Four Reasons Why Stock Screeners Won’t Work For Next Few Years

It has become trendy to declare that "buy-and-hold is dead". Some critics regard dollar-cost averaging, or automatically investing a fixed amount every month/quarter/year, as foolish as well.

Many buy-and-hold investors have essentially lost a decade of accumulated wealth, and there is no guarantee that these losses will be reclaimed, according to a recent article in the May/June 2009 issue of CFA Institute Magazine. The US market historically has been an anomaly in regaining lost ground. If you look at other countries of the world, three quarters of them have shown that you could spend a quarter of a century without achieving a zero real return on equity. The most recent example is Japan.

As a result, more and more people turn to “stock screeners” and try to find a “killing” from time to time. In his new book, Your Next Great Stock, author Jack Hough presents following 12 ways to screen outperform stocks using stock screeners such as MSN, SmartMoney.com or Zacks:

1. Buy High, Sell Higher: price momentum

2. Impatient Value: pay off over the next 5 years

3. Surprise, Surprise: positive earnings surprises tend to foretell big stock gains

4. Tomorrow’s Breakthrough: dollars spent on R&D

5. New Dogs: improved dividend-based stock strategy

6. Bold is Beautiful: Follow analysts who stay far from their peers when forecasting earnings

7. Rising Expectations

8. Follow the Leaders: insider trades

9. Accrual to be Kind: companies generate more cash profits than paper profits

10. Sales on Sale: sale never lay

11. Combination Platter: combinations of different matrices

12. Guru Screens: Put the market-beating strategies of some of the greatest investors to work, including Warren Buffett, Peter Lynch, William O’Neill and Martin Zweig

Even though some might work, I believe most of them won’t in the next few years for the following 4 reasons:

1. ETFs Get More Popular

More and more retail investors are abandoning stocks and switching to ETFs. According to Yahoo Finance, there are over 825 ETFs in the market and growing. The top 100 ETFs have combined net assets of over $500 billion. However, lots of them are “me too” products. For example, the following chart shows tlast 2 years’ performance for 5 populates ETFs: iShares Russell 1000 Index (IWB), iShares Russell 3000 Index (IWV), iShares S&P MidCap 400 Index (IJH), iShares Russell Midcap Index (IWR) and iShares S&P SmallCap 600 Index (IJR). Even though they are in 3 totally different categories: large, mid and small blends, their performances have been virtually the same.

click to enlarge

2. Supply-Demand

When ETFs and institution investors tend to concentrate on big-cap stocks, it is very hard for handpicked-small-companies to out-perform, or at least not within a few years.

3. Results Diminish Over Time

When one stock-screen approach works, too many people might rush in to apply the same way, thus diminish the return. A perfect example is “The Dogs of Dow” theory.

4. Hard to Find Growth Stock

Since this once-every-80-years credit crisis began last year, almost every company’s revenue took a hit. Thus, it is almost impossible to find any “growth” companies over the next few years if you rely purely on computer generated “stock screens”. In addition, lost metrics inside stock-screeners' database for the last 12 months would be significantly out of range.

Asked if dollar-cost averaging could ensure long-term success, Benjamin Graham said:

Such a policy will pay off ultimately, regardless of when it is begun, provided that it is adhered to conscientiously and courageously under all intervening conditions.

“Buy and Forget” might not work, but I believe “Buy and Hold (for at least a few years)” still works for your core holdings. Some of the tools, especially UltraShort ETFs like UltraShort Financials ProShares (SKF) might not suitable for long-term hold. However, from time to time, they can be used to express your feelings about the market or sector, and enhance your overall performance.

According to Bloomberg, after surging 40 percent, the S&P 500 may rise just 8 percent in the next 12 months, based on the combined share-weighted price projections of more than 1,700 securities analysts. Second-quarter profits may fall 35 percent, while third-quarter earnings may drop 23 percent. Last week, Barron’s magazine called the rally “too far, too fast”. With limited upside potential and much larger downtrend risk for SP, this week I bought UltraShort S&P500 ProShares (SDS) to short the market.

Disclosure: I have a long position on SDS

Comments

[Roger Knights]

Looks like you might have timed it perfectly!

2009 Jun 20 03:46 AM

[Alphameister]

And how do you arrive at those core buy-and-hold stocks without a screening process of some sort? This is a very illogical and unpersuasive article that, in essence, says to suspend judgment in your investment process. There are really only two ways to beat the market: time your entry and exit points well, or find the best stocks in which to invest.

2009 Jun 20 10:51 AM

[whatanorder!]

My formerly effective screens for long but especially for short stocks have had a rough time of it in recent months. It seems as if they may just be starting to regain some performance advantage again over the last few weeks.

2009 Jun 20 07:55 PM