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AAII Stock Ideas
Last year was a chaotic year for many investors. The healthy advances of the market were cut short at the beginning of the year, and many of our portfolios felt the effects. The events of the past several years made markets the most volatile since the recession in 2007–2009. High levels of inflation were witnessed across the globe, resulting from the previous two coronavirus pandemic years and Russia’s invasion of Ukraine. Consequently, the Federal Reserve began taking action against rising inflation by gradually raising the federal funds rate to levels not seen in over a decade.
Consumer inflation has now risen nearly 7.1% for the 12 months ended November 30. This is causing Americans to reduce their discretionary spending, impacting corporate profits. As a result, analysts have lowered their full-year earnings growth forecasts and as of press time stocks remained in a bear market. For the year through the close on November 30, the S&P 500 index has fallen 18.9%. However, there are investment strategies that have performed well during this time—with 12 AAII Stock Screens bucking the market’s downward pull and realizing positive gains.
There was a major reversal in trends for popular investment strategies in 2022. Growth-based investing had performed significantly better than value-based strategies over the past decade. Last year, however, many popular growth stocks—including the tech giants that had been driving the equity markets higher—have suffered. Value, conversely, took the performance lead as is evident by the majority of the top-performing AAII Stock Screens having value tilts. It is too early to know if value stocks will overtake growth stocks in terms of outperformance over an extended period of time following their significant underperformance in the latter half of the last decade.
In addition to the pandemic and changing market trends, the geopolitical turmoil from the war in Ukraine has had a significant impact. Many lives have been lost fighting in what many believe to be an unnecessary display of power by the Russian military. We can only hope that the conflict is resolved quickly and send aid to the people affected. The effects of this war go beyond the human cost: Many companies have cut ties with Russia in response to the invasion. Concurrently, many imports of goods from Russia have ceased. Among other things, Russia is a major supplier of oil and natural gas. The supply disruption caused energy prices to skyrocket in 2022. The price of oil affects the majority of companies in all markets.
Rising concerns of a recession in 2023 drove market uncertainty higher. Continuing supply issues and rising inflation have proven to be worthy opponents to the general market’s health. It is unclear how much the Fed will raise interest rates and when it will pause the current tightening cycle. Hopefully, next year’s AAII Stock Screens review will include a narrative of calmer financial market, economic and geopolitical conditions.
2022 Performance of AAII Stock Strategies
AAII has been developing, testing, refining and tracking a variety of quantitative stock strategies for approximately 25 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, known as “guru” screens. We also present screens based on fundamental financial data known as “factor” screens. 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. (See the AAII Stock Ideas box below for more information.)
The AAII Stock Ideas
AAII has been developing, testing and refining a wide range of screening strategies over the 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. 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 can also be accessed via the Screening page of AAII.com.
Each month, 60 separate screens are performed using AAII’s Stock Investor Pro and the current companies passing each screen are reported. Subscribers to A+ Investor or Stock Investor Pro can see results on a daily basis. The screening results are found at the Screening page of AAII.com, posted early each month using data from the previous month’s end. The weekly AAII Stock Ideas email discusses stock ideas using a featured screen or the new A+ Grades. You can sign up for this complimentary newsletter at www.aaii.com/email.
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, time slippage (the 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 typically benefit more from these simplified rules.
Keep in mind, however, that performance figures for the AAII stock screening strategies represent price change only, and do not include dividend payments or dividend reinvestment. Therefore, the results of screens that tend to isolate large, dividend-paying stocks—such as the Dogs of the Dow (in the value category)—do not receive a boost from dividend payments or reinvestment. The 10 stocks passing the Dogs of the Dow screen at the end of November 2022 were yielding 4.5% (compared to 4.1% at the end of November 2021); investors holding shares in these stocks, therefore, would have a higher annual return by approximately this amount for the coming year.
Sell rules are the same as the buy rules: The hypothetical portfolios are completely reallocated 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. Note that we use these rules for backtesting purposes but do not necessarily advocate them as part of a real-world investment framework. Stocks that no longer qualify are dropped even if the strategist behind a particular approach suggests different sell rules versus buy rules. This may shorten the holding period and increase the turnover relative to what the strategist would suggest for an actual portfolio.
