The Mosaic of Stock Analysis Part 1: Stock screening

7/23/2019 The Mosaic of Stock Analysis Part 1: Stock screening

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Revision history Overview Benefits Screen details Zacks implementation Portfolio123 implementation Conclusion

The Mosaic of Stock Analysis 2.1Quantitative analysis and stock screening

Work horses not show horses the OShaughnessy way

David J. Moore, Ph.D.

www.efficientminds.com

October 6, 2014
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Outline

1 Revision history

2 Who is James OShaughnessy?

3 Benefits of stock screening

4 Screen details

5 Zacks.com implementationData collectionData processing

6 Portfolio123.com implementationData collectionData processing

7 Conclusion
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Outline

1 Revision history



4 Screen details



7 Conclusion
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The evolution

Revision history

1.0: The beginning

Based onWhat Works on Wall Street 3e(2005).Screen used to narrow focus of stocks.

1.1: UpdateBased onWhat 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 selectstocks.
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The evolution

Revision history ...continued

2.1: Response to student feedback & more

Changed minimum market cap to 1000M (1B) in preparation forfundamental 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 slowvain, the VCZ screen variables have some validity in predicting thedesired outcome (high risk adjusted return).Admittedly, BBY also has this validity (David L.). Unfortunately it is

unavailable in Zacks. However, GAME IV panelists dont likerepurchases and I suspect repurchase activity will subside in theshort to midterm.

R i i hi t O i B fit S d t il Z k i l t ti P tf li 123 i l t ti C l i
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Outline

1 Revision history



4 Screen details



7 Conclusion

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Motivation for selecting this particular book

Who is OShaughnessy (J.O.)?

2005: Director of Systematic Equity for Bear Stearns AssetManagement & Author of What Works on Wall Street: A guide tothe best performing investment strategies of all time (WWoWS)

This book was referred to me by my dissertation chairman andconfidant with 40+ years of global financial market experience.

2007: J.O. left Bear Stearns to form OShaughnessy CapitalManagement LLC.

2008: Yes Bear Stearns collapsed and was sold to JP Morgan

Chase. Was it J.O.s fault? I dont think so. J.O. did jump out ofthe sinking ship before it sank.

2011: November release of updated book

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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 OShaughnessyfunds.

One can see the screening strategies that worked the best overthe 1964 to December 2009 time frame.

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Supplemental files

Supplemental files to accompany presentation

The following files are available on www.efficientminds.com onthe same page as this presentation.

JOScreens.xlsxDetailed performance measures of all screens inWhat Works on Wall Street, fourth edition.TrendingValueExample.xlsxAn application of the TrendingValue screen to the All stocks universe. This accompanies thestock screen implementation example towards the end of thispresentation.

You may wish to obtain these files now before proceeding withthe presentation.



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Outline

1 Revision history



4 Screen details



7 Conclusion

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y p p

Qualitative and quantitative evidence

How can screening help us?

The WWoWS screening strategies to select stock portfolios thathave persistently outperformed the market (as measured byreturns, standard deviation, sharpe ratio).

The Student Investment Fund can apply the strategies toindividual 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 selldecisions. This structure is based on historical financial data.

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y p p


Quotes from The Intelligent Investor

... the greater the premium above book value, the less certainthe basis of determining its intrinsic value - i.e., the more thisvalue will depend on the changing moods and measurements ofthe stock market

... concentrate on issues selling at a reasonably closeapproximation to their tangible-asset value - say, at not morethan one-third above that figure.

The 33% premium can be considered ..a kind of extra fee paidfor the advantage of stock-exchange listing and the marketability

that goes with it.Dont go with just low P/B. Demand ...a satisfactory ratio ofearnings to price, a sufficiently strong financial position, and theprospect that its earnings will at least be maintained over theyears. (this is a prelude to The Mosaic of Stock Analysis Part 2)

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Occams Razor Screen

Occams Razor stock screen:

P/B< 1.33

But, according to The Intelligent Investor that is not the end ofthe story.

Of the resulting stocks, look at P/E, financial position, andearnings growth prospects.

All of these considerations are inherent in the upcoming JOscreens, to some extent.

What is not covered: when to sell?



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JO Methodology

Portfolios are formed each month of the year and held for oneyear (WWoWS p. 54).

We hope to hold stocks longer, but a one year target holdingperiod 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 whichit lost money (WWoWs p. 584).

Reported results reflect the average of the twelve portfolios. That

is, the average of Jant

Jant+n, Febt

Febt+n,. . .Dect Dect+nportfolios.

Reesults reported in this manner indicate what you can expect(on average) irrespective of the month of portfolio formation.

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Performance data of suggested screens

Universe Screen geomean stdev Sharpe BetaAll stocks none 11.01% 19.26% 0.31 N/AS&P 500 none 9.33% 15.31% 0.28 0.88All stocks Value composite 2 17.12% 17.32% 0.70 0.85All stocks Trending value 21.08% 17.66% 0.91 0.81Consumer discretionary EV/FCF 13.89% 21.36% 0.42 0.95Consumer staples Shareholder yield 17.80% 14.73% 0.87 0.87

Energy Value composite 2 18.36% 21.84% 0.61 0.81Financial Value composite 3 15.96% 18.65% 0.59 1.02Healthcare Value composite 2 17.50% 20.01% 0.62 0.72Industrial Value composite 2 15.34% 19.89% 0.52 0.93Infotech Value composite 2 12.55% 25.83% 0.29 0.78Materials Shareholder yield 15.36% 19.29% 0.54 0.88Telecommunications Value composite 1 17.00% 17.07% 0.70 0.68Utilities 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 thosestocks 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 itwas added to VC2 to form the top-performing Trending value screen.

