Stock Strategy Winners From the 2004 Performance Derby

    by John Bajkowski

    After nearly 10 months of jockeying up and down, the stock market nosed decisively ahead and is poised to end 2004 with gains for all the major indexes. The S&P 500 is up 6.1% through December 10, 2004, while the S&P SmallCap 600 is up 17.6%. Forty-five of the 54 strategies tracked on showed positive gains for 2004.

    Table 1 on presents the performance of the stock screens tracked on, along with index performance data. The screening approaches 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 companies are ranked by performance for 2004.

    The value-priced technology screen that follows the Michael Murphy philosophy led all strategies during 2004 with an 87.7% gain, while the growth-and-value Zweig approach continued as long-term leader by gaining 39.4% during 2004, resulting in a 1,183.2% cumulative gain since 1998.

    AAII has been developing, testing, and refining a wide range of screening strategies over the last seven years. Many of the screens follow the approaches of popular investment professionals, while others are tied to basic principles of investing. These approaches run the full spectrum, from those that are value-based to those that focus primarily on growth, while most fall somewhere in the middle. There are even a number of specialty screens that attempt to gauge the stock selection impact of a single variable—such as the short ratio.

    Screens following the approach of an investment professional do not represent their actual stock picks. The rules of each screen are defined by our interpretations of their respective investment approaches. The results of the screening strategies, as well as the criteria for each screen, are programmed into the Stock Investor Pro program and are also posted in the Stock Screens area of

    Each month over 50 separate screens are performed using AAII’s Stock Investor Pro and the current companies passing each individual screen are reported. Stock Investor Pro subscribers can perform the screens themselves, while AAII members can access the screening results by clicking on the All Screens link within the Stock Screens area of The results are usually posted to the site in the middle of each month using data from the previous month’s end.

    The performance of the stocks passing each screen is tracked on a monthly basis. The month-to-month closing price is used to calculate the return, with equal investments in each stock at the beginning of each month assumed. The impact of factors such as commissions, bid-ask spreads, cash dividends, time-slippage (time between the initial decision to buy a stock and the actual purchase) and taxes is 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.

    Small-cap issues continued to outperform larger companies with a 17.6% gain, marking their fifth year of outpacing larger-company stocks. Historically, small-cap performance tends to be streaky and five years of strong relative performance has pushed the price-earnings ratio (price divided by earnings per share) of small-company stocks above that of larger companies. Time will tell if the small-cap winning streak will continue through 2005.

    Value strategies tended to perform better than growth approaches across all market capitalization segments during 2004, although the difference was more pronounced with larger-company stocks.

    Judging How They Performed

    Table 1 summarizes the performance and variability of the stock screens built into AAII’s Stock Investor Pro software program and presented on

    When examining the figures, it is important to keep in mind that past performance is no guarantee of future success. While the Murphy Technology screen was the best-performing strategy during 2004, it was the only strategy to show a loss during 2003. Many of the growth-oriented strategies came up short during 2004, after exhibiting exceptionally strong performance in 2003.

    The 2004 Winner

    The Murphy low-price-to-growth-flow approach identifies technology stocks with high research and development spending, strong margins, a solid return on equity and high revenue growth, but selling at attractive valuation levels. It is a growth-and-value strategy that invests in the volatile technology sector. Exchange-listed technology stocks in Stock Investor Pro were up 5.3% during 2004. The 87.7% gain for the Murphy approach was impressive, but it came on the heels of a 33.7% loss in 2003 and a 79.6% loss in 2002. The strategy did well in the technology-driven bull market of the late 1990s, but then collapsed even more dramatically than the technology sector during the bear market that followed. So although the Murphy Technology screen had the best performance during 2004, it also has the worst long-term performance record, with a 52.2% cumulative loss since 1998.

    Value Winner

    The Piotroski screen led the value strategies during 2004 with its 62.3% gain and is also the long-term value leader with its 933.2% cumulative gain since 1998. The screen seeks stocks with low price-to-book values that have strong and improving financial strength. The screen tends to turn up smaller-cap value stocks, which have led the market in the past few years.

    Growth & Value Winner

    The Lynch screen is the 2004 leader among the growth-and-value approaches with a 53.3% gain. This screen looks for reasonably-priced stocks that are not widely held by institutions. It seeks companies with price-earnings ratios below the industry norm as well as stocks with a low PEG ratio adjusted for dividend yield (price-earnings ratio divided by the dividend yield plus the earnings growth rate), strong financials, and below-average institutional ownership.

