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| The Basics | Simple strategy delivers 18% a year
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Buy them cheap
The price/sales (P/S) ratio is similar to the price-earnings (P/E) ratio, except the recent stock price is divided by 12 months' per-share sales instead of earnings. In his tests, OShaughnessy found that P/S worked better than P/E, probably because earnings often fluctuate wildly from year to year while sales usually follow consistent trends.
Theres no hard-and-fast definition as to the dividing line between value and growth, but most would agree that stocks with P/S of 1.5 and below are values.
Screening parameter: Price/Sales Ratio <= 1.5
Any earnings growth will do
OShaughnessy required that the most-recent years annual earnings exceed the previous year. But he didnt set a minimum growth rate. In fact, he found that lower-earnings-growth stocks produced better returns than high-growth stocks. So my screen requires only 1% year-over-year earnings growth.
Screening parameter: EPS Growth Year vs Year >=1
Say no to anomalies
If you do much screening, you know that screens sometimes turn up unexpected results. I added the following two tests to eliminate stocks that mathematically meet OShaughnessys requirements, but not his intentions.
Sometimes screens turn up stocks with zero, or even negative P/S ratios. I require a minimum 0.1 P/S to rule out such stocks.
Screening parameter: Price/Sales Ratio >= 0.1
OShaughnessys formula implies stocks with positive earnings. But the way the math works, money-losing stocks can pass the tests. I require a positive trailing 12-months net-profit margin, which rules out unprofitable firms.
Screening parameter: Net Profit Margin >= 0.1
Stocks meeting these simple tests form the universe of Cornerstone Growth stock candidates.
Only the strongest survive
Relative strength measures how a stock has performed compared to the overall market over a specified period. To build his Cornerstone Growth portfolio, OShaughnessy picked the 50 stocks with the highest 12-month relative strength, meaning that they had moved up the most during the previous year.
If you want a portfolio of 50 stocks, require a minimum 12-month relative strength of 90. That should give you a list of 80 to 100 stocks to choose from. Then, sort the list based on relative strength by clicking on the 12-Month Relative Strength heading on the screeners stock list. You may have to click the header twice to organize the list with the highest-relative-strength stocks at the top. The top 50 stocks are the Cornerstone Growth stocks. Implement the strategy by buying an equal dollar amount of each stock.
Screening parameter: 12-Month Relative Strength >= 90
You dont need 50 stocks
There is nothing magic about 50 stocks. In his book, OShaughnessy said he chose 50 because it was a common portfolio minimum for professional and institutional money managers. But he also mentioned research showing that most of the benefits of diversification come from as few as 16 stocks.
If you agree with that premise, simply pick the 16 stocks with the highest relative strength.
By the time you pay commissions, 16 could still be too many if youre buying through a conventional stockbroker. If thats true for you, check out services such as Sharebuilder.com, which are set up to handle this type of investing cost-efficiently.
In my June 2004 column, I suggested that you might be able to cut the list down to as few as 10 stocks, and it was a 10-stock portfolio that I used to check the returns. However, if you do plan to go that low, increase the minimum-relative-strength requirement in your screen to 98, which will list around 20 to 25 stocks. Then, maximize the portfolios diversification by eliminating multiple stocks in the same industry.
Start by sorting the list based on industry. Then, within each industry, eliminate the duplicate stocks with the lowest relative strength. My screen listed 23 stocks when I ran it last week. Eliminating industry duplicates cut the list down to 17 stocks.
Heres the original 23-stock list with the industry duplicates crossed out. Since all energy stocks tend to move together, I considered Oil & Gas Services and Oil & Gas Refining & Marketing as being in the same industry. I arbitrarily picked one stock to delete if two stocks in the same industry had the same relative strength.
| My initial Cornerstone Growth strategy stock list | | Company | Industry | 12-month relative strength | | LMI Aerospace (LMIA, news, msgs) | Aerospace/Defense Products & Services | 100 | | Empire Resources (ERS, news, msgs) | Aluminum | 100 | | The Dress Barn (DBRN, news, msgs) | Apparel Stores | 98 | | The Andersons (ANDE, news, msgs) | Basic Materials Wholesale | 99 | | A.M. Castle (CAS, news, msgs)* | Basic Materials Wholesale | 98 | | Escala Group (ESCL, news, msgs) | Business Services | 98 | | The Lamson & Sessions Co. (LMS, news, msgs) | Diversified Electronics | 99 | | IntriCon (IIN, news, msgs) | Diversified Machinery | 100 | | Infosonics (IFO, news, msgs) | Electronics Wholesale | 100 | | WESCO International (WCC, news, msgs)* | Electronics Wholesale | 98 | | Columbus McKinnon (CMCO, news, msgs) | Farm & Construction Machinery | 98 | | JLG Industries (JLG, news, msgs)* | Farm & Construction Machinery | 98 | | Imperial Industries (IPII, news, msgs) | General Building Materials | 100 | | Sterling Construction (STRL, news, msgs) | Heavy Construction | 100 | | Encore Wire (WIRE, news, msgs) | Industrial Electrical Equipment | 99 | | DXP Enterprises (DXPE, news, msgs) | Industrial Equipment Wholesale | 100 | | CE Franklin (CFK, news, msgs)* | Industrial Equipment Wholesale | 99 | | ENGlobal (ENG, news, msgs) | Oil & Gas Equipment & Services | 100 | | Giant Industries (GI, news, msgs)* | Oil & Gas Refining & Marketing | 98 | | Frontier Oil (FTO, news, msgs)* | Oil & Gas Refining & Marketing | 98 | | Glenayre Technologies (GEMS, news, msgs) | Processing Systems & Products | 98 | | NewMarket (NEU, news, msgs) | Specialty Chemicals | 98 | | Administaff (ASF, news, msgs) | Staffing & Outsourcing Services | 100 | | *-Deleted industry duplicates | | |
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Next, I cut the list to 12 by deleting all stocks below 99 relative strength, which is the portfolio Im going to test over the next 12 months. If you want only 10 stocks, youll have to arbitrarily pick two of the three 99-relative-strength stocks to delete.
| My final Cornerstone Growth strategy stock list | | Company | Industry | 12-month relative strength | | LMI Aerospace (LMIA, news, msgs) | Aerospace/Defense Products & Services | 100 | | Empire Resources (ERS, news, msgs) | Aluminum | 100 | | The Andersons (ANDE, news, msgs) | Basic Materials Wholesale | 99 | | The Lamson & Sessions Co. (LMS, news, msgs) | Diversified Electronics | 99 | | IntriCon (IIN, news, msgs) | Diversified Machinery | 100 | | Infosonics (IFO, news, msgs) | Electronics Wholesale | 100 | | Imperial Industries (IPII, news, msgs) | General Building Materials | 100 | | Sterling Construction (STRL, news, msgs) | Heavy Construction | 100 | | Encore Wire (WIRE, news, msgs) | Industrial Electrical Equipment | 99 | | DXP Enterprises (DXPE, news, msgs) | Industrial Equipment Wholesale | 100 | | ENGlobal (ENG, news, msgs) | Oil & Gas Equipment & Services | 100 | | Administaff (ASF, news, msgs) | Staffing & Outsourcing Services | 100 |
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Although OShaughnessy formed his portfolios at the beginning of each year, you can start anytime.
At the time of publication, Harry Domash did not own or control shares of companies mentioned in this column.
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