Finding a Stock Winner: Finding a Stock Winner: First Step - - PDF document

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Finding a Stock Winner: Finding a Stock Winner: First Step Screening First Step Screening

John M. Bajkowski

President President AAII AAII

johnb@aaii.com johnb@aaii.com

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Discussion Overview Discussion Overview

• A computerized screening program

computerized screening program can be used to

locate/analyze stocks in an organized, systematic and disciplined fashion

• Discuss screening factors that help to highlight winning stocks

– Value approach – Growth approach

• Stock screening resources

– AAII Stock Screens – Top Web Screeners

• Take home a feeling for some of the elements that help to

build successful portfolios

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Stock Selection Strategies Stock Selection Strategies

1st step = Screening Process

• Approach should match your investment philosophy
• Establishing criteria to narrow a large stock

universe to a few that hold promise and warrant further analysis

• Screening system identifies stocks that have

common, desirable traits

• Screening system adds discipline to the stock

selection and selling process

• Provide framework for buy/ hold/ sell process

2nd step = Valuation Process

• In-depth examination of a company to establish if its

stock price reflects a fair value

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Buy Buy Low, Sell High Low, Sell High Buy Buy High, Sell Higher High, Sell Higher

VS. VS.

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Long-Term Performance by Approach Long-Term Performance by Approach

Long-Term Performance

Ann'l Return (%) Standard Deviation (%) Large Growth 9.1 20.0 Large Value 11.3 27.4 Small Growth 9.4 32.8 Small Value 14.1 32.3 1928 to 2014

1920s* 1930s 1940s 1950s 1960s 1970s 1980s 1990s 2000s 2005-14 Large Growth 8.1 1.5 7.3 17.6 7.9 3.4 15.8 19.9

• 1.8

8.5 Large Value 9.0

• 5.5

17.2 22.2 10.7 12.2 20.2 13.9 0.3 6.7 Small Growth

• 13.3

7.4 11.6 17.7 10.7 5.8 10.8 15.0

• 1.1

8.2 Small Value

• 4.8
• 0.3

21.0 20.0 15.4 15.0 21.1 14.5 10.6 8.0 *Based on the period 1928-1929 Source: Morningstar & CRSP

Long-Term Performance By Approach (%)

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Long-Term Performance by Size Long-Term Performance by Size

Decile Ann'l Return Standard Deviation Serial Correlation 1 - Largest 9.4 19.1 0.07 185 $591.0 bil 64.3 2 10.7 21.7 0.01 199 $24.3 bil 14.1 3 11.1 23.8 (0.03) 194 $10.1 bil 6.9 4 11 25.8 (0.03) 221 $5.8 bil 4.5 5 11.7 26.4 (0.03) 215 $3.7 bil 3.0 6 11.5 27.3 0.01 265 $2.5 bil 2.5 7 11.6 29.2 0.01 317 $1.7 bil 2.0 8 11.7 33.3 0.00 417 $1.0 bil 1.5 9 11.6 37.4 0.06 395 $548 mil 0.8 10 - Smallest 13.5 42.8 0.14 948 $300 mil 0.6 Large Cap, S&P 500 10.1 20.1 0.02 500 $591 bil 78.3 Mid Cap, 3-5 11.2 24.6 (0.03) 630 $10.1 bil 14.4 Small Cap, 6-8 11.6 28.9 0.01 999 $2.5 bil 5.9 Micro Cap, 9-10 12.3 39.1 0.08 1343 $548 mil 1.3 Treasury Bills 3.5 3.1 0.91 Inflation 2.9 4.1 0.64 Source: Morningstar & CRSP

• No. of

Firms Largest Stock % of Total Market Cap. 1926 to 2014

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Recent Performance by Size Recent Performance by Size

Data as of 4/30/2016

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Recent Performance by Style Recent Performance by Style

Data as of 4/30/2016

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Stock Strategies Stock Strategies

Value Value

Benjamin Graham, Walter Schloss

Growth Growth

William O’Neil

Growth at a Growth at a reasonable price reasonable price

Davide Dreman, Peter Lynch, John Neff

Value with price momentum Value with price momentum

Lakonishok, Value on the Move

Earning estimate element Earning estimate element

Dreman with Est Revisions

See these on AAII.com

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Strong-Performing Growth & Value Screens Strong-Performing Growth & Value Screens

Data as of 4/30/2016

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Value Screen: John Neff

• While serving as portfolio

manager of the Vanguard Windsor Fund from 1964 until his retirement in 1995, Neff employed a value investing approach using a stringent contrarian's viewpoint

• Approach presented in his book

"John Neff on Investing"

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Screening Process Screening Process

1) 1) Construct and refine primary criteria Construct and refine primary criteria 2) Construct secondary criter 2) Construct secondary criteria to determine if companies ia to determine if companies passed the screen for the right reasons passed the screen for the right reasons

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Prim ary Neff Value Filter: Price-Earnings

• Price divided by earnings per share
• Ratio embodies the market’s expectations
• f future company performance

– Stocks with high growth prospects trade with high P/ E ratios, while those with low ratios are expected to have low growth or high risk

• Seek out stocks with low price-earnings

ratios with the belief that the market may be over-discounting the negative news or

• blivious to company’s potential

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Price-Earnings Ratio: Drawbacks Price-Earnings Ratio: Drawbacks

It’s important to understand the possible drawbacks of the metrics you use.