This annual recap provides a view into the strongest- and weakest-performing strategies for 2022. It also provides data on previous years to show how these strategies performed during up and down markets. Note that since the most recent bear market began essentially at the start of 2022, the bear market performance matches the year-to-date performance.
Table 1 summarizes the performance and variability of the screening strategies that 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, 2022. 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. At the far right on the table, 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 box at the end of this article.
Most of the stock screening strategies that AAII tracks have posted gains over the last 10 years. Only four of the 60 screens show a loss for their average annualized return over the last 10 years. Fifteen 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 Screens in Table 1, you can see that 2022 was a rough year in terms of absolute returns but a good year in terms of relative performance. Twelve of the 60 AAII screening strategies were up for the year through the end of November, and 42 AAII screening strategies outperformed the S&P 500’s price loss of 18.9% year to date. [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.]
Download the Excel spreadsheet of this table.
For the year through the close on November 30, the top AAII guru strategy was the Foolish Small Cap 8 Revised screen, a growth, momentum and size-oriented strategy. This approach led all AAII strategies with a 56.7% gain through the first 11 months of the year. The revised screen reduces some constraints in the original Foolish Small Cap 8 screen to discover more stocks. For the year, the Foolish Small Cap 8 screen came in second place, increasing 32.3% through November 30.
The top three screens in terms of total number of followers are the O’Shaughnessy Tiny Titans screen, the O’Shaughnessy Small Cap Growth & Value screen and the O’Neil CAN SLIM Revised 3rd Edition screen. AAII members can favorite a screen by clicking on the star next to a screen’s name. Favoriting makes it easy to follow specific screens and get additional insight via the My Screens tool, which is available to all AAII members.
The top AAII factor approach for 2022 is the High Relative Dividend Yield screen. It gained 5.6% through November 30. The approach is value-based and attempts to find stocks that are out of favor but have a dividend yield of 3% or higher. It should be noted that the performance of this strategy is understated since dividend payments are not included in the performance calculation.
As previously mentioned, growth-oriented strategies performed much worse this year than in recent years. Value-based strategies were able to outperform on a relative basis during 2022’s market volatility. In fact, nine out of the top 10 screens year to date contain value-based screening criteria. In addition, dividend strategies performed well as they tend to do during market downtrends.
Through the close on November 30, 2022, the S&P 500 Value index posted a total loss—including dividends—of 1.4%, while the S&P MidCap 400 Value index lost 2.0% and S&P SmallCap 600 Value index lost 4.9%. These three indexes performed much better than the other indexes that AAII tracks. Reversing the trend from last year, large-cap technology stocks performed badly this year. This is 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 2022, the Nasdaq 100 had a price loss of 37.4% through the close on November 30, down from full-year 2020 and 2021 gains of 47.5% and 26.8%, respectively.
In comparison to value investing, growth investing struggled this year at the large-cap level. The S&P 500 Growth index lost 23.6% year to date, down from a 27.2% gain in 2021. The S&P MidCap 400 Growth index and the S&P SmallCap 600 Growth index performed slightly better, losing 13.8% and 15.3%, respectively.
Top Factor Screen: High Relative Dividend Yield
As previously mentioned, the top AAII factor strategy for 2022 was the High Relative Dividend Yield screen, which generated a price return of 5.6% through the end of November. The strategy ranks fourth in terms of 10-year average annual performance for the factor screens, gaining 10.6% on average. As previously mentioned, the performance calculation does not consider dividend payments. Thus, the performance for this strategy is understated since the strategy specifically looks for stocks with a minimum dividend yield of 3%.
The primary goal of the screen is to discover established companies that pay consistent dividends. Dividends contribute to returns in any market situation, with the stream of income having even more appeal during market declines. A strategy seeking higher dividend yields can help identify potentially undervalued stocks with reduced downside risk, provided the dividend is secure. Because mostly mature firms pay significant dividends, dividend analysis is geared toward established firms that are past their explosive growth and cash-consuming stage.
A screen for dividends can be useful for the investor who seeks steady income along with the potential for healthy price performance. The AAII High Relative Dividend Yield approach seeks companies that have increased their dividend payments over each of the last six fiscal years. In addition, the seven-year growth rate for dividends per share must be greater than 3% and current yield must be higher than the firm’s seven-year average yield. The screen also looks for companies with a healthy dividend payout ratio and better-than-average three-year earnings growth.
