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Revision history Overview Benefits Screen details Zacks implementation Portfolio123 implementation Conclusion

The Mosaic of Stock Analysis 2.1
Quantitative analysis and stock screening
Work horses not show horses the O’Shaughnessy way
David J. Moore, Ph.D.
www.efficientminds.com
October 6, 2014
Revision history Overview Benefits Screen details Zacks implementation Portfolio123 implementation Conclusion
Outline
1
Revision history
2
Who is James O’Shaughnessy?
3
Benefits of stock screening
4
Screen details
5
Zacks.com implementation
Data collection
Data processing
6
Portfolio123.com implementation
Data collection
Data processing
7
Conclusion
Revision history Overview Benefits Screen details Zacks implementation Portfolio123 implementation Conclusion
Outline
1
Revision history
2
Who is James O’Shaughnessy?
3
Benefits of stock screening
4
Screen details
5
Zacks.com implementation
Data collection
Data processing
6
Portfolio123.com implementation
Data collection
Data processing
7
Conclusion
Revision history Overview Benefits Screen details Zacks implementation Portfolio123 implementation Conclusion
The evolution
Revision history
1.0: The beginning
Based on What Works on Wall Street 3e (2005).
Screen used to narrow focus of stocks.
1.1: Update
Based on What Works on Wall Street 4e (2011).
Screens based on updated data.
2.0: Utilization change
Screen used to establish the QUANT score, not to narrow focus of
stocks.
Ultimately, the overall SCORE will be used to narrow and select
stocks.
Revision history Overview Benefits Screen details Zacks implementation Portfolio123 implementation Conclusion
The evolution
Revision history ...continued
2.1: Response to student feedback & more
Changed minimum market cap to 1000M (1B) in preparation for
fundamental scoring (Tamir G).
Added % Price Change (YTD) and Beta to list of Zacks data items.
Corrected WWoWS (4e) FCF definition.
Added VCZ (Zacks-able Screen). In the “Thinking fast, and slow”
vain, the VCZ screen variables have some validity in predicting the
desired outcome (high risk adjusted return).
Admittedly, BBY also has this validity (David L.). Unfortunately it is
unavailable in Zacks. However, GAME IV panelists don’t like
repurchases and I suspect repurchase activity will subside in the
short to midterm.
Revision history Overview Benefits Screen details Zacks implementation Portfolio123 implementation Conclusion
Outline
1
Revision history
2
Who is James O’Shaughnessy?
3
Benefits of stock screening
4
Screen details
5
Zacks.com implementation
Data collection
Data processing
6
Portfolio123.com implementation
Data collection
Data processing
7
Conclusion
Revision history Overview Benefits Screen details Zacks implementation Portfolio123 implementation Conclusion
Motivation for selecting this particular book
Who is O’Shaughnessy (J.O.)?
2005: Director of Systematic Equity for Bear Stearns Asset
Management & Author of “What Works on Wall Street: A guide to
the best performing investment strategies of all time” (WWoWS)
This book was referred to me by my dissertation chairman and
confidant with 40+ years of global financial market experience.
2007: J.O. left Bear Stearns to form O’Shaughnessy Capital
Management LLC.
2008: Yes Bear Stearns collapsed and was sold to JP Morgan
Chase. Was it J.O.’s fault? I don’t think so. J.O. did jump out of
the sinking ship before it sank.
2011: November release of updated book
Revision history Overview Benefits Screen details Zacks implementation Portfolio123 implementation Conclusion
Motivation for selecting this particular book
What is the book about?
A plethora of stock screening strategies applied to historical data.
Strategies →portfolios →superior risk adjusted performance.
A number of the strategies are used in actual O’Shaughnessy
funds.
One can see the screening strategies that worked the best over
the 1964 to December 2009 time frame.
Revision history Overview Benefits Screen details Zacks implementation Portfolio123 implementation Conclusion
Supplemental files
Supplemental files to accompany presentation
The following files are available on www.efficientminds.com on
the same page as this presentation.
JOScreens.xlsx Detailed performance measures of all screens in
What Works on Wall Street, fourth edition.