    Growth Winners

    Half of the growth strategies suffered losses during 2004, but the Investor’s Business Daily Stable 70 screen led the pack with its 23.8% gain. This screen identifies stocks with strong quarterly earnings and revenue growth coupled with consistent annual increases in earnings per share.

    Breeder’s Cup: The Investment Characteristics of the 2004 Winners
    The 2004 investment environment provided a more difficult and uncertain track than in 2003. Economic, political and world issues were prime concerns. Investors were forced to deal with a weak dollar, rising short-term interest rates, high oil prices, Middle East violence, and a close presidential race. Over the course of the year, smaller-cap strategies outperformed strategies that feature larger companies, and strategies that look for reasonably priced stocks performed better than strategies that focus on growth and momentum.

    The Murphy low-price-to-growth-flow approach was the best-performing strategy during 2004 with its 87.7% return, a big turnaround from 2003 when the strategy lost 33.7%. Exchange-listed technology stocks tracked in Stock Investor Pro were up 5.3% during 2004, so the few stocks passing the Murphy approach managed to easily beat their peer group. However, even with its strong 2004 performance, the Murphy Technology approach has the weakest seven-year performance with a cumulative loss of 52.2%.

    Table 2 presents the current characteristics of the top- and bottom-performing strategies for 2004 and cumulatively since 1998.

    Many of the bottom-performing strategies are specialty and sector screens. The Estimate Revisions Up 5% screen made the list of long-term top performers while its counterparts—Estimate Revisions Down and Estimate Revisions Down 5%—made the list of weakest cumulative performing screens. Note that the strong performance for the upward revision screen and weak performance for the downward revision screens came the month after the revision, which points to the persistent impact of an estimate revision.

    Market Capitalization

    The median market capitalization (share price times number of outstanding shares) for major S&P indexes is:

    • S&P 500: $10.1 billion
    • S&P MidCap 400: $2.2 billion
    • S&P SmallCap 600: $736 million

    Among the top 2004 performers, the Murphy, Piotroski, and Lynch strategies would be classified as small-cap portfolios, while the current portfolios of the Value on the Move—Estimated Growth and Zweig approaches are mid-cap in size. The only large-cap strategies to make the list of winning and losing strategies are the Dogs of the Dow strategies. These strategies look at Dow Jones industrial average stocks with the highest yield. The median market cap for these strategies is over $80 billion. Both Dogs of the Dow strategies also made the Total History bottom-performing list. Large-cap issues have underperformed small- and mid-cap strategies over the last seven years. The large-cap S&P 500 is up 21.6% since the beginning of 1998, while the S&P MidCap 400 gained 92.4% and the SmallCap 600 gained 75.9%.


    The price-earnings ratio (price divided by trailing 12-month earnings per share) of the Murphy Technology screen is well below the median for all the exchange-listed stocks in Stock Investor Pro. All of the winning strategies for 2004 have current portfolios with price-earnings ratios below the typical exchange-traded stocks, while three of the losing 2004 strategies feature portfolios with high ratios.

    The Piotroski screen has the lowest price-to-book-value ratio (price divided by book value per share) among all of the strategies. Its ratio of 0.9 is less than half the median for all exchange-traded stocks. This screen looks for stocks with price-to-book-value ratios among the lowest 10% of all stocks.

    The multiples (price-earnings, price-to-book and price-to-sales ratios) of winning strategies tend to be lower for the 2004 winning strategies than those of the losing strategies.

    The price-earnings to earnings-per-share-growth ratio is called the PEG ratio and attempts to balance the trade-off between price-earnings ratios and earnings growth rates. Investors are willing to pay more for current earnings when there are reasonable expectations of growth and higher earnings in subsequent years.

    The PEG ratio is computed by dividing the normalized price-earnings ratio (price divided by the estimated current year earnings per share) by the estimated earnings per share growth rate. Normally, companies with PEG ratios near 1.0 are considered fairly valued. Ratios above 1.5 may indicate overvalued stocks, and ratios below 0.5 potentially indicate attractively priced stocks.

    While no clear patterns emerge among the winning or losing strategies, many of the growth strategies sport higher PEG ratios. The Piotroski value screen has the highest PEG ratio of 3.2, but this figure is based upon the single company (out of a passing portfolio of three stocks) within this small-cap strategy that has a long-term earnings estimate.

