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O'Shaughnessy's Tiny Titans Screen

by Cara Scatizzi

O'Shaughnessy's Tiny Titans Screen Splash image

There are many proponents of investing based on market capitalization. James O’Shaughnessy is one of those proponents. We introduced four stock screening strategies in 2006 based on his book “Predicting the Markets of Tomorrow: A Contrarian Investment Strategy for the Next Twenty Years” (Portfolio, 2006). The book discusses market-capitalization trends and investment cycles that O’Shaughnessy believes last about 20 years.

The best-performing strategy of the group is called Tiny Titans, which focuses on low-price micro-cap stocks. Much research has been done regarding the success of investing in this market-cap category. AAII’s Shadow Stock Portfolio is based on a study that showed that small and micro-cap stocks tend to outperform the overall market over long periods of time.

O’Shaughnessy believes the reason for this outperformance is that few analysts follow these small stocks. In addition, many institutional investors and mutual funds cannot trade these stocks without moving the price due to the relatively small number of outstanding shares. This leaves room for surprises, which can lead to a performance “pop.” O’Shaughnessy also says that micro-cap stocks have a low correlation with the overall stock market, making them a potential hedge in a portfolio of larger-cap stocks.

On the flip side, micro-cap stocks can be very volatile and risky. A sudden influx or outflow of money in the stock can cause the price to move dramatically.

Screen Overview

AAII’s version of O’Shaughnessy’s Tiny Titans stock screen consists of very few criteria. First, all foreign stocks and over-the-counter stocks are eliminated. Next, a stock’s market capitalization must be between $25 million and $250 million. As of April 30, 2010, AAII’s fundamental stock screening program, Stock Investor Pro, included 2,299 stocks out of 9,858 that met this criterion. In contrast, large-cap stocks are generally considered to have a capitalization of $5 billion or greater.

After filtering out the larger capitalization stocks, the Tiny Titans screen looks for stocks with price-to-sales ratios of less than 1.0. O’Shaughnessy uses this as a proxy for “cheapness,” as opposed to a price-earnings ratio. His reasoning is that all viable companies have sales, and sales are harder to manipulate than earnings. In his book called “What Works on Wall Street” (McGraw-Hill, 2005), O’Shaughnessy found that stocks with low price-to-sales ratios produced higher returns. A total of 3,026 stocks in the Stock Investor Pro database met this single criterion, and 568 met all the criteria.

Finally, O’Shaughnessy thinks investors should hold 25 stocks in this micro-cap portfolio to diversify the risk that goes along with holding such volatile stocks. He narrowed the list to the 25 stocks with the highest 52-week relative strength as compared to the S&P 500. We adjusted this criterion until exactly 25 stocks passed, and ended up with a 52-week relative strength of greater than 245% for all passing companies.

Performance & Characteristics

Figure 1 gives the performance of the Tiny Titans screen since 1998. The performance is compared to the S&P 500, S&P MidCap 400, S&P SmallCap 600 and a list of all U.S. exchange-listed stocks. The Tiny Titans screen has outperformed each of these benchmarks on a cumulative basis, gaining 3,010.3% since 1998. The S&P SmallCap 600 index has gained 110.4% over the same period.

The worst year for the Tiny Titans was 2008 when it lost 56.4%. During that year of market turmoil, all but one of AAII’s stock screens (Piotroski) lost money and the Tiny Titans loss was among the largest. Its best year was 2003 with a gain of 154.8%. This was a good year for stocks in general and a better year for smaller capitalization stocks. Year-to-date, Tiny Titans is one of the better-performing screens, up 36.1% as of April 30, 2010.

Also worth noting is that the standard deviation (a measure of volatility) of this screen is 9.1 compared to a much lower 4.7 for the S&P 500.

Table 1 lists the portfolio characteristics compared to all exchange-listed stocks. Not surprisingly, the Tiny Titans have a much lower market cap ($174.6 million versus $468 million), a lower price-to-sales ratio (0.5 versus 1.5), and a much higher relative strength (370% versus 5%). Interestingly, looking at traditional measures of value, the Titans have a higher price-earnings ratio (21.0 versus 19.4) and a higher price-to-book-value ratio (1.8 versus 1.7) than the exchange listed stocks. However, looking at the passing companies list on page 29, you can see that most of the stocks have negative trailing 12-month earnings per share, making the price-earnings ratio not meaningful. A lot of micro-cap companies tend to be young, so negative earnings per share is not abnormal.

The highest number of passing companies in a month is 27 and the lowest is 24, due to ties in relative strength. The screen has a relatively high rate of turnover of 42.3% each month.

  Tiny
Titans
Exchange-
Listed
Stocks
 
Portfolio Characteristics (Median)
Price-earnings ratio (X) 21.0 19.4
Price-to-book-value ratio (X) 1.8 1.7
Price-to-sales ratio (X) 0.5 1.5
Price-earnings-to-EPS est growth (X) 2.0 1.5
EPS 5-yr. historical growth rate (%) -26.1 -0.6
EPS 5-yr. estimated growth rate (%) 10.0 12.1
Market cap. ($ million) 174.6 468.0
Relative strength vs. S&P (S&P=0) (%) 370 5
Monthly Observations
Average no. of passing stocks 25  
Highest no. of passing stocks 27  
Lowest no. of passing stocks 24  
Monthly turnover (%) 42.3  

Passing Companies

Looking at Table 2, you can see that the smallest company has a market cap of $30 million (Patrick Industries) and the largest of the group is $240 million (Libbey Inc.). Libbey also has the highest 52-week relative strength of the group (798%). The company designs, manufactures and markets a line of glass tableware, ceramic dinnerware and metal flatware.

