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Lesson 1: The Motley Fool Mechanical Investing BoardThe main page can be found at Motley Fool Mechanical Investing Board Lesson 2: Introduction to the Screens.IntroductionIn the previous addition of this Guide, I chose to first cover the basics of investing, then how to construct a mechanical investing portfolio. In this revision, I'm going to change things around and lead you through setting up a mock portfolio first. I feel it is important you as a new mechanical investor, become familiar with the volatility you will experience with our screens. And over the 9 weeks of this seminar you will almost certainly see volatility. We will be using just those screens derived from Value Line, Inc. to set this first portfolio up. I'm doing this, not because Value Line, Inc. screens are any better, but that we have a longer backtest with them. And as we look deeper into the basics of portfolio construction, the data from that longer backtest will be useful. We will though devote several lessons to covering the screens created from the SIPro universe, and as you become more familiar with mechanical investing and learn to create your own portfolio, I am sure you will probably include a SIPro screen.
How do we screen for stocks?One of your objectives as a knowledgeable investor should be, is not to depend upon others for finding your stock picks. You should learn how to generate the rankings for the screens you use. If you decide to use one of the screens that use data from Value Line, Inc. you will need to purchase a subscription to Value Line Investment Survey for Windows. Value Line, Inc. updates their data weekly, usually around noon on Friday. This subscription normally runs $600 a year, though Value Line, Inc. periodically posts discount offers which will lower this. If you decide to use one of the screens that use data from Stock Investor Pro you will need to purchase a subscription of that from the American Association of Individual Investors. This subscription runs $250 year. Some SIPro screens can be run on the AAII website's free Multex screener, and we are making an effort to convert other screens as well. Both subscriptions come with their own screener software. Unfortunately both are a bit clunky and user unfriendly. Several years ago, I hosted a Workshop on my discussion board to look at what various MI Board members were using, and the problems they were having. Out of this Workshop came "RadiScreens". RadiScreens is a series of Excel based macros, which will download the weekly data, and then automatically generate the various screen rankings. It is a shareware program available for free, though we recommend you register your copy. What is particularly nice for new investors, RadiScreens creator, who goes by the screen name "Radish", provides tech support and periodic updates on his TMF discussion board "Radish's Roughnecks". That board can be found here. And an introduction to RadiScreens found here. With so many people generating their own rankings, we found it was useful for volunteers from the MI Community to post the rankings from all screens to the board each week. This is done so those running their own subscriptions can double check their results before their stock purchases. There are two such posts. The first and biggest, the "Screen Rankings" covers the 190 or so screens generated from Value Line, Inc. and Investor's Business Daily. The second covers the more recent SIPro screens. These posts usually come out over the weekend. An example of the weekly Screen Rankings: Screen Rankings 02JAN04 . An example of the SIPro rankings: SI Rankings 02JAN04. I can hear you saying, "Wow, $300 to $600 just to get started on something I don't even know I'll be using. That's a lot to dump down." What many beginners do in their first year of mechanically investing is use the weekly ranking for their stock picks. They wait until the rankings are posted over the weekend then place their buys and sells on Monday after the market has opened. Once they have more experience and have decided on using MI for their investing, they then purchase subscriptions. Long or ShortOver the last six years the MI Community has developed literally hundreds of screens. Naturally, you won't be investing in that many, but will probably narrow your selection down to between 3 and 10 screens. So let's look at the screens in more detail, specifically those in the Value Line, Inc. derived “Screen Rankings” post. (We will look at the SIPro screens in a later Lesson.) The first category we can divide the screens into are those designed to identify stocks whose price, we hope will go up, or Long Screens, and those designed to identify stocks whose price, we hope will go down, or Short Screens. Shorting stocks is an advanced investment technique requiring extensive study. If you are new to investing do not use short screens! The Short Screens from the Screen Rankings are:
Notice, they all begin with the word SHORT. Most screen names and their abbreviations are descriptive of their criteria or purpose. Not all. As we continue, you will learn more about the different families of the screens. All other screens listed are Long Screens. Overlaps and Screens of ScreensNot all the listings are screens. We have two methods of combining the picks of groups of screens, into single lists of ranked stocks. These are Overlaps and Screens of Screens (aka SOS). These two methods and how their stocks are picked is described in this post: http://boards.fool.com/Message.asp?mid=12377369 Additionally, this post helps explain the difference between and SOS and a Blend: http://boards.fool.com/Message.asp?mid=13801133 We will cover these methods in more detail in a later chapter. The Overlaps from the Screen Rankings are: Olap_RS52keyeps OVER_RSOlap_RS52keystone Overlap_4/13OVER_PEG RSPEGOL The Screens of Screens from the Screen Rankings are: SOS_A SOS_D SOS_Annual SOS_KSOS_Ancer SOS_E SOS_Elan_v2000 SOS_KJSOS_B SOS_F SOS_Elan_v2001 SOSBM_ESOS_BMOD SOS_G SOS_Elan_v2002 SOS_TOP3SOS_C SOS_Plow_RS SOS_GJ UNIQUE3 The rest of listings in the weekly Screen Rankings are single screens.
