It's no secret that value stocks tend to lead the way at the beginning of bull markets, while higher growth stocks tend to take control as the bull matures. It makes sense. Value stocks tend to be more risky -- that's why their valuations tend to be much lower than those of high-growth stocks. So in bear markets, when fear and pessimism reign, those perceived riskier plays tend to get hit harder. Then, when the fears subside, they are the first to bounce back.
When you get deeper into a bull market, the low-hanging, beaten-down value plays have rebounded, and investors tend to look more at fundamentals and quality. It's no surprise then that, with the bull market now more than four years old, my Martin Zweig-based Guru Strategy -- which runs a stock through a variety of strict earnings growth tests -- has been one of my best performers in 2013. But what has been a bit of a surprise is the magnitude of its gains. While the S&P 500 is up about 23% year -to-date, my 10-stock Zweig-based portfolio has gained about 62%.
Zweig, who passed away earlier this year, was a legend in the investing world. He made his mark in a number of ways, from predicting the 1987 market crash just days before it occurred, to pioneering the put/calls ratio, to coining the phrase "Don't fight the Fed", to owning what at one time was the most expensive apartment in New York City (a $70 million penthouse).
Zweig had a big impact on me personally through his book Winning on Wall Street. In it, Zweig laid out his strategy for picking growth stock winners, a strategy that formed the basis for my "Growth Investor" model. The approach looks at numerous criteria, most of which focus on earnings. They include:
Long-Term Growth: Earnings per share should be growing by at least 15% over the long term (I use an average of the three-, four-, and five-year EPS growth rates to determine a long-term rate); a growth rate over 30% is exceptional.
Earnings Acceleration: EPS growth for the current quarter (vs. the same quarter last year) should be greater than the average growth for the previous three quarters (vs. the respective three quarters from a year ago). EPS growth in the current quarter also should be greater than the long-term growth rate. These criteria made sure that Zweig wasn't getting in late on a stock that had great long-term growth numbers, but which was coming to the end of its growth run.
Earnings Persistence: Earnings per share should have increased in each year of the past five-year period; EPS should also have grown in each of the past four quarters (vs. the respective year-ago quarters).
Quality of Earnings: Zweig wanted earnings growth to be sustainable. That meant it was driven by revenue growth, not cost-cutting or other non-sales measures. It also meant that it wasn't driven by large amounts of debt. My Zweig model requires a firm's long-term revenue growth to be at least 85% of EPS growth (or at least 30% a year, since that is still a very strong revenue growth rate), and it wants sales growth for the most recent quarter (vs. the year-ago quarter) to be greater than the previous quarter's sales growth rate (vs. the year-ago quarter). It also targets stocks whose debt/equity ratios are lower than their industry average.
Be aware that Zweig was willing to pay a premium for strong growth, but only to a point. The model I base on his writings requires a firm's P/E ratio to be no greater than three times the market average (currently about 16), and never greater than 43 (no matter what the market average).
Zweig also relied a good amount on technical factors to adjust how much of his portfolio he put into stocks. But over the years, I've found that using only the quantitative, fundamental-based criteria Zweig outlined in his book can produce very strong results. My Zweig-inspired 10-stock portfolio has returned 208.8%, or 11.6% per year, since its July 2003 inception, while the S&P 500 has gained just 75.1%, or 5.6% per year (through Oct. 24).
If you believe, like me, that the bull market has more room to run, then the Zweig-based approach could be a good one to continue to focus on, given where we are in the bull run. Here are a handful of stocks that it's currently high on. As always, you should invest in stocks like these as part of a broader, diversified portfolio.
Cognizant Technology Solutions Corporation (NASDAQ:CTSH): This New Jersey-based IT and business process outsourcing company ($26 billion market cap) has been growing EPS at an impressive 24.4% rate over the long term, and that's been supported by strong revenue growth of 28.5%. The firm also has no long-term debt and trades for a reasonable (given its growth) 23 times earnings.
Michael Kors Holdings (NYSE:KORS): Who says the Great Recession meant the death of the consumer? This trendy clothing designer/retailer ($16 billion market cap) is proof it didn't, as it has grown EPS at a 110% pace over the long term. Sales growth hasn't been quite as strong but it's still been impressive, at 54%. The firm has upped EPS in each year of the past half-decade, and also has no long-term debt.
Qualcomm Inc. (NASDAQ:QCOM): This San Diego-based tech firm introduced CDMA technology back in the late 1980s. Today, its technology is used in cell phones around the world, and recent growth has been strong. Its long-term growth rate of 21.2% accelerated to an average of 25.9% in the three quarters before last quarter, and then jumped to 30.4% last quarter. Sales growth also accelerated last quarter, rising to 35% (from 24%). And the firm had no long-term debt. All of that for a price -- 17.8 times EPS -- not much higher than the market average.
Dick's Sporting Goods, Inc. (NYSE:DKS): This Pennsylvania-based sports and fitness retailer has been expanding and now has nearly 550 Dick's stores and more than 80 Golf Galaxy stores across the United States. The firm ($6.5 billion market cap) has grown earnings at a 19.1% pace over the long-term. That accelerated to 55.8% last quarter. Dick's also has a debt/equity ratio of less than 1% ( versus the specialty retail industry average of more than 70%), and at about 20 times earnings, its price is quite reasonable.
Amtrust Financial Services (NASDAQ:AFSI): Founded as a workers' compensation insurance firm, this New York City-based company has expanded into a multi-national property and casualty insurer. It specializes in coverage for small businesses.
Amtrust's long-term growth is just shy of the Zweig-based model's target, at 14.4%. But that growth has been accelerating -- it was 54.5% in the three quarters before last, and then jumped again to more than 96% last quarter --and it had been supported by strong revenue growth. In fact, while financial firms often engineer strong earnings out of mediocre revenues, AFSI 's long-term revenue growth (32%) more than doubles its EPS growth, and that accelerated to more than 65% last quarter. Plus, shares are cheap, at just 11.4 times EPS.
Disclosure: I am long AFSI, CTSH, KORS, DKS, QCOM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.