• Low P/E stocks without additional qualifiers may only highlight risky or

troubled firms

• Quality of earnings: earnings influenced by management assumptions

trickling through the account statements

• Negative earnings & temporary developments—such as costs of new

product rollouts or general cyclical slowdowns—can distort P/E *** *** Be cautious of cyclical and financial firms when it comes to P/E

peak expansion trough Expectation of high earnings, increasing earnings figure = higher P/E Anticipation of earnings decline, larger earnings = low P/E Expectation of improving earnings, earnings below $1 or negative = high P/E or NA P/E

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P/ E Ratio: Screening Strategies

• Low absolute price-earnings screens
• Relative price-earnings screens

– Below market P/ E ratios – Below industry norms – Below company historical average

• P/ E to growth ratio (PEG ratio) screens

– P/ E divided by EPS growth

• Future vs. historical earnings growth
• Adding dividend yield to growth rate

– Look for low ratios – Identify stocks with earnings growth prospects that are not fully recognized by the market as measured through the price-earnings ratio

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• P/ E Ratio = 10, EPS Growth = 5%

– PEG = P/ E ÷ Growth = 10 ÷ 5 = 2.0

• P/ E Ratio = 10, EPS Growth = 10%

– PEG = P/ E ÷ Growth = 10 ÷ 10 = 1.0

• P/ E Ratio = 10, EPS Growth = 10, Yield =

5%

• Div Adj. PEG = P/ E ÷ (Growth + Yield)

= 10 ÷ (10 + 5) = 0.67

• For further info see AAII stock screen “A

Combination Approach: Value on the Move”

w w w .aaii.com / stock-screens/ screendata/ ValueEstGrow th

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Screening Using Stock Investor Pro Screening Using Stock Investor Pro

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The ratio of the price-earnings ratio to the sum of the estimated growth in earnings and dividend yield (div-adjusted PEG ratio) is less than or equal to half the median value for the entire database

Current Market PEG Avg: 3.48 Median: 1.80 Stocks: 1,675 219 firms passing from a total

• f 6,813

companies (data as of 6/6/2016)

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The estimated growth rate in earnings per share is greater than or equal to 7% and less than or equal to 20%

1,321 firms passing independently, 114 cumulatively Note only 2,359 stocks with long-term growth estimates

• Neff wants companies with strong projected earnings growth, but not too high to

avoid high risk stocks

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The five-year growth rate in sales is greater than or equal to 7% and less than

• r equal to 20%

1,341 firms passing independently, 30 cumulatively

• Growing sales leads to growing earnings
• Strong, but reasonable growth

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Free cash flow over the last 12 months and the last fiscal year (Y1) is positive

2,216 firms passing independently, 13 cumulatively

• Free cash flow is cash from operations left over after satisfying capital

expenditures and dividend payments

• Excess cash generation will hopefully be used to benefit investors: stock

repurchase, increase dividends, strategic acquisitions, expansion, etc.

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The operating margin over the last 12 months and last fiscal year is greater than

• r equal to the industry’s median operating margin

2,362 firms passing independently, 12 cumulatively

• Robust margins point to competitive advantage
• Comparison should be made against industry norm because margins are very

industry specific

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Stock Investor Pro - Screening data date: 5/6/2016

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Value Summary Value Summary

• Produces consistent, long-term

long-term success, but can fall behind

• ther approaches on occasion, particularly in the strongest

portion of a bull market or during economic transitions

• Value strategy has worked at all market-cap levels—micro cap to

large cap

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Growth Screen: CAN SLIM Growth Screen: CAN SLIM

William O’Neil William O’Neil developed his growth stock approach through study of company characteristics prior to their big stock price increase

With all the options you have as an investor, why settle for stocks with little to no growth in earnings per share?

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C= Current Quarterly Earnings

• Strong and improving quarterly EPS performance—at least

18% to 20%

• Important to compare a quarter to the same quarter from the

previous year

• O’Neil looks at earnings from continuing operations

706 firms passing from a total of 6,813 companies (data as of 5/ 6/ 2016)

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A= Annual Earnings I ncreases

• Significant and steady increase in annual earnings

– Increase in EPS for each of the last five years – Strong annual growth rate of 25% or greater over the last five years

164 firms passing independently, 41 cumulatively

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N= New Products, Managem ent, Highs

• Catalyst to start a strong price advance

– New product or service, management team, technology

• Stocks reaching new high after consolidation period

Screen for stocks within 10% of their 52-week high

1,531 firms passing independently, 18 cumulatively

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S= Supply and Dem and

• Firms with a smaller number of shares outstanding

should increase more quickly

• O’Neil recommends looking at “float”

