Interpreting the Rankings Report

A sample PowerStocks JSE Ranking Report appears below. We will go briefly through how to interpret it before showing you how to build a portfolio. Click on the image for a larger view.



Going from left to right on the headings at the top:

1. Rank, JSE Ticker code, Share name, industry, price at trough
2. P1 to P9 are Piotroski sub-scores
3. TOT = Piotroski overall "F" score (Financial robustness)
4. MCAP = market capitalisation at trough price
5. Trade/day = Average trades per day for last 30 days (liquidity)
6. PE = Price-to-Earnings ratio in trough
7. P2Bk = Price-to-Book Ratio in trough
8. DE = Debt-to-Equity Ratio
9. DY = Dividend Yield
10. GR = positive & growing earnings per share in last financials

The PowerStocks ValuScore is then displayed:

1. "F" score for Piotroski (inclusive of bonus point)
2. "P/E" score for PE ratio
3. "P2B" score for price:book value (inclusive of bonus point)
4. TOT is total ValuScore

Shares are then grouped into ValueFinders, PriceFinders(a) and (b), Piotroski Universe etc. These are the PowerStocks Screens whose performance was discussed HERE.

You may elect to exclude small-cap and/or illiquid stocks from your portfolio (these are the grey-shaded shares but bear in mind we have shown that these contribute quite a bit to overall growth over 5 years).

You may also elect to use the DE, GR and EY fields to further apply selection criteria. Buffet, apart from using the techniques we have described on this blogsite, also avoided highly indebted stocks (DE>40%) in a downturn and focussed on high dividend yielding (DY) stocks that were showing EPS growth (GR). Note that our research has shown that eliminating these stocks significantly downgraded the performance of the portfolios (ie they had no negative bearing on ultimate growth achieved by portfolio inclusion).

It is recommended that you focus your attentions on the PowerStocks GrowthFinders, which are shares with ValueScores of 5 and 6 as these have shown to be the top performing portfolios. However, should you eliminate stocks that are small-cap or illiquid, or have debt:equity rations above 40% or have low dividend yields you will land up with a much smaller portfolio which may not be a good idea as ideal portfolio size should be at least 10 stocks. It is then suggested you consider stocks with ValuScores of 4 as well (essentially a PriceFinder(b) portfolio) as these have shown to perform nicely in the first 3 years of the recovery.

From the table you can see that if you focus only on larger cap, liquid issues we only have 7 shares in ValueFinder and 8 shares in GrowthFinder(b). We think you are better off either including all the small-cap/illiquid stocks (making 18 stocks in total) or including shares with ValueScore of 4 (making 13 stocks in total) to get to a better sized diversified portfolio.

NEXT UP : HOW TO SIZE YOUR PORTFOLIO ALLOCATIONS

ValuScore Performance

When we first introduced the PowerStocks ValuScore, we showed that small portfolios of JSE shares with scores of six (4 shares) and five (9 shares) significantly outperformed all other stocks on average, over a 5 year period. The graph below illustrates this performance on an accumulative basis:


Notice how the portfolios of shares with scores of 5 and 6 really "powered" ahead from year 3. These were real "PowerStocks"! Also notice how from year one already, the PowerStocks were already pulling ahead of the rest of the pack, and stayed ahead of the pack for the entire 5 year bull market! In fact shares with ValuScores of four (12 in total) were the only other group of companies that kept pace with the PowerStocks in the initial 3 year period. This is illustrated below:


The above graph also shows us that the PowerStocks (and the "4" stocks) almost doubled the average growth of the whole market in years one, two and three. Also note how remarkably quick the recovery of the PowerStocks were, coming out of the bear market. They doubled in year one and by year two had grown by 240% versus the group average of 120%. This is promising as it means we may not have to sit forever to realise our gains.

The reason for this is by design - PowerStocks, when bought at the trough of a bear market are:

1. very undervalued/oversold compared to the rest of the market
2. are cheap in relation to their per-share earnings power
3. are financialy strong (enough to survive economic slowdowns)
4. have the highest statistical probability of superior price growth

Remember, this is not some concocted methodology we have devised. It is based on accepted and proven principles used by the greatest value investors of all time (including Warren Buffet) for the last 100 years. All we have done is prove and tweak them for the JSE, added some automation to the financial analysis (Piotroski) and devised a nifty scoring system to help you screen and build up portfolios of stocks. For your initial portfolios to capitalise on the new bull market, we feel that stocks of ValuScores of 6, 5 and 4 should be selected for the first 3 years as this will offer a portfolio of suffcient size (15-25 stocks) and appropriate diversification.

