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The easy way to growth

The easy way to growth

Created: 22 February 2008 Written by: David Stevenson Who can read what

Stock screening - the process of setting minimum criteria for shares A guide to accessing articles on the
before investing in them - has proved itself to be a successful way to IC website
choose investments. The screen based on the ideas of the hugely
successful American fund manager and analyst Martin Zweig has More information...
consistently been one of the best. It looks for fast-expanding, high-
growth companies with reasonably cheap and popular shares -
essentially, it's about paying a reasonable price for fast-growing
companies.

It was many years ago that a smart, young American trader and
investment analyst called Martin Zweig picked up a copy of
Reminiscences of a Stock Operator, a series of interviews between a
certain Lawrence Livingstone (a pseudonym for Jesse Livermore)
and the financial journalist Edwin Lefèvre. (You can buy this book at
a discount in the IC bookstore).

Livermore was an immensely successful stock trader from the 1920s

and 1930s who decided - rather like the equally legendary Ben
Graham - to share his hard-won tips for success in the stock-picking
game. Livermore had learnt the hard way, too - he'd lost all his
money on more than one occasion. But he went on to be one of the
most successful traders ever, before committing suicide in 1940.
Livermore's greatest triumph was in 1929 when he went short just
before the crash and netted a profit of at least $100m, a truly
enormous sum in those days.

So, in Reminiscences of a Stock Operator, Livingstone spelled out

his secrets for success. For Zweig, two particular tips must have
particularly resonated. The first tip is to stick to rules. According to
Livermore: "It took me five years to learn to play the game
intelligently enough to make big money when I was right."
Livermore absolutely believed that investors needed rules to play and
win on the markets. Aimless speculating was a quick road to ruin.
You needed to understand both technical and fundamental analysis.
"I have been in the speculative game ever since I was fourteen. It is
all I have ever done. I think I know what I am talking about. And the
conclusion that I have reached after nearly thirty years of constant
trading, both on a shoestring and with millions of dollars back of me,
is this: A man may beat a stock or a group at a certain time, but no
man living can beat the stock market!" The key for Livermore is to
stick to trading rules through thick and thin - never deviate. When
Livermore broke his rules, he lost everything.

The second tip concerns timing. "The point is not so much to buy as
cheap as possible or go short at top price, but to buy or sell at the
right time... Don't become an involuntary investor by holding onto

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The easy way to growth - Investors Chronicle Page 2 of 5

stocks whose price has fallen."

Jesse Livermore's key trading rules

• Buy rising stocks and sell falling stocks.

• Do not trade every day of every year. Trade only when the market
is clearly bullish or bearish. Trade in the direction of the general
market. If it's rising, you should be long, if it's falling you should be
short.

• Only enter a trade after the action of the market confirms your
opinion and then enter promptly.

• Continue with trades that show you a profit, end trades that show a
loss.

• End trades when it is clear that the trend you are profiting from is
over.

• Never meet a margin call - get out of the trade.

• Go long when stocks reach a new high. Sell short when they reach
a new low.

• Don't become an involuntary investor by holding onto stocks whose

price has fallen.

• A stock is never too high to buy and never too low to short.

• Markets are never wrong - opinions often are.

• The highest profits are made in trades that show a profit right from
the start.

• No trading rules will deliver a profit 100 per cent of the time

For Zweig, these ideas validated one clear starting principle for all
investors including himself: don't try and work against the market by
taking a contrarian position. If the market's marking down a share,
there's usually a good reason - always buy popular shares that are
doing well and that the market likes.

But Zweig decided to take Livermore's ideas one step further. Why,
he wondered, are certain shares so popular in the first place? What
makes them become popular, thus driving up the share price?

The answer for Zweig was simple: accelerating profits and earnings.
There's copious amounts of research that proves that the key mover
in share prices over the long term is the rate of earnings growth -
companies that grow fast, tend to have sharply rising share prices. So
the key is to find those stocks before the whole of the market piles in,
sending the share price shooting up.

Enter Zweig's own classic investing magnum opus and rival to

Livermore's Reminiscences of a Stock Operator, the bestseller
Winning on Wall Street. In summary, Zweig reached three simple

http://www.investorschronicle.co.uk/InvestmentGuides/Shares/article/20080222/8402d24a-e12e-1... 05/03/2008
The easy way to growth - Investors Chronicle Page 3 of 5
conclusions: © The Financial Times Limited 2008.
All rights reserved. "Investors
Chronicle", "FT" and "Financial Times"
1. Look for shares where earnings growth is accelerating. are trademarks of The Financial Times
Limited. No part of this publication may
2. Look for shares that are reasonably priced. be reproduced or used in any form
without prior permission in writing from
the editor.
3. Don't buy stocks where the price is underperforming the market.
Buy shares with some relative market strength.

In essence what Zweig outlines is a classic middle-of-the-road,

higher-risk, growth screen combining elements of both technical and
fundamental analysis. Crucially, though, it also seems to work.

Zweig made a fortune operating his analysis on Wall Street - he was

the proud owner of the most expensive apartment in Manhattan, a
trifling $70m triplex penthouse on Fifth Avenue - and other analysts
who've studied his principles have also found that his relatively
simple methodology can work wonders for private investors who
stick with the core principles.

