- Exclude companies that trade on the over-the-counter (OTC) market
- Exclude American depository receipts (ADRs)
- The current price per share is at least $12
- Earnings per share from continuing operations for the trailing 12 months is greater than or equal to earnings per share from continuing operations for the last fiscal year
- Earnings per share from continuing operations has increased by at least 10% over each of the last five fiscal years
- Quarter-on-quarter earnings and sales growth, as defined by growth between the latest fiscal quarter and the same quarter one year prior, is at least 10%
- The trend in growth in earnings per share from continuing operations is reasonably stable over the last seven years [R-squared for earnings from continuing operations is at least 80%]
The IBD Stable 70: Screening for Long-Term Growth and Stability
by Wayne A. Thorp
In 2001, the analysts and editors at Investors Business Daily (IBD) attempted to identify the characteristics of those companies that had weathered the recent economic and stock market downturn. The goal was to apply those factors going forward to identify recession-proof stocks. The fruit of their efforts was the IBD Stable 70 list, consisting of companies with strong and stable long-term earnings growth.
The IBD Stable 70 screen was short-lived within the pages of Investors Business Daily. However, a screen that follows the IBD Stable 70 approach is built into Stock Investor Pro, AAIIs fundamental stock screening and research database. In 2004, the IBD Stable 70 screen was the top growth screen among those tracked by AAII, up 29.0%. [For more on 2004 stock screen performance figures, see Stock Strategy Winners From the 2004 Performance Derby by John Bajkowski, in the January 2005 AAII Journal and available at AAII.com.]
Evaluating the Screen
Companies passing each of the AAII screens are reported and tracked on AAII.com each month, along with the performance of a simple hypothetical portfolio that has been backtested on a monthly basis over the last seven years.
The IBD Stable 70 screen has generated a positive return in every year but one (2002) between 1998 and 2004 (see Figure 1). And even though the screen lost 11.0% in 2002, it still managed to outperform several popular indexes, including the S&P 500, which lost 23.4% that year.
The year 1999 saw the worst relative performance for the IBD Stable 70 screen. While it was up 3.6% for the year, it lagged the major indexes by a considerable margin. Overall, the screen has been able to easily outperform the small-, mid-, and large-cap indexes over this seven-year period, gaining a cumulative 191.7% compared to a 24.9% gain for the S&P 500.
The characteristics of the stocks passing the IBD Stable 70 screen are presented in Table 1, while Table 2 lists the current passing companies. Screening criteria for the IBD Stable 70 are listed below.
Profile of Passing Stocks
|IBD Stable 70 Screening Criteria|
The stock market is forward-looking in its analysis, and if it expects high future growth in earnings for a given stock with great certainty, it may be willing to accept a higher price-earnings ratio today for that stock.
The stocks that passed the IBD Stable 70 screen have exhibited strong, consistent earnings growth over the last several years. Despite that, the median price-earnings ratio of 21.2 for those stocks currently passing the screen is not much higher than the median price-earnings ratio of all exchange-listed stocks of 20.6. However, the 4.0 price-to-book-value ratio of the passing companies is significantly higher than the 2.2 median ratio of all exchange-listed stocks.
Beazer Homes USA (BZH), a builder of single-family homes in the south, southwest, central, and mid-Atlantic regions of the U.S., has the lowest price-earnings ratio of the stocks currently passing the screen, 8.0. Construction services companies, along with regional banks, make up almost half of the current roster of passing companies. Cognizant Technology Solutions (CTSH), an information technology services company, has the highest price-earnings ratio, 65.4.
Since the IBD Stable 70 screen looks for companies whose earnings per share have grown by at least 10% over each of the last five fiscal years, it is probably not surprising that the 28.7% historical earnings per share growth rate of the passing companies well exceeds the 7.9% norm for all exchange-listed companies. However, looking forward, analysts have earnings growth expectations for this group of passing companies that are closer to those of exchange-listed stocks (16.4% versus 14.1%). This might help explain why the group has price-earnings ratios that are only slightly higher than exchange-listed stocks.
As its name indicates, the IBD Stable 70 screen looks not just for strong earnings growth, but also for companies with stable earnings growth. The Stable 70 screen, as originally constructed by IBD, made use of a proprietary earnings stability rate, which showed how a companys annual earnings compared with the trend of its earnings over the last five years. In our reconstruction of the IBD Stable 70 screen with Stock Investor Pro, the R-squared for earnings per share from continuing operations over the last seven years is used as a proxy for the stability filter. (Earnings from continuing operations ignores extraordinary and one-time charges, providing a better indication of a companys earnings potential going forward.)
|TABLE 1. IBD Stable 70 Portfolio Characteristics|
|Portfolio Characteristics (Medians)||IBD Stable 70 Screen||All Exchange-Listed Stocks|
|Market cap (million)||$2,649.90||$381.10|
|EPS 5-yr. historical growth rate||28.70%||7.90%|
|EPS 3-5 yr. estimated growth rate||16.4%||14.1%|
|EPS 7-yr. growth R-squared||98.4%||46.6%|
|Relative strength vs. S&P||19.0%||6.0%|
|Average no. of passing stocks||57|
|Highest no. of passing stocks||103|
|Lowest no. of passing stocks||24|
|Data as of January 7, 2005.|
In simple terms, R-squared measures how closely the actual data falls to a plotted trendline. A higher value for R-squared indicates a higher degree of stability or predictability. Stocks passing our IBD Stable 70 screen must have an R-squared value of at least 80%. The median R-squared value for the current list of passing companies is 98.4%, which overshadows the median value for exchange-listed stocks of 46.6%.
Table 2 lists the 51 stocks that passed the IBD Stable 70 screen as of January 7, 2005, ranked in descending order by R-squared for earnings per share from continuing operations over the last seven years. The total number of companies currently passing the screen is slightly below the average of 57 over the last seven years. Bed Bath and Beyond, best known for its domestics merchandise stores, has the highest R-squared value of 99.9%, while CUNO Incorporated had the lowest of the 51 passing companies at 84.3%.
The median market capitalization (shares outstanding times share price) of the stocks currently passing the IBD Stable 70 screen is $2,649.9 million, well above the median value of $381.1 million for all exchange-listed stocks. Among the passing stocks, market behemoth Johnson & Johnson (JNJ) is the largest company to pass the screen, with a market cap of $185.8 billion, and Fauquier Bankshares (FBSS) is the smallest to pass, with a relatively paltry $83.8 million market cap.
Given the markets refocus on real earnings following the bursting of the Internet bubble and 2002s stock market decline, it is perhaps not too surprising that stocks such as those passing the IBD Stable 70 screen that have exhibited strong and stable earnings growth have also seen their stock prices rise accordingly. As a group, the stocks currently passing the screen have outperformed the S&P 500 by 19% over the last 52 weeks, while the typical exchange-listed stock has outperformed the S&P 500 by 6% over the same period.
Earnings growth is not the only area of stability exhibited by these stocks. Since the IBD Stable 70 screen relies so heavily on historical annual financial performance, most of the data underlying the screen changes only once a year. Therefore, there is a relatively low level of turnover among these stocks. On average, 89.5% of the stocks that pass the screen one month pass the screen the next month.
The IBD Stable 70 screen looks for companies that are equipped to withstand economic and stock market downturns by isolating firms that have had strong long-term growth in earnings. Furthermore, the screen isolates companies that have been able to grow earnings in a stable manner.
However, the companies passing this or any other stock screen do not represent a recommended or buy list. Stock screening is merely a stepping-off point: It is important to perform additional due diligence to verify the financial strength of the companies and to identify those stocks that match your investing constraints.