Screening Methodology

The below graphic summarises the process flow we have defined from the various research projects and back-tests in this blog to the last JSE crash, with respect to the various stock screens and how the combination of them narrows the field and enhances share growth probability (click on image for larger view.)



The above process, when conducted on the JSE on 28 April 2003 (bottom of last crash) resulted in 6 stocks being eventually highlighted from a total of 271, with these 6 stocks growing up to a staggering 1042% in the subsequent bull market (based on a portfolio constructed in proportion to these shares' market cap) or 593% (based on a portfolio constructed in equal 1/6th proportions per share).

The NAV and Piotroski screens on their own and combined were found to create less growth with portfolios constructed according to market-cap proportion, however PE, PriceFinder-a and especially ValueFinder showed much stronger growth using market cap based portfolio construction.

Note how ALL the 6 PowerStocks screens narrowed down the portfolio size and substantially outperformed the 350% growth of the ALSI Index, for BOTH portfolio construction methods. As the screens were used in combination, they significantly enhanced the performance achieved

Click here for a recap of the PE screen
Click here for a recap of the Price-to-Book screen
Click here for a recap of the PriceFinder-a screen
Click here for a recap of the Piotroski and PriceFinder-b screen
Click here for a recap of the ValueFinder screen

NEXT UP : Using our unique PowerStocks scoring system to increase above portfolio performance by 20% whist reducing portfolio sizes by 75%

Classic Investment Books

At PowerStocks, we have all read the famous classics before we decided to create our research company. There are many investment books, but there are only a few all time global classics. Following on from the huge response we had for "Security Analysis", and additional requests from investors, and the difficulty of getting these books locally we also offer those global best-sellers and classics listed below for sale.

We are not in the book selling business, but would like to see the SA public read the books that have lead to most of our research methodologies and investment strategies. So we don't keep piles of stock. We place orders as we receive them so please allow up to 2 weeks for delivery.

TO ORDER : email us with the SKU at powerstockz(at)gmail.com and we will mail you back with bank details to make your EFT. The prices below includes the cost of us posting the book to you via courier.

1. How To Make Money In Stocks: A Winning System in Good Times or Bad, 3rd Edition
SKU=PSB001, Price : R279.00
THE BUSINESSWEEK, USA TODAY, AND WALL STREET JOURNAL BUSINESS BESTSELLER! The bestselling guide to buying stocks, from the founder of Investor's Business Daily­­now completely revised and updated. When it was first published, How to Make Money in Stocks hit the investing world like a jolt, providing readers with the first in-depth explanation of William J. O'Neil's innovative CAN SLIM investing method. Five years later, O'Neil, founder for the industry icon Investor's Business Daily, revised his classic text and provided readers with a newer glimpse on how the average investor can make money in the equities market.

2. The Warren Buffett Way, Second Edition
SKU=PSB002, Price : R279.00
Starting with $10,000 in 1956 and today worth some $8.5 billion,Omaha, Nebr.-based Buffet is a major player on Wall Street. Hagstrom, a principal in a Philadelphia investment firm, describes the investment strategies and techniques used by Warren Buffett to realize enormous success as a professional investor. Aiming his analysis at the individual investor, Hagstrom reviews the influence of Buffett's mentors, Ben Graham and Philip Fisher, and illustrates Buffett's synthesis of their investment philosophies. Hagstrom provides case studies of Buffett's major investments, showing the qualities of the companies that had appeal. Buffett's investment philosophy espouses long-term investing, respect for good management, and recognition of the value of a business franchise. This insightful work is a worthwhile complement to Graham's classic writings, considered essential for new investors.

3. A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing, Ninth Edition
SKU=PSB003, Price : R349.00
The million-copy bestseller, revised and updated with new investment strategies for retirement and the insights of behavioral finance. Updated with a new chapter that draws on behavioral finance, the field that studies the psychology of investment decisions, here is the best-selling, authoritative, and gimmick-free guide to investing. Burton G. Malkiel evaluates the full range of investment opportunities from stocks, bonds, and money markets to real estate investment trusts and insurance, home ownership, and tangible assets such as gold and collectibles. This edition includes new strategies for rearranging your portfolio for retirement along with the book's classic life-cycle guide to investing, which matches the needs of investors in any age bracket. A Random Walk Down Wall Street long ago established itself as a must-read, the first book to purchase before starting a portfolio, and it remains the best investing guide money can buy.