The Five Types of CriterionAs we mentioned in Lesson 1, the criteria for screening can be broken down into five general categories. 1) Momentum or Relative Strength. 2) Growth. 3) Value. 4) Contrarian. 5) Income. Some screens will be purely one type, but most screens will be a mix of several criterion. Let's look at each criterion closer.
Momentum or Relative StrengthBy far the most common single criteria used for screening is Momentum. Screens which use this criteria will often have the letters RS, which stands for Relative Strength. Due to the way our Screen Builder database is set up, Momentum as reported by Value Line, Inc. has several look back periods. They are, 1 week, 4 weeks, 13 weeks, 26 weeks, and 52 weeks. Therefore, when you see RS13, that means the criteria is "Relative Strength looking back 13 weeks". Momentum is used in two ways. The first is as the final sort in a screen of other types of criterion. When a screen sorts stocks, we are often left with more stocks than we want to buy, sometimes dozens. We then use Momentum to identify those stocks which have had the best recent price appreciation, hoping they will continue to rise. Screens which do this should not be necessarily considered Momentum. An example is the first two screens listed in the weekly Screen Rankings, AssRS13 and AssRS26. They sort first by Value Line, Inc. Timeliness Rank (which we deal with in a moment), then by the criteria "Total Current Assets", then the resultant group of stocks is sorted by Relative Strength. The final sort doesn't make them momentum screens. Though they are and we'll see why in a moment.
Along with numerical stock data, they offer several proprietary rankings, including Timeliness Rank, Safety Rank and Technical Rank, which we use in our screen criteria. Timeliness Rank is the one we use most, in about two third of our screens. Timeliness Rank breaks down the 1700 stocks they cover into five Timeliness Ranks, T1, T2, T3, T4 & T5, with T1s being the highest. There will be 100 T1s, 300 T2s, 900 T3s, 300 T4s and 100 T5s. While proprietary, we have been able to learn most of the criteria focus of Timeliness Rank is high Relative Strength and Earnings Growth. If Mechanical Investing strives to be 100% quantifiable, how can we use a criterion like Value Line's Timeliness Rank, or any other investment service's proprietary ranking, that is a "black box" formula? Especially since we have discovered the method of ranking has not been historically static, but has been tweeked, sometime radically by Value Line, Inc. This issue has been much discussed and evenly divides the MI Community. In a recent poll 53% of MI investors now felt Timeliness Rank was not a useful criterion, 47% still felt it was. The argument against using Timeliness Rank can be summarized as: We have been able to find several pamphlets published by Value Line, Inc. where they explain their method. One from 1975, another from 1979. Both show different methods. Additionally in an interview at a 2004 seminar, long time head of Value Line, Inc. Mr. Eisenstadt, admitted Value Line, Inc. re-evaluates Timeliness each year and makes changes. Those who feel Timeliness Rank is not a useful criterion argue that given that Value Line, Inc. does make changes, and we as investors don't know what they are, we're dependent on Value Line, Inc.'s research staff to make the right decisions. If they guess wrong, then Timeliness Rank may be less effective than a more transparent substitute. The argument for using Timeliness Rank can be summarized as: In the case of Value Line, Inc.'s Timeliness Rank, (and others), we have a historical record of which stocks ranked in each of these rankings going back to 1969, and by that, the performance of each ranking. Timeliness Rank 1 stocks have performed on an average of 14.6% per year, versus the S&P's of 7.4%, from 1965 to 2002. So while we are dependent on Value Line, Inc.'s research staff, it seems like they know what they are doing. Additionally, Value Line, Inc. does no investment banking business. Unlike many other investment services, they have no financial business gain tied up in favorable recommendations of a company's stock. This should allow Value Line, Inc. analyst's to call a bad stock, BAD.
