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%

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 Methodology

We will compare shares from the JSE ALSH ORD stock set to see how they have grown since the bottom of the last significant bear market in May 2003 to the peak of the last bull market in May 2008 (click on attached graphic for a detailed view.)



We will compare the growth rates of each stock over the 5 year ("A" to "B") period to key fundamental "value" indicators/ratios of each stock at the bottom ("A") of the last bear market. We will look at P/E, PEG, Price/NAV, Debt Ratios, Earnings growth etc.

We will then try to determine any correlation between these indicators/ratios and extent of growth achieved to finally derive a model for selecting (screening) value stocks most likely to achieve superior growth from point "C" onwards. Only "tradeable" stocks are considered that have at least 3 trades executed per day. There are about 100 stocks on the JSE that do not meet this criteria and we will not consider them since they are hard to trade and equally hard to liquidate to realise a profit.

We will also evaluate some famous "Score based" systems such as the Piotroski "F" Score system used to select stocks most likely to survive bear markets, and their effectiveness in predicting the stocks that showed superior growth since the last bear market. We will publish the first ever Piotroski ranking system of the JSE.

Finally we will use combinations of the above to present the first ever JSE fundamentals-based stock screening, ranking and scoring system that investors can use to select robust, powerful stocks most likely to outperform the market in the next bull run. Using our screening methodology in the last big bear market we would have picked 6 stocks that eventually grew in excess of 1,000 percent on average as opposed to the ALSI growth of 350%.

All of the above three objectives have not been done on the JSE and/or published for the general South African public before.

NEXT UP : Introduction to the PE Ratio

Our Philosophy

We subscribe to the time tested value investing methodologies of the industry greats, such as Warren Buffet, Benjamin Graham and William J O'Neil and research their works extensively. We then use unique methodologies and automated research systems to track various data on the JSE and turn that into unique never before seen information that allows you to subscribe to "Value investing" principles pioneered by these great men.

Our methodologies focus on being active in large bear markets to seek out stocks of companies that are financially powerful, well run, leaders in their segments, resilient in the face of downturns and above all properly valued or even undervalued. These stocks will exhibit superior growth during and after the downturn and will exhibit large "buffers of safety" after being purchased to make your investment virtually indestructible.

These are the South African PowerStocks - rock solid, powerful and virtually guaranteed to significantly outperform the market over a period of 3-5 years, and best of all going for a song. We will demonstrate the use of quantitative analysis, never before seen in South Africa to compare stocks for selection. In short the methods we will introduce are completely new to South Africa and are going to rivet you to your seat and your screen.

To be clear, we are not speculators nor financial advisers. We merely offer you unique never before seen tools and analysis tailored for investment on the JSE and ALT-X. We built these methodologies and tools out of necessity for ourselves, since although most of them may exist for the US markets and investment public, nothing like it is available for the South African public.

NEXT UP : A history of JSE Bear Markets