Evidence for this comes from a US-based association of private

investors called the American Association of Individual Investors
(AAII). It has been running a screen that filters through the US
market using Zweig's principles for nearly 10 years. This AAII
Martin Zweig screen, and the resulting portfolio, has delivered the
biggest gains of any stock screen studied (more than 60 have been
put through their paces) - cumulative gains have totalled 2,418 per
cent and, even in 2007, the screen delivered profits of 20.7 per cent.
Another highly respected American outfit has also run its own, much
shorter-term test. Website Validea has run a Zweig stock screen since
summer 2003 and, like the AAII's screen, it's delivered the best
results with a cumulative gain of 133 per cent.

Over here in the UK, Investors Chronicle's sister publication, the

Stock Screening Newsletter, has also been running a model portfolio
based on Zweig's idea - and, yet again, its results have been top of
the class, with consistent outperformance, even in the current rather
difficult markets. In just two years of operation, a portfolio of up to
14 shares has delivered average gains of just under 15 per cent
(against 10 per cent for the FTSE All-Share), even after the massive
rout of recent weeks.

Understanding Zweig's strategy

Zweig doesn't study any single stock in great detail. He prefers to use
what he calls a shotgun approach - he screens thousands of stocks
purely on their financials, settling on a relatively short list of
potential candidates. Zweig found that five out of eight of the shares
that get through these basic screens perform well. So, what's in these
fundamental screens? Two measures are of supreme importance -
what he calls the earnings trend and the price-earnings (PE) ratio.

Both are easy to understand. The first, earnings trend, is a simple

pattern that shows accelerating profit growth over time. Zweig wants
to see the company's earnings rising consistently for the last four or
five years, but he also wants to make sure that this pattern will hold
for the future - he checks that the most recent quarterly earnings have
shown considerable growth compared with the same quarter a year

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The easy way to growth - Investors Chronicle Page 4 of 5
ago. But what constitutes a considerable growth rate? For Zweig, the Warning: Do remember,
particularly if you are new to
minimum is between 15 and 20 per cent a year. The upward earnings stock market investment that the
trend should also ideally be backed by a parallel sales trend. Zweig prices of shares and other
believed that earnings growth is not sustainable if earnings are rising investments can fall sharply. You
due to cost cutting rather than increased sales. may not get back the money you
originally invested. The material
here is for general information
The second key measure is also easy to understand. Zweig doesn't only and is not intended to be
want to overpay for a share. He wants a reasonable PE ratio. He says: relied upon for individual
"The data going all the way back to the 1930s show conclusively that investment decisions. Take
independent advice before
stocks with low PE ratios outperform stocks with high PE ratios over making such decisions. This site
the longer term". is aimed at UK residents only. To
read more please see our
Zweig is interested only in stocks whose PE ratio is not high relative Important Warning
to the current market. He believes high PE stocks are risky - that
means that a PE much above 40 is much too expensive while a PE
ratio of less than five is probably an anomaly and indicates a
catastrophic decline in profits and sales.

Zweig doesn't like highly indebted companies, believing that

company debt should be average or below average for the sector tin
which it operates. And he also avoids companies where insiders are
selling shares in any significant quantities. Finally, unlike Warren
Buffett or Peter Lynch, Zweig does not insist on understanding what
a company does or how its products work. He will consider buying
any company whose fundamentals are favourable. Zweig says "If a
company can show nice consistent earnings for four or five years, I
don't care whether it makes broomsticks or computer parts."

Applying these principles to the UK market (with one important

exception) isn't too problematic. The exception is that Zweig likes to
focus on quarterly earnings figures, whereas, here in the UK,
earnings are released on a six-monthly basis – so the key is to look at
the most recent figures and re-assure yourself that the earnings
growth acceleration is holding steady and that there aren't any hidden
surprises.

Zweig investing 2008 style

Trying to apply Zweig's ideas to the choppy, bearish markets of 2008

is no easy game. Zweig himself is pretty specific about how to run a
market-timing strategy: "People somehow think you must buy at the
bottom and sell at the top to be successful in the market. That's
nonsense. The idea is to buy when the probability is greatest that the
market is going to advance".

As ideas goes, that may have sounded sensible enough a few years
back. In the current markets, though, it's hard to maintain much
bullish conviction using the Zweig view - markets keep on plunging
and most technical analysts believe that it's going to get much, much
worse before it starts to get any better. On the other hand, Zweig is
also a monetary market timer - he believes that if interest rates are
falling and companies are tackling their debt problems, then markets
might start moving upwards.

WHAT THE SCREEN SAYS NOW:

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The easy way to growth - Investors Chronicle Page 5 of 5
Running a Zweig screen across the UK market right now reveals four
shares, all of which boast strong growth credentials and are
reasonably priced. Their shares have all held up reasonably well in
the current market turmoil.

You can find out what they are by reading Latest Zweig screen
shares, but you'll need to be an IC Advantage subscriber to do so. To
take a free, no-obligation trial to IC Advantage, click here.

For more on stock screens, see our STOCK SCREENS page.

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