Top Guru Screen: Foolish Small Cap 8 Revised
The Foolish Small Cap 8 Revised screen is the top AAII guru screen for 2022, gaining 56.7% through the end of November. This small-cap stock screening strategy is based on a methodology developed by David and Tom Gardner, founders of The Motley Fool. Called the Foolish 8, the strategy uses eight criteria to look for profitable and rapidly growing small companies with strong price momentum. It’s partly based on the premise that the lack of coverage and interest in small-cap companies presents a better opportunity to locate undiscovered, attractive investment candidates. The revised screen adds elements of valuation and management effectiveness while broadening the criteria to discover more stocks. The revised screen and the original took the top two spots for performance this year.
The Foolish Small Cap 8 Revised screen takes a page from Robert Hagstrom’s book on investing like Warren Buffett—“The Essential Buffett: Timeless Principles for the New Economy” (John Wiley & Sons, 2001). According to Hagstrom, one of the elements that Buffett uses to measure company performance is return on equity (ROE), instead of the more traditional earnings per share. Buffett does not take quarterly or annual results too seriously when studying company financials. He finds it better to focus on three- to five-year averages to gain a feel for the financial strength of a company.
The Foolish Small Cap 8 Revised screen makes use of several elements of the original Foolish Small Cap 8 screen:
- Recent earnings and sales growth of at least 25%,
- Net profit margin of at least 7%,
- Positive operating cash flow and
- Insider ownership of at least 10%.
The revisions and additional criteria used in the Foolish Small Cap 8 Revised screen are as follows:
- Raising the revenue cap from $500 million to $900 million;
- Eliminating the $25 million daily dollar volume maximum limit, while keeping the $1 million or greater minimum requirement;
- Lowering the relative strength requirement from 90% to 50%;
- In addition to positive cash from operations, requiring that free cash flow must also be positive;
- Requiring that the ratio of price-to-free-cash-flow to free cash flow growth is less than or equal to 1.00; and
- Requiring that return on equity for the last four quarters (trailing 12 months) and for each of the last three fiscal years is greater than or equal to 15%.
Weakest Screen: Murphy Technology
The weakest overall AAII stock screening approach for 2022 is the Murphy Technology guru screen, down 48.4% through the end of November. The strategy looks for technology stocks with high research and development (R&D) spending and strong growth that are selling at attractive values. Michael Murphy regards technology not so much as a sector, but rather as the growth driver of the U.S. economy, covering a relatively diversified group of companies. His approach seeks to identify technology stocks that are most likely to be the future leaders, and then buy those stocks when they become undervalued relative to their growth potential.
The Murphy Technology screen uses the following criteria:
- Only companies in the technology sector are included,
- The three-year growth rate in sales is greater than or equal to 15%,
- The pretax profit margin for the last 12 months is greater than or equal to 15%,
- The return on equity for the last 12 months is greater than or equal to 15%,
- R&D as a percentage of sales for the last 12 months is greater than or equal to 7% and
- The ratio of current price per share to the sum of R&D per share and earnings per share over the last 12 months (price-to-growth-flow ratio) is less than or equal to 8.
The Murphy Technology screen is one of just four of the 60 strategies with a negative annual return over the last 10 years. The strategy also has a weak return since inception, losing 2.6% per year on average. Still, the strategy has had some years with big gains, rising by 50.9% in 2021 and by 88.6% in 2019.
There were 48 AAII screening strategies down for the year through the end of November 2022, compared to only 10 last year. Only two strategies rose in 2022 that had posted a loss in 2021: the Foolish Small Cap 8 screen and its revised screen. Three of the 60 AAII screening strategies have now had losses for three consecutive years: Stock Market Winners, Schloss and ADR screens. Each of these strategies include a value focus.
Best 10-Year Performance: O’Shaughnessy Tiny Titans Screen
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 individual investors have a longer-term investing timeline.
Therefore, Table 1 also shows performance for the AAII Stock Screens over longer periods—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 to capture at least one full economic cycle.