To get a list of all JSE stocks together with their current ValuScores (as at 29 October, still our current "bottom pick" for the 2008 bear market) go HERE.

JSE Rankings Report

We would like to pay the bills for the tools and books we use for our research, so we are offering the first PowerStocks JSE Rankings Report for sale for R249.00.



This report will list all 420 JSE/ALT-X shares together with their Piotroski scores (and 9 sub-scores), as at 29 October (our pick of the bottom of this current bear market) together with the PE, Price:Book, Debt:Equity, Earnings yield and PowerStocks ValuScore.

The report is categorised and ranked into the following sections:

1. GrowthFinders (Piotroski >6 AND Price:NAV less than 1)
2. ValueFinders (Piotroski >6, AND Price:Nav less than 1 AND PE 2-6)
3. TurboStocks (Piotroski >6 AND PE=2 to 6, but Price:Nav >1)
4. PriceFinders (Piotroski less than 7 AND Price:NAV less than 1 AND PE=2-6)
5. Piotroski Vanillas (Piotroski >6 but PE > 6 and Price:NAV >1)
6. Undervalued (Piotroski less than 7 AND Price:NAV less than 1)
7. Cheap issues (Piotroski less than 7 AND Price:Earnings from 2 to 6)
8. Borderline (Piotroski of 5 or 6 but PE > 6 and Price:Nav > 1)
9. Dogs of the JSE (Piotroski less than 5 and PE > 6 AND Price:Nav >1)

Each category above is ranked according to Piotroski score, PowerStocks ValuScore, Market Capitalisation and average trades made per day (liquidity). This web site has described categories 1 to 7 in detail and how powerful they could be in selecting value stocks. The report is the first comprehensive ranking we have seen in South Africa of the JSE and ALT-X using fundamental data that historically showed the greatest correlation to share growth since the last big JSE crash.

The report will serve as a useful reference guide to any private or institutional investor. A sample from the top page of the report appears below (click for details).


The report highlights stocks in yellow that Graham, Buffet and other grand master investors would be picking right now according to their methodologies, namely liquid, as large cap as possible with low PE and Price:Book and sound financials, low debt/gearing and high dividend yields. It even recommends what % of your portfolio each share should constitute. The idea is you buy the yellow stocks, sit back for 5 years and reap the rewards!

Go here for instructions on how to interpret and use the JSE Rankings Report.

Email powerstockz(at)gmail.com with your name and address and we will email you an order form together with our bank details for an EFT.

PowerStocks ValuScore

In the previous section we saw how various fundamental screens and combinations thereof could narrow down a JSE portfolio candidate list whilst dramatically enhancing growth performance of said portfolios. The effectiveness of the various screens when performed on the 2003 crash can be summarised in the below graph:


*Note in the above graph we have not limited the PE screens to "liquid issues" only as this significantly reduces performance of any screens using PE.

At PowerStocks, we have derived a scoring method called the "ValuScore" to indicate how much "intrinsic value and growth probability" a share is exhibiting. This scores shares according to their PE, Price:Book and Piotroski "F" scores, and takes the effectiveness of the various screens and combos into account when performing the scoring. The effect is to significantly boosts historical ValueFinder portfolio performance (from 1,470% to 1,750% in the 2003 excersise) whilst dropping portfolio size by a staggering two-thirds! The scoring system is out of a maximum of 6 points and works as follows:

1. Start with zero score
2. Allocate 1 point if Piotroski "F" score is equal to 7
3. Allocate 2 points if "F" score is greater than 7
4. Add bonus point if "F" > 6 and Price:Book less than 1
5. Add 1 point if P/E between 2 and 6
6. Add 1 point if Price:Book less than 1
7. Add bonus point if Price:Book less than 0.7

Below is a chart showing how stocks in the April 2003 bear market grew in the subsequent 5 years versus the PowerStocks ValuScores they achieved in the trough:

We can see that portfolio performance was significantly enhanced and in fact collapses all 7 of the high performing screens shown in the previous chart to just two categories, namely "ValuScore 6" and "ValuScore 5" (13 shares in total).