More MomentumThe second way to use Momentum as a criterion is to presort the stocks we are looking at with Value Line, Inc.'s Timeliness Rank. We can then see that any screen which starts with T1 as its first criterion, is primarily a momentum and earnings screen since they begin with stocks in the top 6% of Relative Strength and Earnings Growth. The screens which start with T1 in the Screen Rankings are:
Just because a screen says it is a Value screen doesn't make it so, especially if it first sorts by Timeliness. Is this bad? No. But newcomers to MI should be aware when creating a portfolio of that focus, and not unintentionally create a portfolio heavily leaning towards momentum stocks. Many of us using MI in 1999 and early 2000 forgot that, thinking we had a diverse portfolio, and were hurt when the Market turned against momentum. Two screens SPARK and SPARKRSW use T1 thru T3 stocks, or about 1300 of the 1700 stocks covered. Think of these two screens as having a momentum criterion, but not a focus of momentum. You'll also see in many of the screens I didn't list, a sort by Timeliness. Why are these screens not Momentum screens? Many use T1 thru T4 or T1 thru T5. Value Line, Inc.'s Timeliness Rank is to some extent an indicator of whether a stock and the underlying company are worth investing in. Stocks with a Timeliness Rank of 5 are often in trouble. Rather than a measure of momentum, think of removing T5s as a garbage filter. Growth ScreensAs we said earlier Growth screens are closely related to Momentum screens, and you will see several listed in those using T1 and T2. Screens of this type look for growth in one of the many fundamentals other than Price; like Return on Common Equity, Sales Growth and Relative PE. The most common growth criterion is Earnings per Share (or EPS). The screens which use Growth, but not Timeliness in the Screen Rankings are: CAPLOWEG: Uses Current P/E Ratio, EPS Growth 5-Year, and % Retained to Common Equity.DALY: Uses Current P/E Ratio & Projected EPS Growth Rate. Uses T1-2 in next to final sort,much like other screens use RS.EG5_AT: Uses several factors of EPS Growth, and Current P/E Ratio.FOG_BDF: Uses Gross Income and % Retained to Common EquityROC_RS26WK: Uses Return on Total Capital.ROIC: Uses Return on Total Capital.RSWEPS:Value_EG:SPARK: Use T1-3, consider it Growth with a leaning towards Momentum.SPARKRSW: Same as SPARK. While the screen RSWEPS does not use Timeliness, it uses RSW. RSW is a MI Board formula which tries to replicate Investor's Business Daily's version of Relative Strength. That publication lists RS 39-Week. Since Value Line, Inc. does not, we created the RSW formula as: 0.4*13 Week Total Return + 0.3*26 Week Total Return + 0.3*52 Week Total Return. You will see several screens both in Momentum and Growth using this criterion. RSWEPS should be considered Momentum and Growth, since it also uses Earnings Per Share. Other screens which use EPS and Timeliness, making them both Growth and Momentum are: EG REPEG_PELA REVEG5PE RSEG-rgonsalEGRSW The PEG RatioThe PEG Ratio, used in many of our screens was developed by long time MI Board regular Moe Chernick. As he says in his Workshop article of 07-06-99: "During my first year in the Workshop, I learned about the power of mechanical investing. My first mechanical investments included Keystone, Unemotional Growth, and Formula 90. While I was intrigued with UG and Formula 90, I wondered how a screen-based strategy would do if it looked at projected future earnings instead of the past earnings used by both UG and Formula 90." His article "How the PEG5 was developed" can be read here: http://www.fool.com/workshop/1999/workshop990706.htm The PEG ratio is defined as the Current Price to Earnings (based on previous 12 months' earnings) divided by Projected EPS Growth Rate. Screens which use PEG should be considered Growth. Only