The top AAII guru screen strategy in terms of 10-year performance is the O’Shaughnessy Tiny Titans screen, with an average annual price gain of 23.6% a year over the last 10 years.
James O’Shaughnessy is the chief investment officer of O’Shaughnessy Asset Management LLC. He specializes in investment models that are based on analyzing decades of historical data. O’Shaughnessy believes the Tiny Titans screen appeals to aggressive investors searching for cheap micro-cap stocks with upward price momentum. The strategy focuses on micro-cap stocks since very few analysts cover these companies. The lack of coverage leaves much room for upside potential when good stocks start to get noticed. These types of stocks are also less affected by the general market, so they tend to perform better during a down period in the market. The strategy’s 2022 performance ranks fourth, gaining 19.8% through the close on November 30.
The Price-to-Free-Cash-Flow screen is the top AAII factor strategy over the last 10 years, overtaking the Estimate Revisions Top 30 Up screen that led in terms of 10-year performance for the previous three years. The Price-to-Free-Cash-Flow screen has an average annual 10-year price gain of 16.0%. This strategy looks for stocks with positive free cash flow over each of the last five years. Companies that generate excessive cash after paying for capital expenditures and dividends are likely to perform well. This extra cash allows companies to pay off debt, develop new products, repurchase stock and increase dividend payments to shareholders.
The Schloss screen is the overall worst performer over the last 10 years, losing 8.9% on average. This approach looks for stocks hitting new lows, trading at a price below its book value per share, having no debt and possessing higher levels of insider ownership than the median for all stocks. In 2021, the Schloss screen was the only AAII strategy with negative 10-year performance.
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 its 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 O’Shaughnessy Tiny Titans, Estimate Revisions Up 5% and Estimate Revisions Top 30 Up, gaining 16.5%, 16.0% and 15.9%, respectively.
Five of the 60 AAII stock screening strategies had negative average annual risk-adjusted returns in 2022, versus four in 2021. On a risk-adjusted basis, the Murphy Technology strategy remains at the bottom with an average annual risk-adjusted loss of 20.4%.
Calculating Risk-Adjusted Return
The formula for calculating the risk-adjusted return is as follows:
Margin Rate + (Benchmark Std Dev ÷ Portfolio Std Dev) × (Portfolio Return – Margin Rate)
Where:
- Margin Rate = margin rate (the rate at which you borrow funds); we currently use 12.0% for our calculations, which is the current base rate at TD Ameritrade
- Benchmark Std Dev = standard deviation of the benchmark, in this case the S&P 500 index
- Portfolio Std Dev = standard deviation of the portfolio of stocks passing a given stock screen
- Portfolio Return = return of the portfolio invested in the stocks passing a given stock screen
This calculation assumes that the portfolio return for a given stock screen is higher than the margin rate. If it isn’t, the risk-adjusted return calculation would be as follows:
Margin Rate + (Portfolio Std Dev ÷ Benchmark Std Dev) × (Portfolio Return – Margin Rate)
Following this methodology, we calculate the risk-adjusted returns since inception for all of the AAII Stock Screens.
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 buy or recommended lists. You should view them as idea generators and 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.
If you decide to follow a specific screen and build a portfolio from it, multiple steps are required in the process. An investor should conduct additional research into a stock to see if it is the right fit for a portfolio. This includes qualitative research such as reading past earnings call transcripts, reviewing management’s guidance and following any associated news for the company. You may find that a passing company does not constitute a good investment. Quantitative screening is merely the tip of the iceberg when it comes to developing a well-rounded investment strategy. In addition, overall economic conditions may push a strategy out of favor in the short term, so it is important to stay current with trends in the market.
During 2022, many stocks struggled because of the bear market, high inflation, rising interest rates and economic uncertainty. We saw different strategies perform well compared to previous years. This reinforces the idea that diversifying your portfolio remains important. Investing in stocks can be turbulent, and 2022 was no exception.
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 favorable characteristics. This does not necessarily mean the passing stocks are all good investments. It is important then to perform at least cursory qualitative analysis to decide whether any of the candidates are right for your stock portfolio.