4. Market Wizards: Interviews with Top Traders (Hardcover)
SKU=PSB004, Price : R320.00
How do the world’s top traders make millions of dollars in the markets – sometimes in a matter of only weeks or even days? That’s precisely the question Jack Schwager was trying to answer when he interviewed 17 superstar money-makers including Richard Dennis, Paul Tudor Jones, Ed Seykota, Marty Schwartz, Tom Baldwin and others. After reading this best-selling book, you’ll know what ingredients enable these top traders to consistently work their financial magic in the markets while so many others walk away losers. One of the top-selling trading books of all-time!

5. Crash Proof: How to Profit From the Coming Economic Collapse (Hardcover)
SKU=PSB005, Price : R449.00
The economic tipping point for the United States is no longer theoretical. It is a reality today. The country has gone from the world's largest creditor to its greatest debtor; the value of the dollar is sinking; domestic manufacturing is winding down - and these trends don't seem to be slowing. Peter Schiff casts a sharp, clear-sighted eye on these factors and explains what the possible effects may be and how investors can protect themselves. For more than a decade, Schiff has not only observed the U.S. economy, but also helped his clients reposition their portfolios to reflect his outlook. What he sees is a nation facing an economic storm brought on by growing federal, personal, and corporate debt, too-little savings, a declining dollar, and lack of domestic manufacturing. Crash-Proof is an informed and informative warning of a looming period marked by sizeable tax hikes, loss of retirement benefits, double digit inflation, even - as happened recently in Argentina - the possible collapse of the middle class. However, Schiff does have a survival plan that can provide the protection that readers will need in the coming years.

6. The Intelligent Investor : The Definitive Book on Value Investing. A Book of Practical Counsel (Revised Edition) by Benjamin Graham (Author), Jason Zweig (Author), Warren E. Buffett (Collaborator)
SKU=PS006, Price : R375.00
Since it was first published in 1949, Graham's investment guide has sold over a million copies and has been praised by such luminaries as Warren E. Buffet as "the best book on investing ever written." These accolades are well deserved. In its new form--with commentary on each chapter and extensive footnotes prepared by senior Money editor, Jason Zweig--the classic is now updated in light of changes in investment vehicles and market activities since 1972. What remains is a better book. Graham's sage advice, analytical guides, and cautionary tales are still valid for the contemporary investor, and Zweig's commentaries demonstrate the relevance of Graham's principles in light of 1990s and early twenty-first century market trends. For many of those daunted by the 700 page "Security Analysis" Classic, this may be easier to digest. This was the first book for most of us here at PowerStocks.

Publishing event of 2008/9

"A road map for investing that I have been following for 57 years."--From the Foreword by Warren E. Buffett

Due to the specialised nature of investment books, and difficulty in sourcing them locally, we are bringing in limited stocks of what must be tagged as the investment communities' publishing event of 2008/9 - the release of "Security Analysis: Sixth Edition, Foreword by Warren Buffett" (Buffet, the worlds 2nd richest man has read this book four times!)

At PowerStocks we are Graham/Dodd Disciples, and this is a must-have for any serious investor or proffessional fund manager. First published in 1934, Security Analysis is one of the most influential financial books ever written. Selling more than one million copies through five editions, it has provided generations of investors with the timeless value investing philosophy and techniques of Benjamin Graham and David L. Dodd.

As relevant today as when they first appeared nearly 75 years ago, the teachings of Benjamin Graham, “the father of value investing,” have withstood the test of time across a wide diversity of market conditions, countries, and asset classes. This new sixth edition, based on the classic 1940 version, is enhanced with 200 additional pages of commentary from some of today’s leading Wall Street money managers. These masters of value investing explain why the principles and techniques of Graham and Dodd are still highly relevant even in today’s vastly different markets. The contributor list includes:

1. Seth A. Klarman, president of The Baupost Group, L.L.C. and author of Margin of Safety
2. James Grant, founder of Grant's Interest Rate Observer, general partner of Nippon Partners
3. Jeffrey M. Laderman, twenty-five year veteran of BusinessWeek
4. Roger Lowenstein, author of Buffett: The Making of an American Capitalist and When America Aged and Outside Director, Sequoia Fund
5. Howard S. Marks, CFA, Chairman and Co-Founder, Oaktree Capital Management L.P.
6. J. Ezra Merkin, Managing Partner, Gabriel Capital Group .
7. Bruce Berkowitz, Founder, Fairholme Capital Management.
8. Glenn H. Greenberg, Co-Founder and Managing Director, Chieftain Capital Management
9. Bruce Greenwald, Robert Heilbrunn Professor of Finance and Asset Management, Columbia Business School
10. David Abrams, Managing Member, Abrams Capital

Featuring a foreword by Warren E. Buffett (in which he reveals that he has read the 1940 masterwork “at least four times”), this new edition of Security Analysis will reacquaint you with the foundations of value investing—more relevant than ever in the tumultuous 21st century markets.