Although the 5-year growth above hints that scores of 5 and 6 perform the best, we see that scores of 4 also perform well in the initial 3 year period shown below:

We will use this scoring system in our rankings tables and it is recommended that portfolios be built using shares with PowerStocks Scores of 5 and 6 and even with 4. Shares with a score of 3 perform on average slightly above the market whilst scores of 2 on average perform at market growth whilst scores of 1 and 0 perform on average below market.

NEXT UP : PowerStocks ValueScore Performance on the JSE

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

Piotroski JSE Performance

As we saw from the previous post, the theory is you only apply the Piotroski scoring methodology to "undervalued" stocks with low price-to-net-asset-values (Price:NAV). The theory goes that the growth of these "distressed" stocks in the medium term (5 years) is closely correlated to the Piotroski "F" scores they achieved at the start of the assessment period.

PowerStocks put this to the test on the JSE, ranking the 5 year average growth of stocks together with their Piotroski "F" scores as at 28 April 2003 (trough of the last big bear market). We performed the tests with all JSE shares listed at that time and then only on those shares with Price:Book ratios of less than 1. The results are shown below:


The results are rather remarkable, confirming Piotroskis' theory for the JSE. Note how Piotroski is a great bear market screen for ANY stocks (shown by the blue bars) but worked especially well for "undervalued" stocks (shown by the red bars) when F>6. Note how portfolios of shares selected with F>6 significantly outperformed the ALSI and the group average growths.

Note how the average growth of the group P2Bk<=1 is much larger than the average growth of the entire group (All), confirming the theory we postulated that undervalued share portfolios are much more likely to outperform coming out of bear markets than other stocks (See Price-to-Book : An all-time classic)

We can state that historically, Piotroski "F" scores greater than or equal to 7 for "undervalued" shares showed significant out-performance to the group average (of undervalued stocks) and the all-share index (ALSI). It also showed a lesser but still significant out-performance for all stocks regardless of their price:book ratios.

The most important observation we can make here is that even though Price:Book has been shown to be a stong, safe selection criteria for potential growth stocks, Price:Book coupled with the Piotroski valuation significantly enhances portfolio performance. The almost 1,200% performance of the portfolio of "undervalued" shares with F greater than or equal to eight is double the group average of undervalued stocks (588%) and triple the growth of the market-cap based ALSI index (350%).

NEW : The Piotroski screen is our top performing portfolio we track on the JSE since 20 Nov 2008. You can view its performance coming out of the 2008 JSE crash over here.

NEXT : Piotroski JSE Candidates

Piotroski U.S Performance

The Piotroski method is currently the 3rd most successful value investing system, tracked monthly for the last 10 years by the American Association for Individual Investors (AAII). Over the last 10 years it showed 1,069% return, versus O'Neils CANSLIM (1,489%) and the Zweig method (1,800%).

CANSLIM and Zweig are however BULL MARKET investment strategies, and Piotroski is the only BEAR MARKET screen tracked by the AAII. Since we are in the throes of the 2nd largest bear market in 20 years on the JSE, we are very interested in Piotroski's methods!



Note how the Piotroski screen massively boosts the performance of low PB stocks. And look at how the Piotroski growth exploded from the trough of the 2003 bear and remarkably is showing 20% growth in 2008 when just about everything else is lying on the floor!

But how should we explain the poor performance of Piotroski's method in the mad bull run of 2006 and 2007 and its good performance in the current crash? Quite simply, in the peak of a bull run, everyone is chasing hyped up stocks and not the low PB stocks and in the bear run everyone comes down to the level of the low PB stocks and their value coupled with their sound "financials" from the "F"-Score starts shining through.

Given the current state of the markets now, it looks like a fine time to build up a Piotroski Portfolio! Here at PowerStocks we are going to do just that, building the first EVER published Piotroski Portfolio for the JSE, right in the midst of the 2nd largest JSE fall in 20 years. But first we need to test it to see if it works on the JSE. Sure, there is a 90% chance it should but at PowerStocks we like to back test our theories on the JSE first.

NEXT : Piotroski performance on the JSE

Introduction to Piotroski

Our previous writings showed how the trend in overseas markets for low price-to-book (PB) "value" stock portfolios to outperform high PB value portfolios was spectacularly confirmed on the JSE.