TrendingValueExample.xlsx An application of the “Trending
Value” screen to the “All stocks” universe. This accompanies the
stock screen implementation example towards the end of this
presentation.
You may wish to obtain these files now before proceeding with
the presentation.
Revision history Overview Benefits Screen details Zacks implementation Portfolio123 implementation Conclusion
Outline
1
Revision history
2
Who is James O’Shaughnessy?
3
Benefits of stock screening
4
Screen details
5
Zacks.com implementation
Data collection
Data processing
6
Portfolio123.com implementation
Data collection
Data processing
7
Conclusion
Revision history Overview Benefits Screen details Zacks implementation Portfolio123 implementation Conclusion
Qualitative and quantitative evidence
How can screening help us?
The WWoWS screening strategies to select stock portfolios that
have persistently outperformed the market (as measured by
returns, standard deviation, sharpe ratio).
The Student Investment Fund can apply the strategies to
individual sectors for two purposes.
1
To identify stocks most likely to assist in beating the S&P 500 index.
2
To provide a signal of when to sell a currently held stock. For
instance If a stock no longer passes the screen then consider
selling.
Screening provides more scientific structure to our buy and sell
decisions. This structure is based on historical financial data.
Revision history Overview Benefits Screen details Zacks implementation Portfolio123 implementation Conclusion
Qualitative and quantitative evidence
Quotes from “The Intelligent Investor”
“... the greater the premium above book value, the less certain
the basis of determining its intrinsic value - i.e., the more this
’value’ will depend on the changing moods and measurements of
the stock market”
“ ... concentrate on issues selling at a reasonably close
approximation to their tangible-asset value - say, at not more
than one-third above that figure.”
The 33% premium can be considered “..a kind of extra fee paid
for the advantage of stock-exchange listing and the marketability
that goes with it.”
Don’t go with just low P/B. Demand “...a satisfactory ratio of
earnings to price, a sufficiently strong financial position, and the
prospect that its earnings will at least be maintained over the
years.” (this is a prelude to The Mosaic of Stock Analysis Part 2)
Revision history Overview Benefits Screen details Zacks implementation Portfolio123 implementation Conclusion
Qualitative and quantitative evidence
Occam’s Razor Screen
Occam’s Razor stock screen:
P/B <1.33
But, according to “The Intelligent Investor” that is not the end of
the story.
Of the resulting stocks, look at P/E, financial position, and
earnings growth prospects.
All of these considerations are inherent in the upcoming JO
screens, to some extent.
What is not covered: when to sell?
Revision history Overview Benefits Screen details Zacks implementation Portfolio123 implementation Conclusion
Qualitative and quantitative evidence
JO Methodology
Portfolios are formed each month of the year and held for one
year (WWoWS p. 54).
We hope to hold stocks longer, but a one year target holding
period is a good start.
Besides, a good pick will pass the screen year after year.
“The Trending Value portfolio never had a five-year period in which
it lost money” (WWoWs p. 584).
Reported results reflect the average of the twelve portfolios. That
is, the average of Jan
t
→Jan
t +n
, Feb
t
→Feb
t +n
, . . .
Dec
t
→Dec
t +n
portfolios.
Reesults reported in this manner indicate what you can expect
(on average) irrespective of the month of portfolio formation.
Revision history Overview Benefits Screen details Zacks implementation Portfolio123 implementation Conclusion
Qualitative and quantitative evidence
Performance data of suggested screens
Universe Screen geomean stdev Sharpe Beta
All stocks none 11.01% 19.26% 0.31 N/A
S&P 500 none 9.33% 15.31% 0.28 0.88
All stocks Value composite 2 17.12% 17.32% 0.70 0.85
All stocks Trending value 21.08% 17.66% 0.91 0.81
Consumer discretionary EV/FCF 13.89% 21.36% 0.42 0.95
Consumer staples Shareholder yield 17.80% 14.73% 0.87 0.87
Energy Value composite 2 18.36% 21.84% 0.61 0.81
Financial Value composite 3 15.96% 18.65% 0.59 1.02
Healthcare Value composite 2 17.50% 20.01% 0.62 0.72
Industrial Value composite 2 15.34% 19.89% 0.52 0.93
Infotech Value composite 2 12.55% 25.83% 0.29 0.78
Materials Shareholder yield 15.36% 19.29% 0.54 0.88
Telecommunications Value composite 1 17.00% 17.07% 0.70 0.68
Utilities Value composite 2 16.01% 14.51% 0.76 1.01
Trending value is VC2 plus six month momentum (six month price change). I.e., of those
stocks that pass VC2, choose the top 25 highest prior six month return.