TO ORDER YOURS : email us at powerstockz(at)gmail.com and we will mail you back with bank details to make your EFT. The books will arrive on 10 December and we will be closing orders on 30 November. The price of R1,199 includes the cost of us posting the book to you via courier.

Was the bottom on 27 Oct?

Was the bottom of the current bear market reached on 27 October? You will note that most of our candidate scans were run as of 29 October, as we felt this was a fair guess to the bottom of the market from which we obviously want to pick candidate stocks. But there is a Chinese proverb that goes : "Man who try to pick bottom get very smelly fingers!"

Our intent at PowerStocks is not to pick the bottom, but to get to a point close to the bottom either on the way down or on the way up. We want to figure when this bottom is close as that's when our research has shown the best value is available. Look at the below table on past JSE bear markets for the last 21 years (click for detailed view.)



The current bear has pulled the ALSI down 44.7%, slightly shy of the 45.9% in the '87 crash. The PE on the ALSI is down 50% to 8.3 (incidentally the same as the PE at the bottom of the last bear market) and the Dividend Yield is up 104% to 4.9%. High yielding stocks are going for a song.

Another interesting point is that those wiley investors that bought on 27 Oct would have shown a 15% increase by 5th Nov, merely 9 days later! Although earnings may drop in the ensuing months as business conditions tighten, markets are mostly forward looking and in all likelyhood the bulk of this has been priced in already. As Warren Buffet eloquently puts it "If you wait for the Robins to arrive, you will have missed Spring." Similarly, if you wait for all the good news before climbing in, you will have probably missed a good buying opportunity.

We will continue to peg 29th October as our theoretical "Bottom" in ongoing research and stock screens unless the ALSI goes significantly below 18,000. On that point, it is interesting to note that the trough on 27th October is 144% higher than the trough on the last crash - makes you think doesn't it?

Finally we note with interest that the current fall is very similar to the fall of '98. We are down 44.7% now and were down 43.8% then. We have been falling for 158 days versus 144 days then. The crash of '98 may be a better candidate for testing our theories we devised around the much longer bear market of 2002, and that's exactly what our next scope of research work will be. We will re-run the PE, Price:Book and Piotroski valuations on the crash of '98 and compare these to growths achieved by stocks in the subsequent 45 month bull. We can then compare our findings to the crash of 2002 to see if they are consistant!

Zweig as JSE predictor

Zweig was completely divested during bear markets and fully vested in bull markets. We do not think the Zweig screen works very well as a predictor in pre-bottom bear markets, rather it is suited to bull phases. The effectiveness of the AAI screen over the last 10 years catered for this divesting in bear phases (hence the portfolios "sideways" movement during the bears) and therefore you are ill advised to use Zweig as a stock picker now. It has to be used in conjunction with the "overall market condition" assessment that forms the other part of the Zweig methodology.

At PowerStocks, we have failed to find strong correlation between EPS growth indicators at the bottom of the last bear and subsequent 5 year growth on the JSE. We only found a strong correlation for a small subset of shares showing EPS growth of 100% and more. We are still scratching our heads on this one, but since Zweig itself is heavily weighted to EPS growth we can only assume it also will have low correlation. (Note this does not mean high growth EPS stocks don't show big appreciations, it merely states that the high EPS growth is not a statistically good indicator of future growth.)