It has also been shown that large portfolios of low PB stocks outperform smaller portfolios, because in general, a few stocks in the low PB portfolio have to perform spectacularly, to make up for all the losses of the other stocks in the portfolio.

This is because many low PB stocks are low for a reason and as the lowest PB stocks are generally distressed, very few of them manage to claw out of the hole they are in. Having said that, our previous PB analysis on the JSE showed that very few low PB stocks (not more than 15%) "crashed and burned" and had you put together a portfolio in May 2003 of 10 or more low PB stocks you would have done rather nicely, especially if they had PE's between 2-4.

Nevertheless, it would be nice to apply some sort of financial "evaluation" to low PB stocks to further screen out "weaker" issues and focus on those most likely to have strong financial fundamentals turn in their favour in the short term, further accelerating their over performance of the ALSI, and allowing us to get good performance by only having to manage smaller less risky portfolios.

One particular person came up with such a methodology that is quite successful. He is Joseph Piotroski and he is a professor at the University of Chicago. His paper, “Value Investing: The Use of Historical Financial Information to Separate Winners from Losers”, available as a PDF here, was published in 2000. In that paper, Piotroski showed that by using a set of nine different fundamental signals taken straight from the companies financials, to screen among low P/B stocks, an investor could separate the winners from the losers. By buying only those stocks that had the highest scores, an investor could have outperformed the market by an average of 10% per year from 1976 to 1996.

Piotroski started by screening for the stocks with the lowest P/B ratios that were non-negative. This limits the strategy to true value companies. After the price to book ratio, nine other pieces of information were used, as follows:

1. positive earnings
2. positive cash flow from operations
3. increasing ROA
4. quality of earnings : operating cashflow > net income
5. decreasing long-term debt as a proportion of total assets
6. increasing current ratio, indicating increasing ability to pay off short-term debts
7. decreasing or stable number of shares outstanding
8. increasing asset turnover ratio, indicating increasing sales as a proportion of total assets
9. increasing gross margin

Each company is given either a one or a zero on each variable to create an "F"-Score ranging from 0 to 9. The strategy calls for buying every company with the requisite low P/B ratio and a "F"-score of eight or nine. As Piotroski's research shows, low P/B stocks with high rankings are less likely to go bankrupt or to fall drastically in price than are those with low rankings, so this further adds to our defensive value picking investment strategy.

NEXT : Piotroski U.S Performance

PowerStocks PriceFinder

If we were to combine our PE criteria with the Price:Book criteria we should be getting close to a fairly powerful value-based stock selection system. Our "PriceFinder" has the two criteria that have individually shown to statistically, on average, significantly outperform the ALSI. Here we will find stocks that have P/E between 2 and 6 AND are trading at less than book (net asset) value. We also only look at stocks that trade on average more than twice a day.

It is important to note that the PriceFinder merely seeks out stocks that are available at highly reasonable fundamental valuations based on Price, Earnings, and Book Value and have a maximum probability of market outperformance based on the historical statistical groupings of these values. These are by no means the only stocks likely to outperform the ALSI and indeed the PriceFinder selection method has no bearing on the stocks' financial soundness or business prospects.

In the trough of the 2003 crash, we found 111 stocks with a Price:Book less than 1, averaging 585% growth in the subsequent 5 year period. We also found 39 stocks trading more than twice a day and with a PE between 2 and 6, averaging 508% growth in the subsequent 5 years. Combining the two criteria however, only yielded 11 stocks averaging 741% growth in the subsequent 5 years. Combining the criteria significantly narrowed the field and boosted the subsequent average growth of the portfolio.

We bet you are just itching to see what stocks on the JSE currently meet these criteria right? Below is the list of 19 JSE shares as at 29 October 2008 meeting all three criteria for the PriceFinder (PE, Price:Book and at least three trades a day). Click on the image for a larger view.


Remember that some or most of these stocks will be "obscure", since the selection criteria are typically those of "neglected or overlooked" stocks (but which we have determined, hold incredible value).

NEXT UP : Introduction to Piotroski

Price:Book - JSE Candidates

As of 29 October 2008, over 170 (or 40%) of the JSE's 426 ordinary shares are trading at less than or equal to book value. But only 90 of these are "liquid" enough for our consideration (trade more than 3 times a day on average). Of these 90 stocks, only 27 are trading at half their asset value.