PEG-NT can be considered pure Growth. All other screens using PEG add Timeliness, either T1 or T1-2, making them a combination of Momentum and Growth. They are: GARPEG PEGRSW R13_EG_EPEG RSPEG1 R13_EG2PEG13 RSPEG2PEGFF R13_EG BetaDavid Forrest (aka TMFBogey) in his Workshop article of 09-10-98 described the criteria Beta as a measure of the extent to which a stock moves with the market as a whole. In other words, all other things being equal, how much will a stock go up if the market is up 10%? How much will it go down if the market is down 10%? By definition, the market itself has a beta of 1.0. As of this writing, the beta on Dell Computer is 1.71. This means that for every 10% move in the market, Dell will tend to move 17%. Keep in mind that this includes both UP and DOWN movements. Many people use the beta statistic to manage the risk in their portfolios. David's complete article can be found here: http://www.fool.com/Workshop/1998/Workshop980910.htm Several screens use Beta. Those screens which use Beta in the Screen Rankings are: BETA: Uses T1 as first sort, so it is both Momentum and Growth.CAPLOWEG: Also uses the Plowback Ratio. Consider it Growth. See next section.PST_5/10: Also uses Price Stability Rank and EPS. Also Growth. The Plowback RatioThe Plowback Ratio is a measure of the net profit that a company reinvests in its operations, expressed as a percentage of common equity. It's almost the same as straight ROE (return on equity) but includes subtracting out any dividend distributions from the return before calculating the ratio. Essentially, it's a measure of the profits retained by the company relative to the company's net worth. A company with a high Plowback Ratio is generating a lot of profit and reinvesting it to expand the company's business. In other words, they're "plowing back" the profits into the business. Like ROE, it is a measure of Growth. The screens which use the Plowback Ratio in the Screen Rankings are: CAPLOWEG: Also uses the Beta. See previous section.PLOW26WKPLOWRSWPLOWBKLD: Also uses % Debt/Capital Latest Qtr, so it is a Growth and Contrarian screen.ROEPLOW: While it requires Dividend Yield to be greater than 0, this probably doesn'tadd a Income criteria. Consider ROEPLOW Growth. These screens use the Plowback Ratio, but also use T1 and T2, making them a mix of Momentum and Growth: PLOWEG5_RS631: Uses EPS Growth 5-Year.PLOW_PE1:PLOW_PE2: These screens change the Plowback Ratio to [EPS Growth 5-Year]*[Proj EPS Growth Rate])/[Current P/E Ratio]. Also consider them Momentum and Growth since they use T1 & 2. EGPLOW_PE:EGPLOW_PE_E These screens use T1-2, but add a Contrarian criteria. PLOWBVS: Uses Book Value per Share.PLOWLD_NRS: Uses % Debt/Capital Latest Qtr. Exponential Growth and Regression Relative StrengthThere are two other methods developed on the MI Board and listed in the Weekly Screen Rankings which can be thought of as Momentum screens. Exponential Growth, whose screens begin with XG, and Regression Relative Strength, whose screens begin with RRS. They calculate momentum in a way other than standard in an effort to increase screen performance. They are related but different, and you will learn more about them in a later lesson. Loren Cobbs' work on Exponential Growth can be found here: http://www.aetheling.com/MI/ (scroll down) An explanation of Regression Relative Strength can be found here: "DH/RRS for Dummies" http://boards.fool.com/Message.asp?mid=15250765 and a brief list of links by BarryDTO here: http://boards.fool.com/Message.asp?mid=19407181 The Exponential Growth screens from the Screen Rankings are:
