Using R-Squared Growth Rate

Stocks highlighted in this article are: Cracker Barrel (CBRL - Snapshot Report), Citi Trends, Inc. (CTRN - Analyst Report), Domino’s Pizza, Inc. (DPZ - Analyst Report), Euronet Worldwide, Inc. (EEFT - Snapshot Report) and Mastec, Inc. (MTZ - Snapshot Report).

The title of this week's article either scared people away, or made you click on it to read more. If you're reading this now, you're of course one of the latter. Congratulations.

So let's get right to it. The R-Squared Growth Rate is a measure of how close the actual earnings come in to the earnings growth on a regression basis.

In other words, how closely do the earnings conform to the regression line?

The range for an R-Squared value is between 0 and 1. The higher the value, the closer the data points are to matching the regression line. (In this example, the data points are EPS growth numbers.)

A value of 1 means the data is a perfect fit. Zero (0) is the worst.

Someone would want to use this to get a sense of the stock's ability to produce trendline EPS results. Of course there are no assurances that futures data points won't veer off course. But knowing how closely matched the data points have been is good to know.

What's interesting is that the distribution of the R-Squared values for the stocks in the Universe is an inverted bell curve (or well curve) distribution. Twenty-five percent of the stocks had a value of .33 to .66. But roughly 38% of the stocks had lower values. And roughly 38% had higher values.

Usually, with a normal distribution, the majority of the data falls within the middle values with the smaller amounts of data falling on either side to form a symmetrical bell curve.

This distribution was the exact opposite. So I decided to test it.

Before I did (and before I saw the distribution), I had at first thought that a ratio of 1 would be best and 0 the worst. But in my testing along with other items, these proved to be less reliable.

So the screen I'm running today looks at the following parameters:

• Price >= 5
  
• Volume (Avg. 20 Day Shares) >= 100,000
  
• Zacks Rank
• R-Squared EPS Growth: In (range) between .50 and .66
  (Above the median and one of the best tested ranges, i.e., EPS growth rates that show a 50% to 66% fit with the growth rate regression.)
  
• PEG ratio
• P/E Using 12 Month EPS: In (range) 5 and 15
  
• % Change Price over 4 weeks > -5
  (Stock cannot have dropped more than -5% over the last 4 weeks)

I also tested this strategy using a 4-week rebalancing period and using 4 different start dates to verify the screen's robustness. What's so impressive is that this screen showed an average total compounded return of 13.7% in 2008 while the S&P 500 showed a loss of -35.7%.

Very impressive.

Here are 5 stocks from this week's screen (for Tuesday, 3/17/09):

(CBRL - Snapshot Report) Cracker Barrel
(CTRN - Analyst Report) Citi Trends, Inc.
(DPZ - Analyst Report) Domino's Pizza, Inc.
(EEFT - Snapshot Report) Euronet Worldwide, Inc.
(MTZ - Snapshot Report) Mastec, Inc.

Get the rest of the stocks on this list and start using the R-Squared EPS Growth Rate in your own stock picking.

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Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.