Libbey has had a string of negative earnings since 2004. The company lost $5.84 per share in 2008 and lost $1.90 per share in 2009. The company had been increasing sales, losing only a little ground in 2009. With the economic downturn, this is not surprising. Cost of goods sold as a percentage of sales has remained relatively the same through the years. If sales are generally increasing and costs are inline, why is Libbey posting negative earnings? The answer is acquisitions and debt. The company was aggressive with acquisitions, which resulted in taking on a lot of long-term debt. Interest expense is eating away at the company’s earnings each year. In 2005, long-term debt was under $250 million. This number has doubled to over $500 million in 2009.

This demonstrates the importance of careful analysis of any stock. In fact, Libbey announced first-quarter earnings on April 29, 2010, that beat analyst expectations by 75%. However, the stock plummeted more than 7% the next week.

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This also demonstrates the risk of scarcely followed micro-cap stocks—prices can be extremely volatile.

Company (Exchange: Ticker) Share
Price
($)
Mkt
Cap
($ Mil)
P/S
Ratio
(X)
P/E
Ratio
(X)
12-Mo
EPS
($)
52-Wk
Rel
Strgth
(%)
 
 
 
Description
Libbey Inc. (A: LBY) 14.9 240.8 0.3 nmf -1.94 798 glass tableware
Spanish Broadcasting (M: SBSA) 1.7 111.2 0.9 nmf -0.33 640 media & entertainment
Lee Enterprises (N: LEE) 3.8 169.6 0.2 21.0 0.18 632 local news, info & advertising
Commercial Vehicle Gp (M: CVGI) 9.4 221.5 0.5 nmf -3.74 617 seat systems for trucks
Bell Microproducts (M: BELM) 7.0 226.1 0.1 31.8 0.22 551 data storage & server prods
Nexstar Broadcasting Gp (M: NXST) 6.7 190.8 0.8 nmf -0.44 533 TV broadcasting
BioFuel Energy Corp. (M: BIOF) 2.6 85.3 0.2 nmf -0.67 522 ethanol & co-products
NaviSite, Inc. (M: NAVI) 3.0 107.5 0.7 nmf -0.50 471 IT for enterprise-host servs
Salem Communications (M: SALM) 4.7 111.2 0.6 nmf -0.35 446 radio broadcasting
IDT Corp. (N: IDT) 9.9 224.3 0.2 nmf -1.92 436 telecom servs
Federal Agricu’l Mortgage (N: AGM) 22.5 228.4 0.8 2.8 8.08 424 ag real estate & rural mortgage
Emmis Communications (M: EMMS) 2.3 87.3 0.3 nmf -8.53 388 radio broadcasting
Patrick Industries (M: PATK) 3.3 29.9 0.1 nmf -0.61 370 RV building prods
Newcastle Investment (N: NCT) 3.8 200.0 0.6 nmf -4.23 348 real estate & finance
Sypris Solutions (M: SYPR) 4.5 88.4 0.3 nmf -0.30 346 specialty prods and servs
Gray Television (N: GTN) 3.8 182.4 0.7 nmf -0.83 306 TV broadcasting
NN, Inc. (M: NNBR) 7.2 118.9 0.5 nmf -2.17 304 metal & plastic components
Dreams, Inc. (A: DRJ) 1.6 61.7 0.7 nmf 0.00 302 sports memorabilia
Ultra Clean Holdings (M: UCTT) 9.9 212.7 0.9 nmf -0.45 299 systems for semiconductors
Kid Brands (N: KID) 10.0 215.1 0.9 18.5 0.54 284 infant & child consumer prods
Rural/Metro Corp. (M: RURL) 7.1 178.0 0.3 88.1 0.08 278 private fire protection servs
Lifetime Brands (M: LCUT) 14.5 174.6 0.4 111.8 0.13 276 kitchen appliances & home décor
Sport Chalet (M: SPCHA) 3.1 43.1 0.1 nmf -1.35 274 sporting goods stores
Navarre Corp. (M: NAVR) 2.2 78.2 0.2 4.7 0.46 259 PC software & video games
Jamba (M: JMBA) 3.6 188.7 0.6 nmf -0.48 246 retail fruit smoothie franchises
               

Conclusion

O’Shaughnessy believed that investing based on market capitalization could improve performance. However, he never advised holding a portfolio made up of only one market-cap category. He recommends that conservative investors limit small and micro-cap holdings to 25% of an overall portfolio—more aggressive investors can hold up to 35%.

Remember that these stock screens are not lists of recommended stocks. The screens simply find stocks with similar quantifiable characteristics. It is important to perform additional due diligence on any company that passes a stock screen.

 

Click here for the latest passing companies and performance data

 

Cara Scatizzi is a former associate financial analyst at AAII.


Discussion

Blah from ID posted over 4 years ago:

I cannot view


John from MI posted over 2 years ago:

Is there a new listing of these companies that were originally listed in the June Journal. I am referring to the tiny titans. Thanks


Jean from IL posted over 2 years ago:

The Tiny Titans is tracked in our Stock Screens area, where a new list of passing companies is posted each month:
http://www.aaii.com/stock-screens/screendata/OShauTinyTitans
-Jean, AAII


Diego from TX posted 7 months ago:

If you run SIPro, you'll see the screen spits out way more than 25 stocks because the 52% relative strength is based on a 85% change in price, not Top 25 (this article also alludes to that).

I'm not clear if the performance on AAII backtested since 1998 assumes that the % price change has been changed (manually) each month for top 25 or if the % change was kept constant at 85% price change.

In other words, is the recorded performance based on Top 25 or 85% 52-wk relative price change?

Thanks.


Joe Lan from IL posted 7 months ago:

The screen's results are based on the top 25 by 52-week relative price strength. It is manually adjusted monthly.


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