We have also backtested ROE, ROA, PEG and Price:Sales and they too showed to be poor predictors of strong share growth out of a bear market. So for now, until our ongoing research yields otherwise, we have found PE, Price-to-book and Piotroski to be the best statistical predictors of growth, espcially when combined together through PriceFinder (PE+Price:Book) and ValueFinder (PriceFinder + Piotroski)

First Zweig Screen of the JSE

We now proudly present the first ever Zweig screen for the JSE. We screened for stocks that met Zweigs' "consistant turnover and EPS growth" criteria for the last 3 years (taken from last 3 sets of results as opposed to Zweigs' 4)

1. Average annual turnover growth for last 3 years > than 15%
2. Average annual EPS growth for last 3 years > than 20%
3. Minimum annual turnover growth for any of last 2 years > than 10%
4. Minimum annual EPS growth for any one year > than 20%
5. PE greater than or equal to 2

The above 4 criteria only yielded 17 stocks shown in the table below, a sure sign of the struggle to maintain earnings growth in the recent year. Since Zweig's writings only refer to "consistant EPS growth", which is a little "broad", we decided to divide the stocks into 4 categories :

1. those showing accelerating EPS growth for the 2nd & 3rd years
2. those showing accelerating EPS growth for the 3rd year only
3. those showing accelerating EPS growth for the 2nd year only
4. those showing declining EPS growth for the 2nd & 3rd years

Note that even category 4 above could be defined as "consistant EPS growth" since in each case growth is above 20% for each year, and indeed in some cases even above 100% even though it is declining each year.

We then entered the 2nd phase of the Zweig Screen, represented by a "1" or a "0" in the last two columns of our Zweig Screen table, namely looking for the following:

1. Debt:Equity ratio less than 33%
2. Debt:Equity ratio less than average for the stocks' sector
3. PE ratio at not more than 60% premium to the stocks' sector average

The table appears below:

Note that only 6 stocks meet all the Zweig criteria, (look for a "1" in both the DE and PE columns). Only 1 stock meets all the criteria and is showing consistant and accelerating EPS growth for the entire review period. There are 2 stocks that showed accelerated EPS growth in the most recent year and 1 stock that slowed in the recent year but accelerated in the 2nd year. There are 2 stocks that have shown consistant but declining EPS growth.

Note that on a daily basis, a stocks' share price will drive PE which will drive inclusion/exclusion from the Zweig rankings. Also, results (be they interims or finals but we are only looking at finals) will drive EPS, Turnover and DE inputs and will also trigger inclusion/exclusion from the rankings. We will publish the table quarterly to cater for all these changes as well as track the share appreciation of the "Zweig Screen" portfolio of stocks.

Zweig Fundamental Analysis

Zweig used a shotgun approach to screening stocks, rather than investigating individual stocks in depth. Five out of the eight stocks (62.5%) that made it through his screens performed well. Zweig gives greatest weight to PE and earnings trend.

EARNINGS TRENDS
Before he will consider buying a stock, Zweig needs to see the company's earnings rising consistently for the last four or five years. He also needs to reassure himself that nothing has gone wrong recently, so he checks that the most recent quarterly earnings have shown growth compared to the same quarter a year ago. The upward earnings trend should be backed by a parallel sales trend. Zweig believes that earnings growth will not be sustainable if earnings are rising due to cost cutting rather than increased sales.

PRICE TO EARNINGS
Zweig is interested only in stocks whose PE ratio is not unusually high relative to the current market. He believes high PE stocks are risky. If they fail to deliver, even slightly, on the high expectations associated with their PE ratio, their prices can quickly plummet. Zweig rules out stocks whose PE is unusually low because it takes odd circumstances - usually there is something worryingly wrong with the company - to produce very low PE values.

Although some companies do prosper after achieving earnings growth through cost cutting and some stocks do rise appreciably after being marked down to very low PE ratios, Zweig is interested in probabilities. On average, companies that don't fit his criteria won't deliver the strongly rising share price he desires; therefore he avoids them.

ZWEIG CHECKLIST
A Sample Checklist of Fundamentals For a Martin Zweig Type Stock Purchase (modified for the JSE based on our previous research) appears below.

1. The company should have annual earnings growth of 20% or more for at least four years.
2. Sales growth should be similar to earnings growth.
3. The PE ratio should not be too low. Reject companies with a PE of two or less.
4. The PE ratio should not be too high. Fast growing companies tend to have higher than average price/earnings ratios. Reduce the risk of overpaying for growth by rejecting any companies whose price/earnings ratios are more than 60 percent above average for their sector.
5. Company debt should be average or below average for the sector the company operates in.
6. Management should not have overestimated earnings during the last 3 years
7. There should be no selling of stock by insiders. If more than one insider is selling, they should be selling fewer shares than other insiders are purchasing.

For our screening purposes we will be ignoring interims results and items 6 and 7, leaving that up to you to perform after we have taken the grunt work out of preparing the screen.