    Relative Strength

    The relative strength index in the table is calculated against the performance of the S&P 500. Stocks with performance equal to the S&P 500 over the last 52 weeks have a relative strength index of zero. A relative strength rank of 7.0 indicates that a stock outperformed the S&P 500 by 7%. Negative numbers indicate underperformance relative to the index. The stocks making up the Murphy Technology screen have a median relative strength of –16.0%, indicating that the individual stocks currently passing the screen have underperformed the S&P 500 by 16% over the last year.

    The top three performing strategies for 2004 were able to succeed by selecting stocks that had weak relative strength. This is a break in the pattern from past years. As observed among the long-term winners and losers, normally the portfolios of the better-performing strategies are made up of stocks with strong relative price strength.

    Winning Characteristics

    Overall, these are the common elements found in many of the long-term winning stock selection strategies:

    • Low, but not necessarily the lowest multiple (price-earnings ratio, price-to-book ratio, etc.);
    • Emphasis on consistency of growth in earnings, sales, or dividends;
    • Strong financials;
    • Price momentum; and
    • Upward earnings revisions.

    Turnover & Risk

    The Monthly Holdings columns in Table 1 provide data on portfolio holdings over time—the average total number of stocks that were in each portfolio over the last seven years and the average turnover percentage from month to month. On average, 12 companies have passed the Murphy Technology screen since 1998, but during 2004 the screen averaged only two passing companies. Its strong 2004 performance came from holding only a handful of companies in any given month or point in time.

    The Percent Turnover column gives an indication of how many stocks leave a given strategy from month to month. Every month, these portfolios are rebalanced and only those companies passing the screen for a given month are held over to the next month. The lower the percentage turnover, the greater the chance that a company will pass a screen month after month. The Murphy Technology screen has averaged a 22.5% monthly turnover rate, which is below average for the strategies tracked by AAII.

    As a general rule, approaches that focus on value tend to have less portfolio turnover than the pure growth approaches; they also tend to be less volatile and outperform other approaches during bear markets.

    The Murphy Technology screen led the pack in 2004 with a concentrated portfolio of reasonably priced technology stocks—a high-risk approach. When measuring performance, the risk of the strategy should also be considered. The Monthly Variability columns report the greatest monthly percentage gain and loss as one indication of the volatility that occurred over the last seven years.

    The Murphy Technology approach had a maximum loss of 44.9% in value during a single month, and has gained as much as 58.5% in one month. By way of comparison, the most that the S&P 500 index gained in a single month was 9.7%, and its largest single monthly loss was 14.6%.

    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, that indicates the degree of variation in return experienced relative to the average for a strategy over the test period. The higher the standard deviation, the greater the total risk of the strategy.

    The 16.8% monthly standard deviation of the Murphy Technology screen is the highest figure among all the screening strategies and well above the 4.9% figure of the S&P 500. The Long-Term Winner

    The Cumulative Price Change column in Table 1 represents the percentage amount each test portfolio has appreciated or lost from January 1, 1998, through December 10, 2004. It does not include dividends. Large-cap value strategies, such as Dogs of the Dow, would be impacted the most by this type of dividend reinvestment exclusion. The current average dividend yield of the Dogs of the Dow screen is 3.9%; shareholders of these stocks would actually have a return that is higher by approximately this amount annually.

    Figure 1.
    Winning Performance:
    Murphy and Zweig

    The strongest gain over the past seven years comes from the screen using the Zweig approach, which is up 1,183.2% cumulatively. By way of comparison, the S&P 500 has gained 21.6% over the same period of time. Martin Zweig is a former professor who became a newsletter writer and money manager. Our interpretation of his strategy is based upon his book “Martin Zweig’s Winning on Wall Street” (Warner Books, 1997), in which he outlined how to identify companies with strong growth in earnings and sales, a reasonable price-earnings ratio given the company’s growth rate, insider buying (or at least an absence of heavy insider selling), and relatively strong price action.

    This growth-and-value approach examines trends in both quarterly and annual sales and earnings growth, with an emphasis on consistent and strong results.

    Zweig believes that a price-earnings ratio can be too high or too low. He feels that there are two types of companies with low price-earnings ratios—those that are experiencing financial difficulties and neglected companies.

    The risks of investing in financially troubled firms, in Zweig’s opinion, are too great to justify the investment in them, since the risk of these firms going under overshadows any potential “value” in these stocks.