For more information see wwows_ex_28_table4.pdf

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Outline

1 Revision history



4 Screen details



7 Conclusion

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Definitions and screens

Definitions 1/2

Enterprise value (EV): the theoretical takeover value. The cost to acquire a company and payoff its obligations less remaining cash.

EV=market cap + pref. equity + long term debtcash or cash equivalents (1)

Dividend yield (DY): a measure of cash flow to shareholders via dividend payments.

DY=D0P0

(2)

Buyback yield (BBY): a measure of cash flow to shareholders via repurchases.

BBY=shares outt1 shares outt

shares outt1(3)

Shareholder yield (SY): a combined measure of cash flows to shareholders.

SY=DY+ BBY (4)

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Definitions 2/2

UnfortunatelyBBYis not readily available via Zacks.com. For now wecan just useDYas a proxy for BBY (and consequentlySY).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 afternecessary investments to maintain growth.

According to WWoWS 4e p. 143:

FCF=CFCapEXDividendsPref. Dividends (5)

Sharpe ratio (excess return per unit of risk):

Sharpe =E[R]Rf

1Although buyback activity has been observed in the recent past, at least

one articlesuggests companies should continue to institute and raise their dividendyields in 2013.

https://docs.google.com/file/d/0B9A--V2r-2oiZVNQSzduV3VxbDA/edithttps://docs.google.com/file/d/0B9A--V2r-2oiZVNQSzduV3VxbDA/edithttp://find/


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Screening criteria

# VC1 VC2 VC3 Trending value VCZ

1 Price-to-Book Price-to-Book Price-to-Book Price-to-Book Price-to-Book2 Price-to-Earnings Price-to-Earnings Price-to-Earnings Price-to-Earnings Price-to-Earnings3 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-Cashflow5 EBITDA/EV EBITDA/EV EBITDA/EV EBITDA/EV EBITDA/EV6 Shareholder yield Buyback yield Shareholder yield Dividend yield7 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.

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Outline

1 Revision history



4 Screen details



7 Conclusion

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Data collection

Variable definitions

Category Variable Used forValuations P/E (Trailing 12 month) PESCOREValuations Price/Cash Flow PCSCOREValuations Price/Book PBSCOREValuations Price/Sales PSSCOREBalance sheet Receivables Cash=CAAR INV

Balance sheet Inventory Cash=CAAR INVBalance sheet Current assets Cash=CAAR INVBalance sheet Long term debt EV=mktcap+ prefeq.+ LTDcashBalance sheet Preferred equity EV=mktcap+ prefeq.+ LTDcashCompany descrip. Sector Sector classificationCompany descrip. Industry Sector classificationDividends Div Yield % DY substitutes for SY & BBYInc. 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 assessmentPrice & Price Changes Beta Screen assessment

Note: FUNDA = data to be used later in fundamental scoring.

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Data collection

Data collection

Navigate to ZACKS.COM SCREENING STOCK SCREENING.

SIZE & SHAREVOLUMEgroup Market Cap >= 1000, Add.

Select EDIT VIEWand select all of the variables on the previousslide.

Click RUN SCREEN

Note: If you want to apply the screen to a specific sector addSECTORfrom the COMPANYDESCRIPTORSgroup as criteria.

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Data processing

Data processing 1/2

Download the data into excel: Click Export, then open file inExcel.

Add a column forCash=CAAR INV.

Add a column forEV=mktcap+prefeq.+LTDcash.

Add a columnEE=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)

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Data processing

Data processing 2/2

Unfortunately Zacks does not provide BBY data. For now, letDY=SY=BBY. A panelist at GAME IV disapproved of sharerepurchases anyway.

Create a column SYSCORE in the same fashion as EESCOREbut 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 thetop 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 thescreen. Momentum information is covered in the Technicalquadrant.

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Outline

1 Revision history



4 Screen details



7 Conclusion

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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

$BBY Buyback yield (%) ShsOutAvgPTMShsOutAvgTTMShsOutAvgPTM$SY Shareholder yield (%) $DY + $BBY$MOM Six month price change (%) Pr26W%Chg

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Data collection

Procedure

Log in to Portfolio123.com using the username and password Iwill provide in class.

Click Screener

Click Infotech

Notice mktcap > 200M since JO sector screens are based on AllStocks (mktcap > 200M, p. 49).WWoWS (p. 321) mentions general screens applied to LargeStocks (mktcap > mean, p. 49) also improve risk adjusted returns.For perspective, the smallest S&P500 company is about $11B

Click Results

VerifyVC2 is selected as the Report

Click Run

Click download

Thats it!


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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,0.5,1PERCENTRANK(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 (WWoWSappendix 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.


Data processing
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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 thetop 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 valueportfolio.

We cant buy 25 per sector but we can analyze 25 per sector

(plus some that do not pass the screen) and choose the bestones to analyze further.

You may wish to start with the median two (stocks 12 and 13).

Median stocks may mimick the portfolio (SeeThe real cost of equityby Goedhart, Koller, and Williams (2002) inMcKinsey on Finance).

Very low PB and PE could indicate distress.



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Outline

1 Revision history



4 Screen details



7 Conclusion

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What did we learn?

Stock screening the JO way allows one to identify value stockswith growth potential.

Portfolios formed with the value-based screens significantlyoutperform the market as a whole and the S&P500 on arisk-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 furtherenhance risk adjusted returns. However, we dont need to worryabout momentum while screening in Mosaic 2.0.

Zacks can be used to create a close approximation to thescreens in the JO book.

A screening tool that includes six month price appreciation andbuyback yield would be nice.

The Mosaic of Stock Analysis Part 1: Stock screening

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