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| The Basics | Simple strategy delivers 18% a year
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It sounds too good to be true. But I have tested the Cornerstone Growth method for two years, and the returns have been remarkable. Here's how to do it.
By Harry Domash
Almost two years ago, in June 2004, I described a stock-selection strategy that had averaged an 18%-or-so annual return for more than 50 years.
The strategy, called Cornerstone Growth (Read "Earn 18% returns the easy way," is deceptively simple to implement. You pick 50 stocks, hold them for one year and then repeat the process. In my article, I opined that you didnt really need 50 stocks -- you could get away with only 16 stocks, and possibly as few as 10.
I included a screen in the article for finding qualifying stocks. I also compiled a portfolio of 10 stocks to see how a short list would fare. Last week, I dug out the portfolio and tabulated its performance.
My portfolio of 10 stocks returned 50%, on average, in the year or so (53 weeks) from June 21, 2004, to June 30, 2005. By comparison, the S&P 500 ($INX) gained 4% during the same period.
I calculated those returns as of June 2005 to correspond to author James P. O'Shaughnessy's strategy of holding the stocks for 12 months. But there doesn't seem to be anything magic about the one-year time frame. If you had held the stocks through April 17, 2006, the day I wrote this column, your returns would have soared to 118%, on average.
A simple strategy: Use what works
The Cornerstone Growth strategy came out of OShaughnessys exhaustive study of what works and what doesnt, which he described in his 1996 best seller, "What Works on Wall Street.
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For the book, OShaughnessy tracked the returns produced by selecting stocks based on high or low values of valuation ratios such as price/earnings, profitability gauges such as return on equity (ROE), dividend yields, earnings growth -- you name it. OShaughnessy evaluated dozens of factors, by themselves and in combination with each other.
For each year from 1951 through 1994, OShaughnessy used each selection strategy to pick 50 stocks at the beginning of the year, then measured the portfolios return 12 months later.
The best-performing strategy, which OShaughnessy dubbed Cornerstone Growth, uses only three parameters: price/sales ratio, earnings growth and relative strength.
OShaughnessy first identifies a universe of stocks with price-to-sales ratios (P/S) of 1.5 or less, adding the hurdle that they also had to record at least some earnings growth over the prior year. From that list, OShaughnessy picks the 50 stocks with the highest relative strength for his Cornerstone Growth portfolio.
Thats it! Its that simple.
Many value investors use low P/S ratios to identify value-priced stocks. So the name is misleading. Cornerstone Growth is really a value strategy.
According to OShaughnessy, Cornerstone Growth returned 18% on average, annually, compared to 13% for the S&P 500, over his 43-year test period.
Putting those percentages in dollars, if you had started with $1,000, after 20 years youd end up with $27,000 if you saw an 18% average annual return. That's compared to $11,500 at 13%.
Unlike many strategies that fail once theyve been publicized, Cornerstone Growth hasnt lost its mojo. The Hennessey Cornerstone Growth (HFCGX) mutual fund, which uses OShaughnessys selection formula, has averaged an 18% annual return since its November 1996 inception.
Heres my screen for finding Cornerstone Growth stocks.
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Fund data provided by Morningstar, Inc. © 2008. All rights reserved.Quotes supplied by Interactive DataMSN Money's editorial goal is to provide a forum for personal finance and investment ideas. Our articles, columns, message board posts and other features should not be construed as investment advice, nor does their appearance imply an endorsement by Microsoft of any specific security or trading strategy. An investor's best course of action must be based on individual circumstances.
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