Since we showed in the previous blog entry that historically the last JSE crash showed that these types of stocks significantly outperformed the rest of the market, we are now quite interested in seeing who those stocks are today. We present them below (click for bigger view)



NEXT UP : One-two combo - The PowerStocks PriceFinder

Price:Book:An all time classic

We now progress onto one of the most important fundamental metrics on the stock markets. Benjamin Graham and Warren Buffet say above all else that the Price-to-Book (or Price to Net Asset Value) ratio is one sure way to pick "cheap" defensive stocks. Note there is a difference between "cheap" and "value". Value is "Cheap" + "Fundamentally sound", so using the Price:Book is just a way to get a list of properly or under-priced candidates that will warrant further investigation of solid financials, management, etc.

This ratio is simply the market capitalisation on the day divided by its total assets minus its liabilities. It is representative of what the company were worth should it be liquidated. Why should we start with this indicator when building a stock portfolio? From page 9 of Grahams' all time 30 year classic "The Intelligent Investor" he quotes "Strangely enough, we shall suggest as one of our chief requirements that our readers limit themselves to issues selling not far above their tangible-asset value".

The book goes on to state that "The reason for this seemingly outmoded counsel is both practical and psychological. Experience has taught us that, while there are many good growth companies worth several times net assets, the buyer of such shares will be too dependant on the vagaries and fluctuations of the the stock market. By contrast, the investor in sound businesses selling at slightly above asset value can always consider themselves owners of of an interest in sound and expanding businesses, acquired at rational prices - regardless of what the stock market may say to the contrary."

But in market crashes such as the one we are currently in, the Price:Book ratio becomes even more important a selector. This is because markets tend to over-react (both on the up and on the down) and when panic ensues, prices have the tendency to go way below fair value. Graham said that stocks selected with low Price:Book ratios in a crash can form very defensive stocks, since the underlying value of the stock is far higher than what you paid for it. Over time, after one or two interims or finals, the market will quickly realise this and the stock will rise accordingly.

Just about every value investment book mentions this, but nobody has ever tested this theory on the JSE. We set out to do just that and we proudly display the results below.



Sure enough, we are presented with an astounding vilification on the JSE of Grahams sage advice. There is a remarkably clear and distinct correlation between low Price:Book ratios at the trough of a bear market, and their ability to outperform the rest of the market in the ensuing 5 years. We can look at the above graph and state that historically, Price:book ratios of less than 1 will significantly outperform those with a value greater than 1, with spectacular out performance demonstrated by issues worth less than 50% of net asset value.

NEXT UP : Book Value JSE Candidates

PE Ratio Candidates

So we saw in the trough of the last bear market, that those stocks that exhibited PE ratios of between 2 and 4 significantly outperformed all other stocks on average for the 5 year growth period that followed. Assuming we are at or close to the "trough" of the current bear market (and the ALSH PE would seem to indicate that), which JSE stocks currently exhibit this trait?


Whilst it is not safe to use this trait alone in a investment descision, as we will show a far more powerful and accurate system later on, let's satify our curiosity. As at 29 Oct 2008 here are the 29 JSE stocks out of 430 in total that exhibit PE's of between 2 and 4 and trade more than 3 times a day (click on image for details)

NEXT UP : Book value or Net Asset Value

Introduction to PE Ratio

The PE is a valuation ratio of a company's current share price compared to its per-share earnings. The P/E is sometimes referred to as the "multiple", because it shows how much investors are willing to pay per Rand of earnings. Made popular by the late Benjamin Graham, who was dubbed the "Father of Value Investing" as well as Warren Buffett's mentor, Graham preached the virtues of this financial ratio as one of the quickest and easiest ways to determine if a stock is trading on an investment or speculative basis. A low PE indicates value and conversely a high PE indicates "expensive".

Another great investor, Martin Zweig commented : "The data going all the way back to the 1930s show conclusively that stocks with low price/earnings ratios outperform stocks with high price/earnings ratios over the longer term". Zweig's view was that although stocks with high PE's have been known to perform well, when these stocks miss forecasted earnings they get punished much worse than lower PE stocks and thus he would avoid them altogether. However Zweig also avoided stocks with "too low" PE's as he considered that something must be fundamentally wrong for these stocks to warrant such PE's.