Factor Categories of AAII Screening Strategies
Value (V)
The foundation of value investing is the notion that cheaply priced stocks outperform more expensive stocks in the long term. Value has several dimensions: the stock price as a multiple of company earnings, price as a multiple of book value and other such ratios. Comparing a company’s price-earnings (P/E) ratio to its forecasted or historical earnings growth is also used (PEG ratios). Academics and investors differ on which measure best represents a value company. The value factor has a long history in financial research starting in the 1930s when academics developed a methodology for identifying stocks trading less than their actual value. However, the best-known work on the value factor was carried out by Eugene Fama and Kenneth French in their 1992 paper, “The Cross-Section of Expected Stock Returns,” which concluded that a low price-to-book ratio was the most predictive definition of value.
Screening strategies are tagged as “value” if they contain filters that look for stocks with low price multiples on either an absolute or relative basis; have price multiples that are low based on historical averages or sector/industry norms; or have price multiples that compare favorably to either historical or forecasted growth (PEG).
Growth (G)
The foundation of growth investing is the notion that stocks of companies exhibiting strong, consistent and prolonged growth outperform those of slower-growth companies. Growth has several dimensions, including year-over-year increases in sales and earnings, long(er)-term historical sales and earnings growth rates and analyst-forecasted long-term earnings growth.
Stock screening methodologies are tagged as “growth” if they look for stocks with a history of earnings increases; look for minimum levels of growth in sales, earnings, cash flow, etc.; or have minimum projected earnings growth.
Momentum (M)
The momentum factor refers to the tendency of winning stocks to continue performing well in the near term (three to 12 months). Academics first identified the momentum premium in 1993, when Narasimhan Jegadeesh and Sheridan Titman demonstrated that the strategy of buying stocks that have done well and selling stocks that have done poorly generated significant positive returns over three- to 12-month holding periods.
Stock screening strategies are tagged as “momentum” if they look for minimum levels of absolute or relative price strength or require the share price to be within a certain percentage of the 52-week high.
Size (S)
The size factor captures the tendency of small-cap stocks to outperform bigger companies over the long run. The market capitalization of a company is its current share price multiplied by the number of outstanding shares. University of Chicago Ph.D. Rolf Banz identified the size factor in U.S. stocks in 1981. The research on size took off after economists Eugene Fama and Kenneth French included it as a key component in their influential three-factor model.
Stock screening approaches are tagged as “size” if they look for smaller companies, typically with market capitalizations below $2 billion, or relatively small levels of annual sales.
Earnings Estimates (EE)
Investing based on analyst estimates looks for revisions in the consensus estimates as well as earnings surprises (actual earnings deviating from the consensus estimate). Academic studies have shown that companies that have seen strong upward earnings revisions or have reported significant earnings surprises can see an impact on share prices for up to a year.
Screening strategies are tagged as “earnings estimates” if they filter for the number of upward or downward revisions by analysts; the percentage change in the consensus estimate; and the percentage by which reported earnings exceeds or falls short of the consensus estimate (percentage surprise).
Yield (Y)
A yield (or high dividend yield) investment strategy gains exposure to companies that appear undervalued and have demonstrated safe, stable and increasing dividends. Dividend investing is as old as stocks themselves, playing a central role in the evolution of corporations over the centuries. Groundbreaking economists Benjamin Graham and David Dodd famously called dividend payouts “the prime purpose of a business corporation … A successful company is one that can pay dividends regularly and presumably increase the rate as time goes on.”
Screening strategies are tagged as “yield” if they specifically look for dividend-paying stocks as well as minimum absolute dividend yields or stocks that are trading with yields above historical averages or sector/industry norms.
Quality (Q)
The quality factor is described in academic literature as capturing companies with durable business models and sustainable competitive advantages. This definition has been expanded to look at company profitability and growth and quality of management. The quality factor has helped explain the movement of stocks that have low leverage, stable earnings and high profitability.
Screening methodologies that are tagged “quality” look for companies with records of consistent sales or earnings growth; strong returns on equity on either an absolute basis or relative to historical averages or sector/industry norms; and reasonable levels of debt.
Industry/Sector (I)
Sector and industry rotation is an investment strategy involving the movement of money from one industry or sector to another in an attempt to beat the market.
Screening strategies tagged as “industry/sector” explicitly isolate specific sectors or industries.
Other (O)
The miscellaneous category captures specialty screening strategies that do not fall into one of the other factor categories.
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