Martin Zweig Growth Investing Screen: How does it work?

In Brief A GARP investing strategy that uses both fundamental analysis and market timing. It focuses on strong growth in earnings and sales, a reasonable price-earnings ratio given the company's growth rate, insider support, and relatively strong price action.

2011-05-07T11:35:39Z

In Brief

A GARP investing strategy that uses both fundamental analysis and market timing. It focuses on strong growth in earnings and sales, a reasonable price-earnings ratio given the company's growth rate, insider support, and relatively strong price action.

Background

Martin E. Zweig was a reputed US growth money manager back in the 1990’s as well as an investment newsletter writer. He was named stock picker of the year 2 times in a row and wrote a book titled “Winning on Wall Street”, which outlines his investing strategy. He is, according to Forbes Magazine renowned for his quot;eccentric and lavish lifestylequot; as well having at one point the most expensive residence in the United States. 

Zweig is essentially a growth investor but with a conservative streak, focusing on selecting growth stocks with certain value characteristics, through a system that uses both fundamental analysis and market timing. Zweig’s basic investing strategy is to be fully invested in the market when market indications are bullish and to sell when the indications become bearish. 

Zweig’s method brings together several fundamental and technical components:

  • The Super Model, where the other indicators are added to yield a total score. The Super Model tells Zweigh whether the broad market is likely to be bullish or bearish. This is based on i) fundamental analysis of monetary conditions (the main indicators used are interest rates and debt levels) and ii) technical analysis of the stock market as a whole, measuring market momentum via the three indicatirs: the Advance/Decline ratio, Up Volume, and the 4% Indicator. If the Super Model indicates bullish conditions, Zweig believes investors should allocate their maximum funds to buying stocks. 
  • Fundamental Screen - Individual stocks are screened for superior fundamentals, in particular, above average earnings growth and a reasonable price/earnings ratio.
  • Technical Screen: Stocks whose fundamentals look attractive on this basis are screened to find stocks whose price action shows strength.

Calculation / Definition 

Martin Zweig does not study any single stock in great detail but prefers to use a quot;shotgunquot; (rather than a quot;riflequot;) approach based on fundamental screens.

quot;If a company can show nice consistent earnings for four or five years I don't care whether it makes broomsticks or computer parts.quot;

His rough criteria are:

  • Earnings Trend - To pass his strategy, a stock must meet a slew of earnings-related criteria, showing that its earnings growth is at a high rate over the long haul; persistent over several years in a row; consistent and ideally accelerating in more recent quarters.
  • EPS_Growth_4Y Growth gt; 20%: The company should have annual earnings growth of 20% or more for at least four years.
  • Sales_Growth_4Y Growth gt; 20%: Sales growth should be similar to earnings growth to show earnings growth sustainability, i.e. not driven by cost-cutting measures. 
  • Accelerating EPS growth in most recent quarters: He also wants to assure himself that nothing has gone wrong recently.
    • Price/Earnings Ratio – PE gt; 5: He notes that quot;the data going all the way back to the 1930s show conclusively that stocks with low price/earnings ratios outperform stocks with high price/earnings ratios over the longer termquot; but says that the PE ratio should not be too low. Companies with a PE of five or less should be rejected because it takes odd circumstances to produce such PE values.
    • Price/Earnings Ratio not more than 1.5x the market/sector: In looking for stocks with better than average growth rates, Zweig says it is unusual for him to find many stocks trading at average PE ratios. However, he believes that very high PE stocks are risky. If they fail to deliver  on the high expectations associated with them, their prices can quickly plummet. He suggests reducing the risk of overpaying for growth by rejecting any companies whose price/earnings ratios are more than 60% above average for their sector.
    • Leverage -  Debt/Equity lt; Industry Average: As another illustration of his conservative streak, Zweig wanted a firm's debt/equity ratio to be low compared to its industry average. 
    • Conservative Forecasting: Management should not have overestimated earnings during the last 3 years.
    • Insider Support: He is less focused on insider buying but there should be no selling of stock by insiders. If more than one insider is selling, they should be selling fewer shares than other insiders are purchasing.

    Stocks whose fundamentals look attractive on this basis are screened using basic technical analysis. Only stocks whose relative price action shows strength are selected.

    • Yearly Relative Strength Year gt; 0 amp; 3 Month Relative Strength gt; 0: Zweig eliminates those companies that are underperforming the market as a whole, especially when the market is performing well. He theorizes that if a company is as good as it appears, it should perform at least as well as the overall market.

    Does it Work? 

    During the 15 years that it was monitored (1980 – 1995), Zweig's stock newsletter returned an average of 15.9%per year, during which time it was ranked number one based on risk-adjusted returns by Hulbert Financial Digest. According to AAII (the American Association of Individual Investors), their Martin Zweig Stock Screen has returned 24% compounded since its inception vs. 2.4% for the Samp;P 500. According to Forbes, this compounded to return 1,463.6% in the eleven years to February 2009.

    Watch Out For

    To judge the market as a whole, Zweig gives greater weight to technical analysis than fundamental analysis. To judge individual stocks, he gives greater weight to fundamental analysis than technical analysis.

    This is not a buy and hold strategy. He places heavy emphasis on risk minimization and limiting losses. For loss limitation, Martin Zweig's basic stock market strategy is to be fully invested in the market when the indications are positive and to sell stocks when indications become negative. Zweig says:

    quot;People somehow think you must buy at the bottom and sell at the top to be successful in the marketquot;. That's nonsense. The idea is to buy when the probability is greatest that the market is going to advancequot;.  

    Martin Zweig holds stocks until the price action weakens. Obviously, he hopes that this will only be after the price has risen appreciably. Sometimes, however, the price action can weaken soon after he has bought:

    Basically what I do is place a stop, generally 10 to 20 percent below the current price, whenever I buy a stock. The exact level depends on my own analysis of a stock's trading pattern. If a stock violates this stop, I'm out. 

    From the Source

    Zweig’s 1997 book, Winning on Wall Street, presents a simplified version of the approach he uses in his Zweig Forecast newsletter calculations. The inspiration behind a number of Martin Zweig's methods apparently came from Jesse Livermore's Reminiscences of a Stock operator. 

    Other Sources


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