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.)