– Shares outstanding less shares held by insiders

Screen for float

• f less than 20

million shares

• utstanding

2,493 firms passing independently, 7 cumulatively

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L= Leader or Laggard

• Look for market leaders in rapidly expanding industries

– Buy among the best two or three stocks in a group

• Use relative strength to identify market leaders

Screen for 52- week relative strength rank above 70% 2,009 firms passing independently, 6 cumulatively

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I = I nstitutional Sponsorship

• A few institutional sponsors are needed for

above-market performance, but not too many

• Look at record of institutions

Screen for at least 5 institutional shareholders, consider cap 5,041 firms passing independently, 5 cumulatively

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M= Market Direction

• The trend of the overall market will have a

tremendous impact on the performance of your portfolio

• O’Neil tends to focus on technical

measures when determining the market’s

• verall direction
• O’Neil suggests that any good technical

analysis program or study of Investor’s Business Daily should be sufficient

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Stock Investor Pro - Screening data date: 5/6/2016

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Growth Growth Summary Summary

• Requires close monitoring; beyond the ability of many

individuals

• Look beyond high expected or historical growth and consider

stability of earnings and ability to achieve expectations

• Relative strength works reasonably well independently or when

combined with value factors

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Potential Potential Pitfalls Pitfalls of Stock Screening

• f Stock Screening
• Dependent on the accuracy of the underlying data
• Limited mainly to quantitative factors
• May still be missing good companies that meet most but not all

criteria

• Introduces you to companies you are not familiar with and that

require further analysis

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Potential Potential Benefits Benefits of Stock Screening

• f Stock Screening
• Discover potential investment opportunities you might

not have otherwise noticed

• Avoid wasting time on companies that don’t meet your

basic criteria

• Adds a level of discipline to your investing

– Forces you to develop and hone investing parameters – Helps you to think more clearly about your investing style – Helps to keep your emotions in check – Provides framework for buy/hold/sell decision

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Keys to Keys to Long-Term Long-Term Success Success

• Many approaches to investing can be successful, but failure to

identify an approach and follow it will eventually lead to disaster

• Pick sell rules and stick to them!!
• To succeed with a individual stock approach:

– Need enough time to manage a stock portfolio – Need to manage diversification of portfolio – Need an interest in managing a portfolio—in good times and bad – Need discipline to follow the program once you have committed to it Don’t forget transaction costs!! Don’t forget transaction costs!!

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Don’t expect Don’t expect miracles miracles

• Maintain reasonable expectations
• Market is reasonably efficient
• Micro-cap stocks tend to have consecutive periods of
• verperformance and then underperformance
• Important to maintain diversified portfolio and consider all

asset classes, and foreign markets as well as domestic markets

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Common Elements Common Elements

• Reasonable Value

– Low P/E, P/Sales, P/Book, high yield, etc. – Low P/E relative to growth

• Consistent Growth

– Emphasis on consistency of growth in earnings, sales or dividends

• Unique Niche
• Strong Financials
• Price Momentum
• Earnings Revisions
• Disciplined Investment Approach

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Article on Screening Process

http:/ / w w w .aaii.com / stock-screens/ constructingw inningstockscreen

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What is What is your your investment strategy? investment strategy?

“Confronted with a challenge to distill the secret of sound investment into three words, we venture the motto, Margin of Safety.”

• Benjamin Graham

Write down Write down what you look for in stocks: earnings growth, return

• n equity, financial strength, dividends, price-earnings ratio of x,

etc.

How long would you say your investment period is? What is the most you are willing to lose

• n an investment?

How much time do you have to spend on research? Do you care about price momentum? Are you investing for income? (dividends)

4 2 Screens are located within the “Stock Screens” area of the website Sort order of table can be changed by clicking on tabs

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Members can download spreadsheets that detail performance by month or year

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 Members subscribing

to the “AAII Stock Screens Update” email receive a monthly email alert when the Stock Screens area is updated

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Top Screening Systems Top Screening Systems

GuruFocus Morningstar Premium Stock Screener StockCharts.com Zacks.com Portfolio 123 Profitspi

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Stock Investor Pro Stock Investor Pro

• (800) 428-2244 – www.aaii.com/stockinvestorpro
• Systems: Windows Vista or higher, including Windows

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• Price:

– $198/year (AAII Member) – $299/year (Non-AAII Member)

• Universe: Approximately 7,000 U.S.–traded stocks
• Number of Data Fields: 2,200+
• Fields for Screening: 2,200+
• Data Sources: Thomson Reuters, I/B/E/S
• Frequency: Weekly
• Distribution: Internet

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Morningstar Premium Morningstar Premium

Price: Price: $189/year or $22.95/month; 14- day free trial At a glance: At a glance:

• Current and historical screening

parameters for time series analysis

• Screen on proprietary appraisals and

style categories

• Deep library of fundamental

screening variables

• Roughly 10,000 companies, over

1,800 screening parameters

Portfolio 123 Portfolio 123

Price: Price: $29/month or $83/month; 15-day free trial At a glance: At a glance:

• Backtest screening strategies
• One of the largest libraries of

fundamental screening variables and predefined screens

• Create custom screening variables
• 8,000 companies, 1,200 screening

parameters

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Thank you very much for attending this presentation.