Small Caps & Value Lead at the Mid-Point of 2006

    by Wayne A. Thorp

    At the halfway point of 2006, investors are left to wonder: Will the markets rebound from their recent slump, or will three years of market gains be wiped out by near-record-high oil prices and the new Federal Reserve chairman’s apparent mission to “whip inflation now” that threatens to drag corporate earnings and the U.S. economy down?

    In early May, the broad market indexes were reaching levels not seen for years—the Dow Jones industrial average was at its highest level since December 1999 and the S&P 500 reached levels last seen in February 2001. However, since then the S&P 500 has lost over 5.5% and clings to a year-to-date increase of 0.3% through the close of June 9.

    Despite recent market weakness, the stock screens tracked on have fared rather well thus far for 2006: Thirty-nine of 54 have generated positive returns.

    Reversing last year’s trend, value-oriented strategies are topping growth-oriented approaches. In addition, strategies investing in small-cap companies have outperformed those focusing on mid- and large-cap companies.

    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

    We have been developing, testing, and refining a wide range of screening methodologies over the last nine years.

    Many of the screens follow the methodologies of popular investment professionals—as interpreted by AAII through the study of works by and about the individuals.

    Table 1 presents the price gains for the various investment methodologies 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 2006 (through June 9).

    Mid-Year Leaders

    Benjamin Graham’s value-oriented “Enterprising” screen led all strategies during the first half of 2006 with a 25.4% gain. Meanwhile, the growth-and-value Martin Zweig approach maintained its record of long-term dominance with a 1,649.5% cumulative gain since 1998. Figure 1 traces their performance compared to benchmark indexes over the same period.

    Figure 1.
    Mid-Year Performance
    Winners: Graham Enterprising
    and Zweig

    The Graham—Enterprising approach identifies low price-earnings and price-to-book stocks with strong balance sheets and positive and growing earnings over the last five years that also pay a dividend. The performance of the Graham—Enterprising approach appears to be a carryover from 2005, where it was one of the top-performing methodologies for the year with a 21.3% return. The approach is on pace for its seventh straight year of gains.

    Despite its long-term superiority, 2006 has not been overly accommodating to the Zweig approach, as it lost 0.6% through the first half of the year—this after posting the second-highest gain last year among strategies tracked by AAII with a 27.8% return. 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 relative to the market norm. The screen currently favors mid-cap companies in the oil and gas operations and oil well services and equipment industries.

    Long-Term Value Winner

    Value-oriented screening approaches have had a relatively smooth time of things thus far for 2006, which is a change over last year.

    Of the 18 value methodologies, all but two have produced positive returns for the first half of 2006. What is surprising, however, is that the two approaches in the red are the groups’ best long-term performers—the John Neff and Joseph Piotroski methodologies.

    The long-term value leader is the Piotroski screen, with a cumulative return of 793.3% since 1998. The screen seeks stocks with low price-to-book values that have strong and improving financial strength and tends to isolate smaller-cap value stocks. The methodology’s abysmal 2006 performance—a loss of 15.8%—is a continuance from 2005 when it lost 8.5% and is the worst year-to-date return of all the approaches AAII tracks. Currently no companies pass the Piotroski screen and its historical average of six holdings is among the lowest of all of the methodologies.

    Growth & Value Winner

    For the second year in a row we find nearly a 50/50 split between gainers and losers among growth-and-value strategies over the first half of the year. Of the 16 methodologies in this group, nine have generated positive returns thus far. The Oberweis Octagon, which led the group with an 18.3% gain, is an eight-step approach to isolative aggressively growing companies that are attractively priced. The strategy calls for rapid annual growth in revenues, pretax income and earnings per share, constant or accelerating quarterly growth in revenues and earnings, a reasonable price-earnings ratio in relation to the underlying growth rate, and high relative price strength. Over one-third of the current passing companies are in the oil and gas operations and oil well services and equipment industries.

    Growth Winners

    The momentum-oriented stockpicking methodology of Richard Driehaus led all the growth strategies for the first half of 2006 with its 17.7% gain. The Driehaus approach seeks out small- and mid-cap companies with increasing annual earnings growth, that have had “significant” positive earnings surprises, and have a rising stock price. This volatile methodology has the second-highest monthly standard deviation (a measure of risk) of all strategies tracked by AAII. It has also generated one of the highest single-year returns (107.4% in 1999) as well as one of the lowest (–42.6% in 2002). It has the third-highest single-month return of 51.3% in February of 2000. The current set of passing companies are focused in the technology, energy, financial and services sectors.

    The long-term performance leader within the growth category continues to be William O’Neil’s CAN SLIM approach. The methodology has generated a 927.4% gain over the last eight and a half years. 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 for each of the last five years, and strong price momentum over the last 52 weeks. Over half of the companies currently passing the CAN SLIM screen are in the financial sector.

       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

    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 members can access the screening results by clicking on the AAII Stock Screens link, listed under Portfolios in the left-hand column of

    At, 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.

    Risk and Turnover

    When measuring the performance of any investment approach, the risk of the strategy should also be considered. Just because the approach has a strong and consistent track record doesn’t necessarily mean it is right for you. Individual risk tolerances should also play a role in deciding the types of stocks a person should invest in.

    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 eight 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 Monthly Holdings columns provide data on portfolio holdings over time—the total average number of stocks that were in each portfolio on a monthly basis over the last eight and a half years, and the average percentage turnover from month-to-month.


    The strategies we track are based on relatively simple screens that are AAII’s 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 strategy, which is the first step in any disciplined investment approach. As you look at the performance of the screens, 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.

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

→ Wayne A. Thorp