The year of 2021 was another memorable one. We saw new surges in coronavirus cases, a global supply chain crisis, inflation at levels not seen in decades and millions of Americans leave the workforce. Despite all of this, the stock market continued to reach new highs throughout the year. However, fourth-quarter market volatility tied to the discovery of the omicron coronavirus variant and heightened inflation worries put the current market uptrend under pressure.

Crisis-era monetary accommodation is nearing an end. On November 30, 2021, Federal Reserve chair Jerome Powell added to the market’s angst by setting the stage for a quicker end to stimulus amid a worsening inflation outlook. Consumer inflation was up nearly 6.8% versus a year ago and was at its highest level since 1982. The data supported the realization that inflation is not transitory and puts an even more critical eye on the next few Federal Open Market Committee (FOMC) meetings.

The Dow Jones industrial average, the S&P 500 index and the Nasdaq composite all soared to all-time highs in November, with the Dow climbing above the 36,000 level for the first time in its history. As we went to press in mid-December, U.S. markets were not too far removed from their all-time highs, but it may not feel like it to some investors after a rocky final few weeks provided a sharp reminder of the market’s capacity to surprise—and of the importance of staying the course through bouts of volatility.

Over short periods, the performance of any strategy ebbs and flows. Large-cap growth stocks dominated the last bull market of 2009–2020. During the so-called lost decade of 2000–2009, small and value stocks did better.

While large-cap growth stocks dominated large-cap value stocks in 2021, smaller value-focused stocks outperformed their growth counterparts. Small-cap stocks were outperforming large-cap stocks as well. In the small-cap segment, growth stocks were up 17.1% through the end of November, while small-cap value stocks were up 31.4%.

We expect that the market’s capacity to surprise will continue in 2022. Higher oil prices, inflation, rising wages and supply chain issues may start eating into companies’ bottom lines in the coming quarters. In addition, the Federal Reserve’s interest rate policies could increase the cost of borrowing in the coming quarters as well. This, coupled with more difficult year-over-year comparisons could most certainly lower quarterly earnings growth. On the other hand, economic growth is forecast to continue in 2022 and inflationary pressures could potentially start to ease. New coronavirus treatments could potentially be available as well.

Before we look too far ahead, let’s look at the year in review.

2021 Performance of AAII Stock Strategies

AAII has been developing, testing, refining and tracking a variety of quantitative stock strategies for over 20 years using Stock Investor Pro, AAII’s fundamental stock screening and research database program. Many of these methodologies follow the approaches of popular investment professionals, while others are tied to basic investment principles. These strategies cover a wide range of investment styles, from those that are value-based to those that focus primarily on price momentum and growth.

While this annual recap article discusses the best- and worst-performing strategies for 2021, you can also review the long-term performance and see how these strategies performed in up and down markets.

Table 1 summarizes the performance and variability of the screening strategies AAII tracks, with the guru and factor screens ranked separately in descending order by year-to-date price change through the close on November 30 (see the AAII Stock Ideas box for more information about them). Table 1 also presents the price change performance (excluding dividends and transaction costs such as commissions, bid/ask spreads, time and price slippage, etc.) over various periods for each approach. The screening strategies are categorized based on the “factors” that underlie each strategy. A key at the bottom of the table explains the initials; for a full description of the factor categories of AAII Stock Screens, see the Factor Categories of AAII Screening Strategies box at the end of this article.

Among the 60 stock screening strategies AAII tracks, all but one posted gains over the last 10 years (as of November 30, 2021). Fifteen of the 60 screening methodologies AAII tracks posted better price returns than the S&P 500 over the last 10 years. Looking at the year-to-date performance for the 60 AAII stock strategies in Table 1, you can see that 2021 was a generally positive year for quantitative stock screening. Forty-nine of the 60 AAII screening strategies were up for the year through the end of November. Thirty-four of the AAII screening strategies outperformed the S&P 500’s price gain (excluding dividends) of 14.5%. [Editor’s note: The price gain for the index is used instead of total return, since the impact of dividends is not included in the performance of the AAII screening approaches.]

For 2021 (through November 30), the top AAII guru strategy was the O’Shaughnessy Small Cap Growth & Value screen, a value, momentum and size-oriented factor strategy. This approach led all AAII strategies with a 170.7% gain through the first 11 months of the year. The O’Shaughnessy Small Cap Growth & Value methodology experienced its best year since its inception in 1998. In fact, for 2021, three of the top four guru strategies are O’Shaughnessy-based strategies, including the O’Shaughnessy Growth II (+76.2%) and O’Shaughnessy Tiny Titans (+55.0%) screens.

