Winning Ways

This week, I’m writing about a screen that uses a lot of the ideas that I’ve written about in past articles, combined together into a powerful and consistently profitable stock picking strategy.

I’ll go over the rest of the statistics at the end of this article. But first, the parameters;

• P/E using 12 month EPS Actuals
  (I’ve written about why focusing only on stocks with P/E’s of 20 or less would’ve kept you out of some of the best stocks over the years. And that a P/E of 20 or less isn’t a ‘magic number’. In fact, I’ve often found that some of the best stocks started with P/E’s of twice that. So in this screen, I allowed stocks to have a P/E ratio of as high as 40.)

• Price to Book
  (In that same article, I showed that a Price/Book value of 1 or less was also not a ‘magic number.’ In fact, many of the best stocks started with P/B’s of 2 and 3 and 4. For this screen, we limited it to 2. But that’s still twice as big as the ‘magic number’ of 1.)

• Price >= 5
  (Most money managers won’t even look at a stock under $5, so we used this as a minimum price point.)

• Volume (20 day average) >= 50,000
  (Anything under 50,000 shares traded daily is excluded -- it has to be tradable. The typical stocks that make it thru however, usually trade several hundred thousand shares daily. In fact, the average daily volume for the stocks qualifying this week is over 312,500 shares.)

• Zacks Rank
  (The Zacks Rank is probably one of the best, if not the best rating systems out there. So only stocks with a Zacks Rank of a 1 or 2 (Strong Buy or Buy) are allowed.)

• % Change Actual EPS Growth Q(0)/Q(-1) >= 0
  (I’m looking for the last Quarter over Quarter EPS Growth to be at the very least flat to positive. (Q(0) being last Quarter and Q(-1) being the Quarter prior to the last Quarter.) In other words, if the last Quarter was worse than the previous Quarter, it’s excluded.)

• % Change in Q(1) Estimates over 4 weeks >= 0
  (And I want the Earnings Estimates for the Current Quarter to be increasing. (Q(1) being the Current Quarter.) The whole idea being; companies that receive upward Earnings Estimate Revisions, have a tendency of receiving even more upward Estimate Revisions. And this paints a solid picture moving forward.)

• % Change in Price over 4 weeks >= 0
  (The stocks have to have either increased in price over the last 4 weeks or at the very least, stayed steady. Any stock with a net breakdown in price over the last month is ignored.)

• Return on Equity -- Top # 5
  (What this means is I’m narrowing down all of the stocks that qualified the above parameters, to only the five with the best (highest) Return on Equity (ROE). And the ROE is one of the quickest ways to see whether a company is creating assets with Investors’ Cash or gobbling it up.)

I ran a series of tests over the last 4 3/4 year time span (2001 thru 9/16/2005), as well as a series of tests for each of the last 4 3/4 yrs. individually. I rebalanced the portfolio every four weeks and started each run on different start dates so each test would be rebalanced over a different set of four-week periods. (This exercise was done to eliminate coincidence and verify robustness.)

Over the last 4 3/4 years, this strategy has shown an average annualized gross return of 56.7% a year, with an average win ratio (winning periods divided by the total number of periods) of 71%. And again, it always only produces five stocks for your portfolio each month.

To break it down further; in 2001, the average annualized gross returns were 48.1%.

In 2002, the average annualized gross returns were 34.2%.

In 2003, the average annualized gross returns came in at 101.7%!

In 2004, the average annualized gross returns were up 55.5%.

And so far in 2005 (YTD thru 9/16/05), the average cumulative gross returns are up 37.4%.

Wow!

(I’d also like to note that I successfully tested this strategy with as few as only three stocks per period and as many as 10 stocks per period and they too came out with very impressive returns as well.)

Of the five stocks that made it thru this screen this week (10/3/05), here’s three of them;

AC Alliance Capital Management Holding, LP
MESA Mesa Air Group, Inc.
(RS - Analyst Report) Reliance Steel & Aluminum Co.

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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.