I further suggest adding six month price change to all sector Screens in the same fashion it
was added to VC2 to form the top-performing “Trending value” screen.
For more information see wwows_ex_28_table4.pdf
Revision history Overview Benefits Screen details Zacks implementation Portfolio123 implementation Conclusion
Outline
1
Revision history
2
Who is James O’Shaughnessy?
3
Benefits of stock screening
4
Screen details
5
Zacks.com implementation
Data collection
Data processing
6
Portfolio123.com implementation
Data collection
Data processing
7
Conclusion
Revision history Overview Benefits Screen details Zacks implementation Portfolio123 implementation Conclusion
Definitions and screens
Definitions 1/2
Enterprise value (EV): the theoretical takeover value. The cost to acquire a company and pay
off its obligations less remaining cash.
EV = market cap+pref. equity+long term debt −cash or cash equivalents (1)
Dividend yield (DY): a measure of cash flow to shareholders via dividend payments.
DY =
D
0
P
0
(2)
Buyback yield (BBY): a measure of cash flow to shareholders via repurchases.
BBY =
shares out
t −1
−shares out
t
shares out
t −1
(3)
Shareholder yield (SY): a combined measure of cash flows to shareholders.
SY = DY +BBY (4)
Revision history Overview Benefits Screen details Zacks implementation Portfolio123 implementation Conclusion
Definitions and screens
Definitions 2/2
Unfortunately BBY is not readily available via Zacks.com. For now we
can just use DY as a proxy for BBY (and consequently SY).
1
Cash flow, or net cash flow (WWoWS 4e p. 125):
CF = net income+dep. & amort. +other non-cash exp.
Free cash flow (FCF): cash left over to distribute to investors after
necessary investments to maintain growth.
According to WWoWS 4e p. 143:
FCF = CF −CapEX−Dividends−Pref. Dividends (5)
Sharpe ratio (excess return per unit of risk):
Sharpe =
E [R] −R
f
σ
1
Although buyback activity has been observed in the recent past, at least
one article suggests companies “should continue to institute and raise their dividend
yields in 2013.”
Revision history Overview Benefits Screen details Zacks implementation Portfolio123 implementation Conclusion
Definitions and screens
Screening criteria
# VC1 VC2 VC3 Trending value VCZ
1 Price-to-Book Price-to-Book Price-to-Book Price-to-Book Price-to-Book
2 Price-to-Earnings Price-to-Earnings Price-to-Earnings Price-to-Earnings Price-to-Earnings
3 Price-to-Sales Price-to-Sales Price-to-Sales Price-to-Sales Price-to-Sales
4 Price-to-Cashflow Price-to-Cashflow Price-to-Cashflow Price-to-Cashflow Price-to-Cashflow
5 EBITDA/EV EBITDA/EV EBITDA/EV EBITDA/EV EBITDA/EV
6 Shareholder yield Buyback yield Shareholder yield Dividend yield
7 6 month momentum
The first five criteria are identical for all composite screens.
Items 1 to 4 (PB, PE, PS, PC): lower is better.
Items 5 to 7 (EBITDA/EV, SY, BBY, DY, 6 mom): higher is better.
Revision history Overview Benefits Screen details Zacks implementation Portfolio123 implementation Conclusion
Outline
1
Revision history
2
Who is James O’Shaughnessy?