The Zweig methodology

Martin Zweig was born in 1942 in Cleveland, Ohio and invented the puts/call ratio, a well-known market indicator. Apart from becoming famous for accurately predicting at least two great market crashes he was the founder of "The Zweig Forecast" a top market advisory for the 15 year period between 1980 and 1995. Zweig Forecast delivered a 16 percent per annum compounding return, the highest risk-adjusted return of any market advisory service during that time.

According to the AAII, out of more than 50 stock-screens it operates on a monthly basis, the Martin Zweig Stock Screen has been its top performer in the last ten years - up more than 1,900 percent between 1998 and 2008 (see below)



Zweig's investing philosophy is to buy and sell stocks in accordance with broader market conditions, the fundamentals of the stocks themselves and entry/exit timing using price action strength. It is not a traditional "buy and hold" strategy and he believed in being fully vested in bull markets and completely divested in bear markets (waiting with cash to get back in with exceptional value).

This is the philosophy that PowerStocks have adopted, with our sole purpose to provide you with those tools to select deep-value stocks with the highest probablity of market outperformance coupled with the largest margins of safety.

As we demonstrated with Piotroski, we will be performing the first ever public Zweig Fundamental Stock Screen for the JSE. We will publish the screen as at 31 October and then PowerStocks subscribers can get an updated Screen once per month via email for a nominal fee (more details later.)

PowerStocks ValueFinder

It now makes logical sense for us to want to perform a "Value" screen on the JSE by seeking stocks that are "cheap" (have low PE's and low Price:Book ratios, as with the PriceFinder screen) but are ALSO "quality" (financially sound, as shown with Piotroski Screen). We can do this by combining the Piotroski rankings with those PE and Price:Book scans we did previously. We call this triple-combo screen our PowerStocks ValueFinder.

Using this screen yielded a portfolio of only six shares at the trough of the last Bear market, that grew an impressive 593% on an equal weighted basis or a staggering 1042% on a market-cap weighted basis. (The weighted basis is merely the method you use to contruct your portfolio.) Every single stock in this portfolio grew more than 250%. To pick such a small portfolio with such impressive results is truly remarkable.

The flow diagram below shows how the PowerStocks methodology successively screened the JSE down from 271 to 6 stocks in the trough of the last Bear market.

We bet you are just itching to see which stocks currently meet the ValueFinder criteria right? If you would like a complete ValueFinder report of ALL 425 JSE stocks then proceed to PowerStocks JSE Rankings Report. However we strongly suggest you resist temptation and read the next section first, as we will show an even MORE powerful refinement to the ValueFinder stock picking methodology.

NEXT UP : Even more powerful, the PowerStocks ValueScore

Piotroski JSE Candidates

In the last two posts we introduced Piotroski, showed how well it worked in the US markets, back-tested it on the JSE and came to the conclusion that is is an extremely powerful selection criteria for picking a portfolio of undervalued stocks with Price-to-book ratios less than 1 that are likely to significantly outperform the market in any subsequent recovery.

PowerStocks are now proud to make history and publish the first ever Piotroski Longs/Shorts candidate ranking tables for the JSE. These are stocks with price:book ratios less than 1 and Piotroski scores of 7-9 (longs) or Piotroski scores of 2 and below (shorts). The Long Table appears below as at 31 October 2008. (click for larger view)



Note that every time a company releases a set of results, its Piotroski scores will change since all the information comes from the financial statements. Also these stocks by definition will be obscure. As Piotroski notes, low Price:Book stocks are generally neglected by the market in favour of more glamorous stocks, and during bear markets like the one we are currently in, this is even more so.

Piotroski scores can be used for picking shorting candidates as well. According to research and practical experience of some fund managers, F scores of 2 and below are good candidates for "distressed stocks" that are unlikely to hold up in depressions, recessions or tough economic times. Even if you don't do short trading, it is advised you avoid these stocks. The Piotroski Shorts table is below:

We showed that even for those shares with price:book ratios >1, Piotroski showed a very strong correlation between growth and "F" scores. If you would like a detailed Piotroski Ranking of all JSE stocks (475 of them) together with their PE's and Price:Book values as at 29 October 2008, sorted according to the ValueFinder scoring/ranking method then email us at powerstockz@gmail.com to place an order for the report, which will cost R250.

NEXT UP : Combining it all together - the ValueFinder