Key

     It is rare to find a purely growth-oriented or purely value-oriented stock selection strategy anymore; most screens only lean toward one style or the other.  Martin Zweig, who was named stock picker of the year two years running in the 1990s by the Hulbert Financial Digest and is chairman of the Zweig Funds, leans toward the growth methodology. The Zweig screen is based on his approach.

     Zweig divides stock-picking into two categories-the shotgun approach and the rifle approach. The shotgun method, which Zweig advocates, entails screening publicly available data on a number of stocks using predetermined criteria. This more mechanical approach allows individuals to follow a large number of stocks at one time, spending a limited amount of time on any one company. In contrast, the rifle approach involves the in-depth analysis of a select number of companies. The analysis may cover accounting methods used, trends in the company and industry, and a variety of economic variables impacting the company. Zweig points out, however, that this approach is unrealistic for the average individual investor because it requires full-time analysis of the market.

    Zweig requires positive growth in earnings per share between the most recent fiscal quarter and the same quarter the prior year.  The first filter specifies that the same-quarter growth rate in fully diluted earnings per share from continuing operations for each of the last four fiscal quarters is greater than zero.

     Since sales drive earnings, Zweig first requires that a company have positive growth in sales as compared to the same quarter the prior year. The screen also compares the same-quarter growth rate in sales for the last fiscal quarter to the same-quarter growth rate in sales for the previous quarter. The screen requires that a company's earnings per share for the last four quarters (trailing 12 months) be greater than or equal to the earnings per share for the last fiscal year as well as requiring year-to-year increases in earnings per share for each of the last two fiscal years. The screen specifies a three-year annualized growth rate in diluted earnings per share from continuing operations of at least 15%. The screen implements the same sales growth requirement as for earnings-the compounded growth rate in sales for the last three-year period must be at least 15%. This way, the screen seeks out companies that are growing at a healthy clip for both earnings and sales.

     The next element Zweig looks for is increasing momentum in earnings growth, both over the short term and longer term. Zweig compares the growth rate in earnings between the last fiscal quarter and the same quarter one year prior, to the growth in earnings between the sum total of the prior three fiscal quarters and the same three quarters one year ago. Zweig also accepts companies whose same quarter growth rate for the most recent quarter is at least 30%. Zweig also compares the growth in same-quarter earnings for the last fiscal quarter to the longer-term growth. For this element, this screen required that the same quarter growth rate in earnings per share be greater than the three-year earnings per share growth rate.

     The other key element of Zweig's stock selection is the price-earnings ratio. Zweig avoids living on the edge—he believes that a price-earnings ratio can be too high or too low.  The price-earnings ratios constraints for the screen consist of a minimum level of 5.0 (to avoid potentially troubled firms) and a maximum level of one and a half times the median price-earnings ratio of the entire universe of stocks. The screen eliminates those companies whose price strength relative to the S&P 500 over the last 26 weeks has been below zero.

Remaining Criteria

     To round out the screen, supplemental criteria were applied to further ensure the integrity of the companies we ultimately want to examine. The first of these eliminates those companies traded as American Depositary Receipts, or ADRs-foreign listed companies that are traded on U.S. exchanges.  The screen also excludes companies categorized as part of the miscellaneous financial services and real estate operations industries, which usually consist of closed-end mutual funds and real-estate investment trusts. Lastly, the screen addresses the difficulty that can arise when attempting to invest in stocks that are lacking liquidity - they have relatively low daily trading volume. While Zweig believes that the average investor will not run into liquidity problems, it is a good idea to establish a minimum level of daily trading volume. The screen requires companies to have an average monthly trading volume (based on the last three months) that falls in the top 75%.

     Since the level of debt a company can safely carry tends to depend heavily on the industry in which it operates, it is best to compare an individual company's level of debt to that of its industry.

     If prices fall following an earnings announcement, chances are the market's expectations were not met. Studies have shown that, in cases such as these, the negative impact on the stock's price could last for up to a year. It is for this reason that Zweig chooses not to "fight the tape." He overlooks those companies whose prices fall "significantly" on the day the latest quarterly results are announced. Likewise, an announcement that is better than what the market was expecting could have a positive impact on the stock price for a long time.

     In general, Zweig is more concerned with heavy insider selling than a lack of insider buying. Zweig uses insider buying and selling activity over the last three months as potential buy and sell signals-three insider buys indicates a potential buy signal and three insider sells, a potential sell signal. He also prefers his signals to be unanimous, meaning at least three insider buys and no sells for a buy signal and at least three insider sells with no buys for a sell signal. Web sites such as MSN MoneyCentral track insider activity over the last three months (moneycentral.msn.com).

     When following any stock screening strategy, it is important to remember that the process is only a first step. Martin Zweig's principles help to reveal a collection of companies exhibiting strong earnings and sales growth, reasonable price-earnings ratios relative to the overall stock universe, and strong relative price strength that can prove to be an interesting starting point.