3
Benefits of stock screening
4
Screen details
5
Zacks.com implementation
Data collection
Data processing
6
Portfolio123.com implementation
Data collection
Data processing
7
Conclusion
Revision history Overview Benefits Screen details Zacks implementation Portfolio123 implementation Conclusion
Data collection
Variable definitions
Category Variable Used for
Valuations P/E (Trailing 12 month) PESCORE
Valuations Price/Cash Flow PCSCORE
Valuations Price/Book PBSCORE
Valuations Price/Sales PSSCORE
Balance sheet Receivables Cash = CA−AR−INV
Balance sheet Inventory Cash = CA−AR−INV
Balance sheet Current assets Cash = CA−AR−INV
Balance sheet Long term debt EV = mktcap +prefeq. +LTD−cash
Balance sheet Preferred equity EV = mktcap +prefeq. +LTD−cash
Company descrip. Sector Sector classification
Company descrip. Industry Sector classification
Dividends Div Yield % DY substitutes for SY & BBY
Inc. Stmt. & growth Annual Sales Industry median OM & NPM (FUNDA)
Inc. Stmt. & growth EBITDA EESCORE and Industry median OM (FUNDA)
Inc. Stmt. & growth Net Income Industry median NPM (FUNDA)
Liquidity & coverage Debt/Equity Ratio Industry median D/E (FUNDA)
Price & Price Changes % Price Change (YTD) Screen assessment
Price & Price Changes Beta Screen assessment
Note: FUNDA = data to be used later in fundamental scoring.
Revision history Overview Benefits Screen details Zacks implementation Portfolio123 implementation Conclusion
Data collection
Data collection
Navigate to ZACKS.COM → SCREENING → STOCK SCREENING.
SIZE & SHARE VOLUME group →Market Cap >= 1000, Add.
Select EDIT VIEW and select all of the variables on the previous
slide.
Click RUN SCREEN
Note: If you want to apply the screen to a specific sector add
SECTOR from the COMPANY DESCRIPTORS group as criteria.
Revision history Overview Benefits Screen details Zacks implementation Portfolio123 implementation Conclusion
Data processing
Data processing 1/2
Download the data into excel: Click Export, then open file in
Excel.
Add a column for Cash = CA−AR−INV.
Add a column for EV = mktcap +prefeq. +LTD−cash.
Add a column EE = EBITDA/EV.
Add a column PxSCORE for each of the first four value criteria.
For example, PBSCORE with the Excel formula
PBSCORE = 1−IF(C3 = 0, 0.5, PERCENTRANK(C$3 : C$2694, C3))
This assigns a higher score to stocks with lower Price-to-X ratios.
Do not forget the $ in the first argument of PERCENTRANK.
Higher EBITDA/EV is better because it indicates higher earnings
(EBITDA) at a lower theoretical takeover price (EV).
EESCORE = PERCENTRANK(S$3 : S$2694, S3)
Revision history Overview Benefits Screen details Zacks implementation Portfolio123 implementation Conclusion
Data processing
Data processing 2/2
Unfortunately Zacks does not provide BBY data. For now, let
DY = SY = BBY. A panelist at GAME IV disapproved of share
repurchases anyway.
Create a column SYSCORE in the same fashion as EESCORE
but reference the dividend yield cells.
Create a column SCORE to represent the total score:
SCORE = PESCORE +PCSCORE +PBSCORE +PSSCORE +EESCORE +SYSCORE
Stocks that pass the VC2 screen are those with a SCORE in the
top 10%:
VC2PASS =IF(PERCENTRANK(Y$3: Y$2694, Y3) >=0.9, 1, 0)
In Mosaic 2.0 we no longer include momentum as part of the
screen. Momentum information is covered in the Technical
quadrant.
Revision history Overview Benefits Screen details Zacks implementation Portfolio123 implementation Conclusion
Outline
1
Revision history
2
Who is James O’Shaughnessy?