    Neglected stocks, on the other hand, are ignored by the market and often exhibit extraordinary performance once discovered.

    The price-earnings ratio constraints for the Zweig growth-and-value screen consist of a minimum level of 5.0 to avoid potentially troubled firms and a maximum level of 1.5 times the median price-earnings ratio of the entire Stock Investor database (to avoid overpriced firms).

    The final element of the Zweig screen looks for companies exhibiting price momentum by requiring that any passing company outperform the S&P 500 over the last half-year.


    These strategies are based on relatively simple screens that are interpretations of the investment approaches advocated by prominent investment professionals. The strategies attempt to establish a practical set of rules for each approach, which is the first step in any disciplined investment approach. Examining their investment characteristics reveals many of the practical problems that you may run into when trying to develop your own disciplined approach to investing.

    As you look at the performance of these screens, do not just quickly buy all the stocks that pass the strategies with the highest performance. Instead, try to gain an understanding of the forces that impacted their performance and how these strategies might perform during current and expected economic and market environments.

    Most importantly, remember that screening is just a first step. There are qualitative elements that cannot be captured effectively by a quantitative screening process.

    For further information on these approaches, consult the Stock Screens area of

    Jockeying for 1st: The Stocks That Won the Strategy
    The Murphy Technology screen crossed the 2004 finish line with a top-performing gain of 87.7%, a great recovery after collapsing during 2003 with a loss of 33.7%.

    What stocks spurred the strategy to such a distinctive performance?

    It was a concentrated portfolio of volatile small-cap technology stocks.

    The Murphy screen seeks out technology stocks with high research and development (R&D) spending as a percent of sales, high pretax margins and return on equity, strong top-line sales growth, but selling at attractive values as measured by “growth flow.” Murphy does not believe in paying any price for growth. Instead, he prefers to follow companies and purchase them only when valuations reach attractive levels.

    The problem, however, is that traditional valuation approaches are misleading for technology companies. R&D spending directly cuts into a company’s current earnings; as a company spends more on R&D, its current reported earnings lower proportionally. The result will be a relatively higher price-earnings ratio for companies that spend more on R&D. Murphy therefore adds per share R&D spending (R&D spending divided by the number of shares outstanding) to earnings per share to determine what he terms a company’s “growth flow.” Dividing the current price of a stock by the growth flow per share provides the price-to-growth-flow ratio. Murphy uses this ratio to measure the underlying investment value of a technology stock. As a guideline, Murphy views technology stocks as fairly priced when price-to-growth-flow ratios are around 10 to 14; anything under eight is cheap and below five is a real bargain; 16 and over is too expensive.

    Table 3 presents all of the stocks that passed the screen during the year, along with their performance while they were held, the number of months the stock was held, and current financial data.

    What these stocks have in common is that they had a low price-to-growth-flow ratio when they passed the Murphy screen.

    Verticalnet, Inc. was the best-performing stock that passed the Murphy screen during 2004. Verticalnet provides supply management software, services and expertise. Its 116.1% gain came while the stock was held two months—January and February. Fortunately, the portfolio held the stock during January—when the stock gained 158.5% as its price shot from $1.18 to $3.05. The stock price jumped on news of winning major contracts and resolving SEC probes without the need to restate reported sales or earnings.

    Simulations Plus gained 45.4% in the eight months that it was held in the Murphy portfolio. The company designs and develops cost-saving pharmaceutical simulation software used in research and in the education of pharmacy and medical students. The micro-cap stock price benefited from the visibility of becoming listed on an exchange and winning a number of contracts. Its price-to-growth-flow ratio was 5.7 one year ago when it first passed the Murphy screen. Today, with its price-to-growth-flow ratio at 15.2, it no longer qualifies for the portfolio.

    Sand Technology passed the screen at the start of every month during 2004. The company’s software products help business users to make fast, easy inquiries of large databases without intervention by specialized information technology professionals. The extremely volatile stock of this company witnessed frequent double-digit monthly price swings up and down and would not pass the screen midway through December.

    The Murphy screen has produced a test portfolio with impressive returns during 2004, but these returns have been achieved through a concentrated small-cap portfolio consisting of a few volatile technology stocks. It offers the sophisticated and knowledgeable investor some promising technology stock ideas, but investors seeking a diversified portfolio will need to look elsewhere.

    John Bajkowski is AAII’s financial analysis vice president and editor of Computerized Investing.

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