Investor's Business DailyThe majority of screens are created from the weekly download from Value Line, Inc. Some though come from Investors' Business Daily (aka IBD). Regrettably most of the latter can not be backtested. You can read about the difference between Value Line and IBD screens here: http://boards.fool.com/Message.asp?mid=18438033 Those interested in IBD and IBD's WERR originally had a board here on the Motley Fool. http://boards.fool.com/Messages.asp?bid=113706&mid=15504464 They have since moved off of TMF to this site: http://groups.yahoo.com/group/werresearcher/ The Investors' Business Daily screens from the Screen Ranking are: ACCDIS F90ADRS F90RSAD RSIBDAD F90RS13 F90RSO UGCATCHRS F90RS26 FORM90 UG90 Additionally, these Overlaps and SOSs, listed earlier use IBD data: F90RSOSOS_TOP3UNIQUE3 Value and Contrarian ScreensAs mentioned earlier Value screens look at fundamental criteria like Price to Book, Net-Net or NCA (Non-Current Assets) trying to identify companies whose current value is less than the intrinsic worth of the company's assets. The thought being that eventually the Market will recognize the under value and the price will grow. Ideally, we'd like to buy a dollar's worth of a company for less than a dollar. Like Value, Contrarian criteria look for stocks that are undervalued by the Market, and we wait for the Market to turn towards them. Unlike Value, these criteria may identify companies whose worth is simply less than other like companies. If the entire sector is over valued, then it is possible we're still buying overpriced stocks. It is hard for me to tell you which of these screens are Value and which are Contrarian, without a much more exhaustive look at each. I consider them most Contrarian, for purposes of portfolio building, and utilize the SIPro screen, "Net-Net" for the Value portion of my portfolio. The Value and Contrarian Screens in the Screen Rankings are: HBSP: Uses Book Value per Share.HI_DIV: Uses Cash Flow, % Debt/Capital Latest Qtr, % Current Yield. Could also beconsidered an Income screen.HIGHCASHFLOW: Uses Cash Flow, Total Return 1-Year.LOWDV: Uses Book Value per share, Free Cash Flow.LOWPB: Uses Book Value per share, Stock Price.LOWPE: Uses Current P/E Ratio, Total Return 1-Year.LOWPE_ZLTD: Uses Long-Term Debt, Current P/E Ratio, Total Return 1-Year.LPE_YLD: Uses % Current Yield, Current P/E Ratio, Stock Price, Book Value per share, Long-Term Debt, Total Assets.LPSAD: Uses Reported Annual Sales, Total Assets, Long-Term Debt.LPSB: Uses Book Value per share, Reported Annual Sales, Stock Price.PEBsize: Uses Current P/E Ratio, Book Value per share, Stock Price. IncomeAs mentioned earlier, there are two ways to make money with a stock. The largest is price appreciation, which the previous four criteria and the majority of our screens identify. The second way to make money on stocks is when a company either puts money into your pocket outright, as with dividends, or increases the value of the outstanding stocks, with stock buy back programs. The Income screens in the Screen Rankings are: CDPD: Uses Current Dividend, Projected Dividend Growth Rate.COREVALU: Uses Financial Strength, Dividend Yield, Projected Dividend Growth Rate.DIVIDEND_GROWTH: HIYIELD: Uses % Current Yield.YldDiv:YLDEARNYEAR:YLDYEAR:YIELD4: Uses Current EPS, and should be considered both Income and Growth.
FURTHER READING:Guide to Screen Definitions
You can also see comments by Value Line, Inc. about their Technical Rank here: http://boards.fool.com/Message.asp?mid=17401520) Additional comments by LLackey on the 1975 booklet "Investing in Common Stocks with the aid of The Value Line Rankings and other Criteria of Stock Value" http://boards.fool.com/Message.asp?mid=20361494 Comments by riprock on the Value Line seminar with Mr. Eisenstadt. http://boards.fool.com/Message.asp?mid=19707750 Lesson 3 - A Mock Mechanical Guide PortfolioLesson 3 is continued here: - Motley Fool Mechanical Investing Board - Part III Lesson 4 - Mechanical Investing Boot CampLesson 4 is continued here - Motley Fool Mechanical Investing Board - Part IV
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