3
Benefits of stock screening
4
Screen details
5
Zacks.com implementation
Data collection
Data processing
6
Portfolio123.com implementation
Data collection
Data processing
7
Conclusion
Revision history Overview Benefits Screen details Zacks implementation Portfolio123 implementation Conclusion
Data collection
Variable definitions
Var Description Formula
$PB Price to book (mrq) Pr2BookQ
$PS Price to sales (ttm) Pr2SalesTTM
$PE Price to earnings (ttm) PEExclXorTTM
$PC1 Price to free cash flow (ttm) Pr2FrCashFlTTM
$PC2 Price to cash flow (ttm) Pr2CashFlTTM
$EE EBITDA to Enterprise Value EBITDA(0,ttm)/EV
$DY Dividend yield (%) Yield
$BBY Buyback yield (%)
ShsOutAvgPTM−ShsOutAvgTTM
ShsOutAvgPTM
$SY Shareholder yield (%) $DY + $BBY
$MOM Six month price change (%) Pr26W%Chg
Revision history Overview Benefits Screen details Zacks implementation Portfolio123 implementation Conclusion
Data collection
Procedure
Log in to Portfolio123.com using the username and password I
will provide in class.
Click Screener
Click Infotech
Notice mktcap > 200M since JO sector screens are based on “All
Stocks” (mktcap > 200M, p. 49).
WWoWS (p. 321) mentions general screens applied to “Large
Stocks” (mktcap > mean, p. 49) also improve risk adjusted returns.
For perspective, the smallest S&P500 company is about $11B
Click Results
Verify VC2 is selected as the Report
Click Run
Click download
That’s it!
Revision history Overview Benefits Screen details Zacks implementation Portfolio123 implementation Conclusion
Data processing
Generate score variables
Open the Portfolio123.com file in Excel.
Add a column PxSCORE for each of the first four value criteria.
For example, PBSCORE with the Excel formula:
PBSCORE = IF(C3 = ”NA”, 0.5, 1−PERCENTRANK(C$3 : C$2694, C3))
This assigns a higher score to stocks with lower Price-to-X ratios.
Do not forget the $ in the first argument of PERCENTRANK.
If a value is missing (NA) a neutral rank (0.5) is assigned (WWoWS
appendix page 3)
Higher EBITDA/EV is better because it indicates higher earnings
(EBITDA) at a lower theoretical takeover price (EV).
EESCORE = IF(S3 = ”NA”, 0.5, PERCENTRANK(S$3 : S$2694, S3))
Create a column SYSCORE in the same fashion as EESCORE.
Revision history Overview Benefits Screen details Zacks implementation Portfolio123 implementation Conclusion
Data processing
Total score and screen winners!
Create a column SCORE to represent the total score:
SCORE = PESCORE +PCSCORE +PBSCORE +PSSCORE +EESCORE +SYSCORE
Stocks that pass the VC2 screen are those with a SCORE in the
top 10%:
VC2PASS = IF(PERCENTRANK(Y$3 : Y$2694, Y3) >= 0.9, 1, 0)
Sort by VC2PASS (descending) and $MOM (descending).
Voila! The top 25 stocks in that list constitute the “Trending value”
portfolio.
We can’t buy 25 per sector but we can analyze 25 per sector
(plus some that do not pass the screen) and choose the best
ones to analyze further.
You may wish to start with the median two (stocks 12 and 13).
Median stocks may mimick the portfolio (See The real cost of equity
by Goedhart, Koller, and Williams (2002) in McKinsey on Finance).
“Very” low PB and PE could indicate distress.
Revision history Overview Benefits Screen details Zacks implementation Portfolio123 implementation Conclusion
Outline
1
Revision history
2
Who is James O’Shaughnessy?
3
Benefits of stock screening
4
Screen details
5
Zacks.com implementation
Data collection
Data processing
6
Portfolio123.com implementation
Data collection
Data processing
7
Conclusion
Revision history Overview Benefits Screen details Zacks implementation Portfolio123 implementation Conclusion
What did we learn?
Stock screening the JO way allows one to identify value stocks
with growth potential.
Portfolios formed with the value-based screens significantly
outperform the market as a whole and the S&P500 on a
risk-adjusted basis.
Their are five basic value criteria (PB, PE, PS, PC, EBITDA/EV)
plus shareholder and buyback yield.
Adding the six month momentum to the VCx screens can further
enhance risk adjusted returns. However, we don’t need to worry
about momentum while screening in Mosaic 2.0.
Zacks can be used to create a close approximation to the
screens in the JO book.
A screening tool that includes six month price appreciation and
buyback yield would be nice.