Scott's Investm...'s  Instablog

I update the following portfolio/screen on a monthly basis on Scott's Investments. April's list of 35 stocks is here and the top 10 rated stocks returned an average of  1.92% versus -1.24% for SPY. The entire list of 35 stocks last month returned an average of .07%, led  by Varian Semiconductor (VSEA) at 34.97%.

The screen looks for the following:

• earnings growers still reasonably priced as judged by the PEG ratio 
• low debt 
• a history of high return on equity and investment, and 
• price momentum as gauged by the percentage the stock is trading to its 250 day high. 
• The stocks are then ranked based on fundamental factors as compiled by stockscreen123.

24 stocks qualified for this month's list. This tells us individual stock momentum still exists in the market and the fundamental factors on the list are easy to find among the high momentum stocks.  However, the number of qualifying stocks is less than last month's list, which is not surprising given that overall equity momentum has waned in May.

As with last month's list, Apple (AAPL) and Intel (INTC) are two of the more popular names on the list.  Both companies short-term momentum has waned but their long-term momentum remains in tact.   INTC yields 3.7% which is outstanding when one considers the strong balance sheet, positive earnings, and low payout ratio.  It is in a cyclical business so earnings could fluctuate, however, the strong balance sheet and powerful brand combined with low payout ratio gives the dividend a significant margin of safety.

Ascena Retail Group (ASNA) is a new addition to this month's list and is the top ranked stock on this month's list.  Ascena Retail Group inc. operates as a specialty retailer of apparel for women and tween girls in the United States and Puerto Rico. It operates its stores under the dressbarn, maurices, and Justice brand names.  The company has shown strong earnings and sales growth this year and is projected to grow earnings at 11.59% next year (source:Finviz) and forward price-to-earnings is projected at 11.81.  The company reported quarterly earnings after the close today (May 25th), and the top ranking is based on data prior to earnings.  However, the company reaffirmed its 2011 earnings guidance of $2.28 - $2.33/share, giving it a price/earnings ratio for 2011 near 13. Net income and sales grew 8% and 9%, respectively, when compared to the same quarter last year.

The rational for this strategy is based on backtests showing stocks with low PEG ratios, debt, and high returns on equity and price momentum have produced good historical returns. The screen has tested well historically in bullish periods and, as with most long-only strategies, has suffered during significant market drawdowns. Strategies an investor could use to avoid major drawdowns would be to either abandon this type of strategy entirely when the SP 500 or another major index is below a long term moving average, or hedge positions using one of the methods I profiled here which detail short ETF strategies for hedging long equity positions.

Below are the backtest results for this strategy starting in March 31st, 2001. Returns exclude commissions and taxes and assume .25% slippage.  No position accounts for more than 25% of the portfolio (relevant in cases when the screen produces less than 4 results) and it was equally rebalanced every 4 weeks.  The backtest and the screen was conducted using stockscreen123. The cumulative returns are in excess of 550%:

Two possible tools an investor could use to conduct this screen on his/her own are stockscreen123 or Finviz. This screen was conducted using stockscreen123. For the full list of stocks and real-time results, please see the right hand side of Scott's Investments.