O'Shaughnessy's Cornerstone Growth Screen: Beating the Market through Relative Strength and Price to Sales
"Generally speaking, when things are going against you, as they inevitably will, you have to stick to the underlying strategy… Only by doing so will you be around for when it comes rebounding back."
The Cornerstone Growth Screen is an impressive growth screen which combines relative strength, earnings consistency and a price-to-sales value measure.
The screen helps identify stocks that the market is embracing (as shown by the high relative strength) but supposedly without overpaying (hence low price/sales). The reasoning was that shares with low valuations but momentum / relative strength were in the process of "being discovered" by the market.
Calculation / Definition
In his "Cornerstone Growth" approach, O'Shaughnessy used the following criteria:
Size - The screen was applied to the all-stocks universe on tbe basis that smaller stocks have greater growth potential than large caps. However, a market capitalisation threshold of $150 million was applied to screen out illiquid stocks.
Earnings growth consistency - A filter was applied for 5 years of consecutive EPS growth (regardless of magnitude). O'Shaughnessy found that the rate a growth stock's earnings grew wasn't as important as the persistence of growth over time.
Price to Sales - The growth requirement was balanced by using a maximum price-to-sales ratio of 1.5x. While the P/E ratio is the touchstone of stock analysts, O'Shaughnessy actually found that the relationship between a stock's price and its sales, rather than its earnings, was the most likely predictor of future success.
Relative Strength - Finally O'Shaughnessy ranked the passing companies for highest relative price strength over the previous year and choose the top 50. Relative strength compares the price performance of a stock to its corresponding Index (stocks outperforming have positive relative strength). This is because he found that a company which is a winner tends to continue winning, while losers tend to continue along that path.
Josef Lakonishok Momentum Screen
Josef Lakonishok Momentum is a strategy that uses price and earnings momentum to identify undervalued companies just at the point when the market is starting to recognise them. It is inspired by detailed research by academic and fund manager Josef Lakonishok, who co-wrote the paper Contrarian Investment, Extrapolation, and Risk.
The strategy combines value and momentum factors, including the price-to-earnings ratio, relative strength and earnings surprises.
Lakonishok wrote: "Regardless of the reason, some investors get overly excited about stocks that have done very well in the past and buy them up, so that these 'glamour' stocks become overpriced. Similarly, they overreact to stocks that have done very badly, oversell them, and these out-of-favour 'value' stocks become underpriced."
A Lakonishok-inspired strategy tracked by the American Association of Individual Investors returned 13.9% in the 10 years to the end of 2014, versus 5.4% for the S&P 500.
Charles Kirkpatrick Bargain ScreenStrategy.
Charles Kirkpatrick Bargain is a rules based strategy inspired by US investment strategist Charles Kirkpatrick's work in his excellent Beat the Market.
Kirkpatrick has established strategies for finding growth and value stocks. His bargain strategy concentrates on value and momentum factors, with a very precise requirement for the price to sales ratio.
Kirkpatrick's testing of of relative price-to-sales ratio rankings found that it was most effective between the 17th and 42nd percentiles in terms of cheapness.
Initial testing of the Bargain Model was promising but Kirkpatrick said that several more years of testing were needed before labeling it a success.
Kirkpatrick wrote: "As a result of these studies of relative selection methods, I decided to create a new list, called the 'Bargain List' that would incorporate the best triggers found so far and would only include value and price strength."