After three consecutive years as one the best-performing guru strategies, the Foolish Small Cap 8 (–1.8%) screen, which blends growth, momentum and size factors, was one of the worst-performing approaches of all 60 AAII stock screening strategies. Sound strategies can and do bounce back from off years as the T. Rowe Price screen shows. Combining factors of value and growth, this strategy focuses on growth stocks at a reasonable price but avoids overglamorized stocks. The screen was delivering its best year since 2011 with a gain of 86.6% as of November 30. In 2020, the T. Rowe Price approach was the second-worst-performing model of all 60 AAII stock screening strategies, losing 23.5%.

As in 2020, the Inve$tWare Quality Growth (+25.7% in 2021) and Foolish Small Cap 8 screens rank among the 10 most favorited screening strategies. AAII members can favorite a screen by clicking on the star next to a screen’s name. Favoriting gives an insight into the screening strategies that real investors are following right now. Two of the most favorited screening strategies this year are O’Neil’s CAN SLIM Revised 3rd Edition (+25.8%) and Stock Market Winners (–12.5%).

The top AAII factor approach for 2021 is the Price-to-Free-Cash-Flow strategy, up 61.5%, which provides a useful technique to highlight more mature value stocks and the effective management of overall company operations.

Following a multi-year trend, growth-oriented strategies did better at the large-cap level, while value-focused strategies outperformed growth among small-cap stocks as previously noted. In a change from 2020, value-focused strategies performed better than growth-oriented strategies at the mid-cap level.

Through the end of November, the S&P 500 Growth index posted a total return—including dividends—of 24.1%, while the S&P MidCap 400 Growth index and S&P SmallCap 600 Growth index had year-to-date total returns of 13.1% and 17.1%, respectively. Growth investing is also reflected in the return of the Nasdaq 100 index, which includes the 100 largest nonfinancial companies listed on the tech-heavy Nasdaq stock exchange. For 2021, the Nasdaq 100 had a price gain of 17.0% through the end of November, down from full-year 2019 and 2020 gains of 38.0% and 47.5%, respectively.

In comparison to growth investing, value investing struggled this year at the large-cap level, but closed the performance gap from last year. The S&P 500 Value index had a year-to-date return of 15.8%, up from a 0.9% gain in 2020. The total return of the S&P MidCap 400 Value index was a far more impressive 23.6% through the end of November, while the S&P SmallCap 600 Value index posted a year-to-date total return of 31.4%.

Download Table 1 Excel Spreadsheet

Top Factor Strategy for 2021

As indicated, the top AAII factor strategy for 2021 is the Price-to-Free-Cash-Flow screen, which generated a price return of 61.5% through the end of November. This is the first year the approach has risen to the top of the factor strategy list on an annual performance basis since 2009. The Price-to-Free-Cash-Flow approach is experiencing its best year since 2013.

The primary goal of the screen is to explore the basics of cash flow analysis and identify companies that generate consistently strong cash flows. Ideally, a company should not only cover the costs of producing its goods and services but also produce excess cash flow for its shareholders. Free cash flow is calculated by subtracting capital expenditures and dividend payments from cash flow from operations. This free cash flow figure is considered to be excess cash flow that the company can use as it deems most beneficial. With strong free cash flow, debt can be retired, new products developed, shares can be repurchased and dividend payments can be increased.

A screen for positive and consistent free cash flow is a good starting point for the investor scanning for firms on a cash-flow basis. The AAII Price-to-Free-Cash-Flow approach starts by seeking out companies with positive free cash flow for each of the last five fiscal years and the most recent 12 months. Firms with low price-to-free-cash-flow ratios may represent neglected firms at attractive prices. The AAII Price-to-Free-Cash-Flow screen looks for companies with a price-to-free-cash-flow ratio below their industry price-to-free-cash-flow ratio median and below the company’s own five-year average.

Top Guru Strategy for 2021

The O’Shaughnessy Small Cap Growth & Value screen is the top AAII guru screen, gaining 170.7% through the end of November 2021. The methodology focuses on small-cap stocks with upward price momentum using both growth and value criteria. The screen seeks “cheap stocks on the mend.” Small-cap stocks normally do well during economic recoveries.

