Which Stock Strategies Did Best? A Mid-Year Performance Review

    by John Bajkowski

    Which Stock Strategies Did Best? A Mid Year Performance Review Splash image

    Midway through 2002, the weakness of the market has helped to create an environment in which negative sentiment dominates the stock market’s reaction to news and world events. Factors such as the threat of additional terrorism, heightened international tensions, and the damaged credibility of the accounting profession, corporations and Wall Street itself, override any positive economic news.

    With the S&P 500 down over 10% year-to-date, a negative return for the 2002 calendar year would be its third consecutive calendar year of losses—the first such occurrence since 1939 through 1941. The S&P 500 is a popular benchmark for stock market performance, but it only covers the largest companies traded on U.S. exchanges and the performance of other market segments has varied over the last few years. The S&P MidCap 400 measures mid-sized firms, while the S&P SmallCap 600 tracks small-cap companies. Notably, smaller companies, as measured with the S&P SmallCap 600 index, have exhibited positive rates of return over the last three and a half years—relatively good performance after a period of underperformance.

    Figure 1.
    Performance of Indexes

    The technology-heavy Nasdaq 100 continued its weakness through the first half of 2002, losing over 27% through early June. This strong decline comes on the heals of a loss of 32.7% in 2001 and a loss of 36.8% in 2000. Figure 1 shows the performance of the various indexes over the last four and a half years.

    The other metric that is normally used to segment stocks is style: growth versus value. Value approaches seek stocks that are priced cheaply relative to tangible variables such as earnings, book value, sales, or cash flow. Growth approaches seek stocks with rapidly expanding sales and earnings, with little regard to the stock price relative to value. Growth-oriented performance tends to move up more sharply during bull markets, but also falls more sharply during bear markets. In contrast, value strategies tend to be less volatile and can even gain during mild down markets. Value strategies have come on strong over the last few years and the effect was especially pronounced among small-cap value stocks, which gained 20.9% in 2000, 13.1% in 2001 and are up just over 10% through the first five months of 2002.

    It is within this context that the performance of the various stock screen strategies followed on AAII.com is examined. The built-in screens of AAII’s stock screening program Stock Investor Pro and the Stock Screens segment of AAII.com have become popular starting points for members seeking a disciplined investment approach following the philosophy of many popular investment gurus.

    For the last four and half years, a monthly stock screen has been presented and discussed on the Stock Screens segment of AAII.com, while the success and the results of all the previous screens have simultaneously been tracked and updated. Over 50 screens are tracked that cover the full spectrum of investment approaches, ranging from value investing in utilities to momentum investing in small-cap growth firms. Some of the approaches attempt to capture the investment philosophy of famous investors such as Benjamin Graham, while other screens explain and implement basic investing approaches—such as investing in stocks with low price-to-cash-flow ratios. It is important to keep in mind that the screens following the approach of a famous investor do not represent their actual stock picks. The criteria for each screen are defined by our own interpretations of the investment approaches. A strategist may or may not actually invest in a passing stock. The criteria used for each screen on AAII.com is presented on-line and is also preprogrammed within Stock Investor.

    The performance of the screens helps investors gain an understanding of their success and performance characteristics. Each month over 50 separate screens are performed using AAII’s Stock Investor Pro and the current companies passing each individual screen are reported. AAII Stock Investor subscribers can perform the screens themselves, while other members can access the screening results by clicking on the All Screens link within the Stock Screens area of AAII.com. The results are posted to the site in the middle of each month.

    Hypothetical portfolios for each screening strategy are constructed each month and the performance of each approach is tracked. The performance reflects buying and selling each month at the month-end closing price. The impact of factors such as commissions, bid-ask spread, 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.

    Table 1 presents the price gains (dividends excluded) for the various investment strategies that are tracked, along with index performance data. Even with over four and a half years of performance tracking, it is difficult to determine if any approach has special characteristics that will make it a top performer over the long haul. But the screens are observable during at least some overall market and sector ups and downs.

    Determining long-term success requires testing over several market cycles at a minimum.

