The screen seeks stocks with low price-to-book values that have strong and improving financial strength.

    The Piotroski screen tends to isolate smaller-cap value stocks, which have led the market the past few years. However, this trend may be reversing itself, as the Piotroski screen had the worst mid-year performance among the value strategies with a 10.9% loss. Currently, the screen has found only four passing companies; historically, the screen averages six stocks per month, among the lowest numbers of the stock methodologies tracked by AAII.

    Growth & Value Winner
    The split between winning and losing growth & value strategies over the first half of 2005 was exactly 50/50. The Stock Market Winners screen, which led with a 14.0% gain year-to-date, is based on a study by Marc Reinganum that extended William O’Neil’s original analysis. While the original analysis eventually led O’Neil to develop CAN SLIM, a clear growth approach, Reinganum’s conclusions fall into the growth and value camp.

    The Stock Market Winners screen seeks companies with low price-to-book ratios, positive quarter-on-quarter and long-term growth in earnings, strong price momentum over the last 52 weeks and two years, and a positive pretax margin. It also requires a low number of shares outstanding. The current companies passing the screen tend to be concentrated in the financial and retail sectors.

    Growth Winners
    The William O’Neil CAN SLIM screen, the best overall performer for the first half of 2005, also leads the growth pack with its 23.9% gain. Of the small number of companies currently passing the screen, half are in the financial sector. The long-term performance leader within the growth category is also the William O’Neil CAN SLIM approach. The methodology has generated an 859.0% gain over the past seven and a half years.

    Risk & Turnover

    When measuring the performance of any investment approach, the risk of the strategy should also be considered.

    Table 1 includes Monthly Variability columns, which report the greatest monthly percentage gain and loss as an indication of the volatility that occurred over the last seven and a half years.

    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, which indicates the degree of variation for a strategy over the test period. The higher the standard deviation, the greater the total risk of the strategy.

    The portfolio that was created using the Murphy Technology screen exhibited the greatest monthly volatility among these strategies, with a 16.5% monthly standard deviation. The screen’s biggest single-month loss was a whopping 44.9%, which occurred during October of 2003, a month where most indexes were up strongly. Its biggest monthly gain of 58.5% was observed in January of 2004, when the four stocks that passed the screen had gains ranging from 22.6% to 158.0%.

    Large monthly performance swings are more common with strategies that tend to have only a few passing companies. Historically, the Murphy Technology screen has averaged 11 passing companies each month.

    The Monthly Holdings columns provide data on portfolio holdings over time—the total number of stocks that were in each portfolio on a monthly basis over the last seven and a half years, and the average percentage turnover from month-to-month. For example, the Piotroski screen has averaged only six passing companies per month, and on average 21.7% of the stocks that pass the screen one month are replaced (do not pass the screen) the following month. (These portfolios are rebalanced every month, and only those companies passing the screen for a given month are held.)


    The strategies we track are based on relatively simple screens that are interpretations of the investment approaches advocated by prominent investment professionals. These individuals were not involved in the creation or testing of our approaches, nor do the stocks passing the screens necessarily represent stocks they own or would purchase.

    Our screens attempt to establish a practical set of rules for each approach, which is the first step in any disciplined investment approach. As you look at the performance of the screens, you should not blindly follow the strategies with the highest performance. Instead, try to gain an understanding of the factors that would impact the performance of that particular screen, and then evaluate the screen based on your best guess of the kind of market environment that can be expected in the future.

    Most importantly, remember that screening is only your first step—the stocks passing a given screen are not a “recommended list” or a “buy list.” There are many qualitative elements that cannot be effectively captured by a quantitative screening process, and those qualitative elements may be very detrimental to the future performance of the stock.

    The results of any screening approach are merely a step-off point from which you should perform additional due diligence. This allows you to verify the financial strength of the passing companies and to identify those stocks that match your investing constraints before you commit any investment dollars.

       How We Evaluate the Screens
    The AAII Stock Screens are designed to provide you with access to a wide range of stock strategies and investment approaches, as well as the individual companies that pass each investment screen.

    Each month, over 50 separate screens are performed using AAII’s Stock Investor Pro software. Approaches run the gamut, from value-based to growth-based, large-cap to small-cap, some specialty approaches and many that fall in between. The complete results are reported each month at AAII.com.

    How Returns Are Calculated
    The performances of the stocks passing each screen are tracked on a monthly basis. Month-to-month closing prices are used to calculate returns, and equal investments in each stock at the beginning of each month are 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 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.

    Real-Time Coverage: AAII.com
    AAII members can access the screening results by clicking on the AAII Stock Screens link, listed under Portfolios in the left-hand column of AAII.com.

    At AAII.com, we report the return performance (based on price changes) of all of the screens in the Performance section. In addition, for each screen, we list all of the companies currently passing the screen.

    Screening results are posted to the site in the middle of each month, using data from the previous month’s end. Stock Investor Pro subscribers can perform the screens themselves using the pre-built screens provided in the software.

    Wayne A. Thorp, CFA, is financial analyst at AAII and associate editor of Computerized Investing.

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