It’s been almost two years since a major portion of the U.S. went into lockdown due to the coronavirus pandemic. After several federal coronavirus aid packages, widespread distribution of vaccines and states reopening, the economy continues to recover. Vaccines have helped many to return to a more normal life. However, many people—both in the U.S. and internationally—have yet to be vaccinated. New variants of the coronavirus are spreading. Economically, many people remain either unemployed or underemployed. We still don’t know what the new normal will be.

However, overall, there was a feeling of optimism among investors in 2021, driven by improving economic expectations, especially among smaller firms. Small-cap companies tend to be more sensitive to economic conditions.

For the patient investor with the ability to withstand the higher short-term volatility and risk of small-cap stocks, there is the potential for strong long-term returns. The O’Shaughnessy Small-Cap Growth and Value screening model has an average annual gain since inception (1998) of 19.8%, versus a 10.0% gain for the S&P SmallCap 600 index in the same period.

AAII tracks several screens from James O’Shaughnessy, the founder and chairman of O’Shaughnessy Asset Management LLC, an asset management firm headquartered in Stamford, Connecticut. The O’Shaughnessy screens that AAII has developed are based on the strategies outlined in his books “What Works on Wall Street: A Guide to the Best-Performing Investment Strategies of All Time,” (3rd Edition, 2005, McGraw-Hill) and “Predicting the Markets of Tomorrow: A Contrarian Investment Strategy for the Next Twenty Years,” (2006, Penguin Group).

O’Shaughnessy believes the reason for this outperformance is that few analysts follow these small stocks. Also, 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 small-cap stocks have a low correlation with the overall stock market, making them a potential hedge in a portfolio of larger-cap stocks.

The O’Shaughnessy Small Cap Growth & Value screening strategy seeks to identify companies with:

• Market capitalization between $200 million and $2 billion listed on U.S. stock exchanges,
• Price-to-sales ratio less than 1.5,
• Earnings per share growth for the last 12 months greater than zero and
• Above-average 13- and 26-week relative strength as compared to the S&P 500.

O’Shaughnessy thinks investors should hold 25 stocks in this small-cap portfolio to diversify the risk that goes along with holding such volatile stocks. So, the field is further narrowed to the 25 stocks with the highest 52-week relative strength.

The Weakest Strategy for 2021

The weakest overall AAII stock screening approach for 2021 is the Insider Net Purchases screen, down 28.3% through the end of November. The strategy looks at insider buying and selling activities for clues to a company’s future prospects. Since insiders have frontline knowledge of what is taking place at a company, they should be most informed about those things that will impact the company’s stock.

The Insider Net Purchases approach looks for companies that are experiencing above-average insider buying activity with:

• Market capitalization between $50 million and $1 billion listed on U.S. stock exchanges, excluding companies categorized by industry as investment holding companies, closed-end mutual funds, exchange-traded funds (ETFs) and real-estate investment trusts (REITs),
• At least three insider buys over the last six months,
• Net shares of stock purchased (shares purchased minus shares sold) by insiders over the last six months is greater than zero,
• More insider buy trades than sell trades over the last six months and
• Net number of shares purchased by insiders over the last six months as a percentage of the overall number of shares outstanding is greater than two.

To buy or sell strictly on what the insiders are doing is not a wise investment strategy. However, to ignore what the insiders are doing may be an investment mistake.

Remember, insiders can sell their shares for a multitude of reasons. For the most part, however, insiders only buy because they expect to make money. By keeping an eye on what the insiders are doing, you have one more piece of the investment puzzle that may aid your investment approach.

There were 11 AAII screening strategies that were down for the year through the end of November. Six of these AAII screening strategies posted double- or triple-digit returns in 2020, including Foolish Small Cap 8 (+142.5% in 2020, –1.8% in 2021), Driehaus (+16.5%, –13.6%), Philip Fisher (+64.6%, –18.6%), Estimate Revisions Down 5% (+43.7%, –6.9%), Estimate Revisions Lowest 30 Down (+33.4%, –7.1%) and Insider Net Purchases (+83.2%, –28.3%). It is interesting to note that the Foolish Small Cap 8 approach was the best-performing methodology of all 60 AAII stock screening strategies last year, while the Insider Net Purchases screen was the top AAII factor approach.

Four of the 11 AAII screening strategies that were down for the year through the end of November were also down last year, including Graham Defensive Utility Investor, Schloss, Stock Market Winners and ADR. All of these strategies emphasize the value factor. It is only the second time in 12 years that the Stock Market Winners screen generated a negative return; it’s a value-growth-momentum strategy developed by Marc Reinganum and based on a publication by William O’Neil & Co. titled “The Greatest Stock Market Winners: 1970-1983.”