    Furthermore, these stock screens are only a first step in developing a real investment portfolio. These portfolios are merely computer-generated lists with no further individual company fundamental analysis. The other thing to keep in mind is that some of these screens were developed to examine and test the potential investment value of a specific investment factor, such as short interest, and resulting test portfolios are not balanced and diversified portfolios.

    As you look at the performance of the screens, do not simply follow the strategies with the highest performance. Instead, try to understand the forces that affect their performance.

    The performance table (Table 1) and portfolio characteristics table (Table 2) group the strategies by growth versus value approaches. They present a summary of the approaches and some of the investment characteristics of the portfolios.

    Price Change

    The Total Gain column within the performance table represents the amount each test portfolio has appreciated in each of the last four and a half years and cumulatively over the over the whole period. It does not include dividends. For example, the Weiss Blue Chip Dividend Yield (value) approach gained 75.8% cumulatively over the last four and a half years. During this time period, shareholders of these stocks would have also received stock dividends that would have increased their rate of return, but the performance figures do not consider the impact of this income. Large-cap value strategies such as Dogs of the Dow would be impacted the most by this type of exclusion. The current average dividend yield of the Dogs of the Dow is 3.4%; shareholders of these stocks would actually have a return increase by approximately this amount over the course of one year.

    Monthly Variability

    When measuring performance, the risk of the strategy should also be considered. The Monthly Variability columns report the greatest monthly gain and loss as an indication of the volatility that occurred over the last three years. For example, the most that the Joseph Piotroski Low Price-to-Book Value screen gained in a single month was 25.7%, while the most that it lost in a single month was 17.2%. By way of comparison, the most that the S&P 500 index gained in a single month was 9.7%, while 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 8.4% monthly standard deviation of the Piotroski screen is above the S&P 500’s 5.1% figure, indicating a more volatile strategy over the last four and a half years.

    Monthly Holdings

    The Monthly Holdings columns provide data on portfolio holdings over time—the total number of stocks that were in each portfolio over the last four and a half years and the average holdover percentage from month to month as an indication of turnover. The Piotroski screen has averaged eight passing companies, but has had as many as 18 stocks and as little as two stocks pass the filter for a given month.

    The Percent Holdover column gives an indication of the turnover for a given strategy. Every month these portfolios are rebalanced and only those companies passing the screen for a given month are held. The higher the percentage holdover, the greater the chance that a company will pass a screen month after month. Within the value groups, the Dogs of the Dow approach averaged 92.3% in holdovers from month to month. Since the portfolio has 10 stocks, normally one stock would have been replaced, while nine were held over for a given month. At 9.2%, the Josef Lakonishok screen had the lowest holdover percentage within the value group. As a general rule of thumb, approaches that focus on value tend to have less portfolio turnover than the pure growth approaches, tend to be less volatile, and outperform other approaches during bear markets.


    So far the top-performing screens during 2002 were also leading strategies during 2001. The Joseph Piotroski screen led the value strategies during the first half of 2002 with a gain of 31.1% through June 7 and 289.8% over the last four and a half years. The Piotroski screen starts with low-price-to-book-value stocks to help identify which stocks may be truly undervalued and neglected, but then adds nine filters to seek out stocks with solid and improving financials. The Piotroski screen examines profitability, financial leverage, liquidity, and operating efficiency using popular ratios and basic financial elements that are easy to use and interpret. The approach has led to relatively small portfolios with significant monthly variability. During 2002, between three and seven stocks have passed the screen for any given month.

    Table 2 presents the characteristics of the stocks that passed the screens in each approach at the beginning of June. The stocks passing the Piotroski screen tend to be very small-cap issues, as indicated by the median market capitalization of $153 million. The Piotroski screen resulted in a portfolio with a median price-earnings ratio (price divided by trailing 12-month earnings per share) of 3.6—well below the typical exchange-listed stock in Stock Investor, which carries a price-earnings ratio of 19.3. The strong financial screening elements of the approach lead to a portfolio with above-average historical growth rates. The small-cap concentration of the screen also leads to companies well in the shadows of Wall Street—no analysts were tracking the stocks currently passing the screen. The stocks themselves, however, have been strong performers as indicated by the median relative strength figure of 89% for stocks within the current portfolio. The 52-week relative strength index 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 figure of 7.0 indicates that a stock outperformed the S&P 500 by 7%. Negative numbers indicate underperformance relative to the index.