Of course, a low PE may indicate a "cheap" share but it will not necessarily indicate a "good quality" or "value" share. Generally speaking, PE ratios of stocks need to be compared to those of stocks in similar industries, however for the purposes of the PowerStocks PE study, since we assume the stocks to be all "depressed" or heavily sold off we will be simply seeking to correlate the growth of all shares related to their PE's reported during the end of the bear cycle.

The graph below shows the growth achieved by JSE stocks since the trough of the last big JSE bear market, relative to their trailing PE's as at 28 April 2003. Note that only 136 stocks that averaged more than 3 trades a day during the month of April 2003 were considered (98 stocks were considered not liquid enough)



Sure enough we find a strong correlation between PE and share price growth. More significantly, those stocks with PE's between 2-4 significantly outperformed the ALSI (All share Index) as well as all the other PE groupings. True to Zweigs affirmations, those PE's that were "very low" significantly underperformed the market.

There were 11 stocks with PE ranging from 2 to 4 and 28 stocks ranging from PE of 4 to 6, making altogether 39 stocks with a PE betweeen 2 and 6 which averaged 508% growth. As a general observation we can safely state that historically, stocks with PE's between 2 and 6 outperformed all other stocks.

NEXT UP : PE Ratio JSE Candidates

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

Bulls and Bears of the past

You can click on the above diagram for a more detailed view of the all-share index in the last 20 years. Note how short the "crashes" are (no more than a year but mostly less than 120 days) and how long some of the "bull runs" can be (2, 3 even 5 years!). Also note how each bull run more than makes up for the losses of the previous "bear run". Also note that as we move to the right each correction seems "deeper"misleading you into thinking the corrections are getting worse and worse but in reality as you can see from the % figures, they are all more or less the same (20-45%). This is merely an optical illusion since each correction is off a much higher base.

Undoubtedly, the last bull run has been remarkable and it is with a sigh of relief that sanity prevailed and we have a long overdue correction. The current correction is the 2nd biggest in 20 years at 45% but it has only retraced 2 years of growth (13 June 2006) and could retrace further to 50% (the 17,000 mark) or even to 16,500. When that happens you want to be ready to pile back in and make sure you are piling back into the the right PowerStocks.

We cannot say how long stocks will languish at these levels, nor how quickly they will rise again, but this is academic to the value long term investor. The idea is to get in when solid stocks are cheap and let earnings growth take care of the rest. We may never see the bull run of the last 5 years again, more likely we will see a slower more cautious and sane ride back to the top. The main point is that by getting a portfolio of the right PowerStocks together you will still be set to reap more than satisfactory returns that will outperform most of the market.

NEXT UP : The PowerStocks Methodology

A History of JSE Bear Markets

Our first lesson is an important one. You need to understand that the current bear market is normal. In fact it is welcomed for the wily investor. To quote Warren Buffet "Be scared when everyone is greedy and be greedy when everyone is scared". Now think of this - the US markets have seen their greatest drops since the great depression and Buffet has started buying American stocks!



Look at the chart above of 11 significant downturns on the JSE over the last 21 years. There have been many more "mini bears" but the ones above are the grown-up bears. Grown up bears last longer than 90 days and represent a decline of more than 15%. The periods above are the only times this has happened. Each time the market bottoms-out, it has risen to higher than all the periods before! These are normal cycles that flush the system as contrary to popular belief the markets are not that efficient. Markets either price things to high due to over exuberance, which leads to collapses and then the subsequent collapses go completely overboard in the ensuing panic. All the investment greats recognised this as golden opportunities for buying stocks for far less than they are worth and selling them for far more than they are worth. How else do you think these men made billions of dollars?

Back to the chart - you will note that we are 154 days into the current downturn and the JSE ALSH is at 18,100 (a record 44.5% down!) Yummy - this looks like the time to pack our rifles and doing some hunting! But before we willy-nilly buy any old stocks (which will lead you to fail) we need to take you through a few more lessons based on our research of the last 18 months. After all, a market is a tide upon which all boats float when it rises, but not all stocks are likely to recover from the downturn and will be smashed against the rocks as the tides drop, never to float again. With JSE PowerStocks there is a detailed and thorough process that needs to be followed to pick those Phoenixes that will rise again from the ashes.

NEXT UP : Bulls and Bears of the Past

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