None of the 60 AAII stock screening approaches generated negative returns for the last three consecutive years through the end of November.

10-Year Performance

Because this is an annual recap article, Table 1 ranks all the screening strategies that AAII tracks based on year-to-date price change. However, saying that a strategy is “good” or “bad” based on one year of performance isn’t practical or realistic because most of us have a longer-term period of investing.

Therefore, Table 1 also shows performance for the AAII stock screening strategies over a longer period—specifically based on average annual price gain over the last 10 years and since inception. Ten years is typically a long enough period to be meaningful and long enough to capture at least one full economic cycle.

For the second consecutive year, O’Neil’s CAN SLIM Revised 3rd Edition strategy is at the top of the list of all AAII guru screens (and overall) with an average annual price gain of 23.9% a year over the last 10 years.

O’Neil’s CAN SLIM Revised 3rd Edition strategy has a strong appeal to the active investor looking for growth stocks. William O’Neil founded the business newspaper Investor’s Business Daily. He is also the author of “How to Make Money in Stocks,” where he introduced the CAN SLIM investment strategy. While the approach is specific, O’Neil stressed the art of investing when interpreting the direction of the market. The CAN SLIM approach uses fundamental company and industry factors to identify attractive stocks and employs technical price and volume analysis to help determine when to buy and sell. O’Neil’s CAN SLIM strategy seeks companies with a history of strong and consistent annual earnings growth, quarterly earnings momentum, strong relative price strength and support from leading institutions.

For the third consecutive year, the Estimate Revisions Top 30 Up screen is the top AAII factor strategy over the last 10 years. It has an average annual price gain of 18.8% over the 10-year period. The Estimate Revisions Top 30 Up strategy looks for stocks that have seen upward revisions over the last month to their annual consensus earnings estimates for the current fiscal year and next fiscal year, with no downward revisions. The strategy then tracks the 30 companies that have seen the largest percentage change in the current-year consensus estimate over the last month.

The Schloss screen is the worst performer over the last 10 years, with an average annual loss of 3.3%. It is the only AAII strategy that has a negative average annual price return over this period. This approach looks for stocks hitting new lows, trading at a price lower than book value per share, with no debt and higher levels of insider ownership. None of the AAII stock screening factor strategies have negative 10-year performance data.

Risk-Adjusted Returns

Table 1 also presents the risk-adjusted return for each of the strategies that AAII tracks. This calculation adjusts the performance of each approach using their volatility as measured through standard deviation of returns, penalizing screens with higher standard deviations (for a more detailed explanation of the risk-adjusted return calculation, see the Calculating Risk-Adjusted Return box  below). Using risk-adjusted returns since inception (1998), the three best-performing strategies are Estimate Revisions Up 5% (+16.7%), Estimate Revisions Top 30 Up (+16.4%) and O’Shaughnessy Tiny Titans (+16.2%).

Four of the AAII stock screening strategies have negative average annual risk-adjusted returns, up from only one a year ago. On a risk-adjusted basis, the Murphy Technology approach is once again at the bottom with an average annual risk-adjusted loss of 15.2%. This screening strategy looks for technology and telecommunications companies that have been growing sales by at least 15% a year over the last three years, as well as net margins and return on equity (ROE) of at least 15%, among other criteria.

Conclusion

The stock screening strategies are intended to be an educational resource to show what types of filters and strategies work over varying market conditions. They are not portfolios nor are they intended to be a buy or recommended list. At best, you should view them as idea generators. You should analyze the passing stocks further before deciding whether to commit real dollars to them. Furthermore, since market conditions change, it is important to be adequately diversified.

One way to achieve sufficient diversification is to select stocks from multiple stock screening methodologies. However, it is not enough to simply choose those strategies that have the best long-term performance. Instead, it is useful to understand the forces influencing both the overall market and a strategy’s performance, and how changing economic conditions can impact both the market and individual stocks. Examining the characteristics of an investment methodology may reveal some practical problems you might face when trying to translate quantitative stock screening into real-world portfolio building.

Something else to keep in mind is that once you decide on which methodologies to follow, you cannot just let the quantitative screens choose your stocks. Screening is a multi-step process. For some investors, this means first applying quantitative filters such as the screens we have discussed here to help you arrive at a set of candidates that all share the same base set of characteristics. This does not necessarily mean they are all good investments. It is important then to perform at least cursory qualitative analysis to decide whether they are right for your stock portfolio. 

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