    Growth and Value

    The performance of the growth and value approaches varied considerably over the last four and a half years, reflecting different emphasis on growth and value as well as market capitalization. The Philip Fisher screen has produced the best performing strategy for the first half of 2002 and 2001 within the growth and value segment. The approach attempts to find companies with a competitive advantage that positions them for long-term growth. The screens look at factors such as above-average profit margins, strong and consistent sales growth, as well as a low forward PEG ratio.

    The PEG ratio 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 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, while ratios above 1.5 may indicate overvalued stocks, and ratios below 0.5 potentially indicate attractively priced stocks.

    The Philip Fisher screen produced a portfolio with a below average price-earnings ratio of 15.2, coupled with the above average expected earnings growth rate of 28.0%. The Fisher screen was more volatile than the typical screen or the S&P 500. It’s monthly standard deviation of 10.5% was the highest of growth and value approaches.

    The Fisher screen’s emphasis on reasonably priced growth, which excluded companies paying dividends, tended to turn up smaller-capitalization companies. The median market capitalization of the Fisher portfolio is $972 million, but the stocks from the June screen had median relative strength of –30%. On average, 38 companies have passed the Fisher screen.


    Growth strategies want to buy growth, period. Their focus is on companies that are rapidly expanding sales and earnings. The approach tends to be more volatile—prices can move up or down substantially, with small changes in expectations. William O’Neil’s CANSLIM approach is the most pure growth strategy of the group and, surprisingly, a strong performer over the last two and half years. The CANSLIM approach led the growth approaches with a 15.4% return during the first half of 2002, but also had group-leading performances of 54.4% during 2001 and 38.0% during 2000.

    Growth strategies tend to have more active portfolios. On average, only 47.3% of the stocks made it from one month to the next with the CANSLIM approach. The screen looks for strong and increasing quarterly earnings growth, strong and stable annual earnings, a limited float (shares available for trading), minimum institutional sponsorship, and strong price strength. As a momentum approach, it is not surprising to see a tremendous swing in the number of stocks passing the screen—from a low of one, to a high of 32. A critical element of the CANSLIM strategy that is not captured by the screen is the element of market timing. While it does not impact the selection of specific stocks, the trend of the overall market will have a tremendous impact on the performance of your portfolio. O’Neil finds it difficult to fight the trend, and his approach emphasizes that investors should try to put 25% of their portfolios into cash during bear markets. He also tends to focus on technical measures when determining the overall direction of the marketplace.


    These strategies are based on relatively simple screens that are interpretations of the investment approaches advocated by prominent investment professionals. They do not replicate a buy-and-hold strategy, which is the optimal approach for an individual investor.

    The strategies do, however, attempt to develop 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 you are trying to develop your own disciplined approach to investing.

    As you look at the performance of the screens, do not blindly follow the strategies with the highest performance. Instead, try to gain an understanding of the forces impacting upon their performance and determine what kind of market environment could be expected in the future.

    Here are some important questions to ask that will help you evaluate any series of screens that seek to capture an investment approach:

    • How is the portfolio reacting relative to the current market environment? If it is deviating substantially, what is the cause of that deviation—is it the particular stock picks, or it is perhaps overconcentration in a particular sector that is a result of the particular set of screens you have chosen?

    • Are the portfolio’s characteristics more similar to a value-based or growth-based approach? This may give you a better idea of how the portfolio is likely to behave in the future.

    • Are the screens actually capturing the kinds of firms you want to invest in based on your chosen investment approach? Make sure the screens are not producing unintentional biases in your portfolio.

    • What is the proper benchmark to measure the performance of your portfolio? It is important to look at the characteristics of your portfolio (market capitalization, industry concentration, growth vs. value) to properly select a benchmark to evaluate the performance of your holdings.

    • How frequently do your screens cause your portfolio to substantially change? If trading is frequent, you need to consider developing “hold” criteria rather than selling whenever initial criteria are no longer met—which may cause you to sell winners too soon. Most importantly, remember that screening is just a first step. There are qualitative elements that cannot be captured effectively by a quantitative screening process. Further fundamental analysis is necessary for successful investing.

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

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