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All-Star Stock Strategy: Martin Zweig

Martin Zweig is not a friend of the underdog; underdog stocks that is. He says "the trend is your friend" and seeks to buy winners and sell losers. But unlike many who make such pronouncements, he isn't just looking for stocks that are racing ahead. He pays a lot of attention to the underlying companies and wants stocks that are winners, not necessarily based on idle hype but based on the strength of company performance, stock that win because the companies deserve to win.

Hot companies equal hot stocks

The simplest form of momentum investing is to simply ride the coat-tails of strong stocks. Great returns can and have been generated that way. But so, too, have great losses. All variations of momentum are vulnerable to reversals because no stock can rise briskly forever and getting out before the end of the party is often easier said than done.

Zweig likes hot stocks as well as anybody, or at least he did when he published Martin Zweig's Winning On Wall Street (initially in 1986 with the most recent revision coming in 1997). But that alone won't satisfy the strategy he articulated back then. The stock's heat needs to be justified by a genuinely hot company. He looks for EPS growth rates that are strong and consistent.

As to the details, we're largely on our own. The book was initially written for investors who were presumed to be doing their analysis without access to the modern readily available databases we take for granted today. He even describes in detail how one might circle noteworthy items that appear in the hard-copy Wall Street Journal or New York Times, make index-card records of companies to be saved for future follow-up, and do further research using other hard-copy research services like Value Line and various charting services.

He uses the phrase "reasonably steady growth" to describe what he seeks. But the anecdotal idea-generating examples he gives suggests that reasonably steady should be at a fairly high level. And he does appear to focus on the acceleration-versus-deceleration question. Beyond that, Zweig is noteworthy (relative to other trend followers) for his awareness of the need for sales growth to accompany EPS gains, his desire to see insider buying, and his deference to value. When it comes to the latter, his criteria aren't so stringent as to cause one to mistake him for Ben Graham. He's mainly interested in seeing value at some level that is reasonable for a company that is growing well; avoiding extremes so to speak.

The Portfolio123 Martin Zweig model

This model reflects the general principles used by Portfolio123 for its All-Star screens (stand-on-their-own models inspired by key elements of the All-Stars' approaches), which can be seen here.

The Portfolio123 Martin Zweig model is built primarily on the notion of strong stock-market performance supported by strong company performance. Although Zweig writes extensively of analyzing market prospects in general, we have not incorporated any sort of market timing into our approach. Here are the details of what we have done:

The screen uses the following rules:

Liquidity filter: Universe(foliofn), which means the stock must be tradable in the Folio Investing.com window system; for backtesting purposes, substitute a rule that bars OTC stocks. (Click here for more information)

Eliminate companies classified in the Miscellaneous Financial Services Industry, most of which are investment companies and funds and not the kind of stocks this all-star tended to seek

P/E based on estimated current-year EPS is greater than one-half the overall median and less than two times the median

Year-to-year EPS growth in the most recent quarter must have exceeded the rate of year-to-year EPS growth in the preceding quarter

The 3-year rate of annual sales growth is at least 75% of the rate of three-year EPS growth

The company's EPS in the most recent quarter must have exceed the consensus analyst estimate

The stock is in the top half in terms of the 20-day exponentially weighted moving average divided by the 200-day average

The stock must have outperformed the market over the past six months

Among the companies that pass the above screen, we select the top 15 based on the Zweig ranking system, which uses the following factors:

Growth - 75% of total
Standard Growth - 35% of this category
3-year EPS Growth rate (20% of this sub-category)

Trailing 12 month EPS growth rate (30% of this sub-category)

Latest quarter year-over-year EPS growth rate (50% of this sub-category)
Acceleration - 65% of this category
Acceleration in year-over-year EPS growth rate, latest quarter versus preceding quarter (30% of this sub-category)

Acceleration in year-over-year Sales growth rate, latest quarter versus preceding quarter (20% of this sub-category)

EPS Growth Acceleration, latest quarter (year-over-year) rate versus 3-year rate (15% of this sub-category)

EPS Growth Acceleration, latest quarter (year-over-year) rate versus trailing-12-month rate (35% of this sub-category)
Market Performance - 25% of total
4-week relative (to S&P 500) share price % change (60% of this category)

13-week relative (to S&P 500) share price % change (25% of this category)

26-week relative (to S&P 500) share price % change (15% of this category)

Portfolio123 users who would like to examine the details or copy the models for their own use, may do so:

Click here for the Martin Zweig screen

Click here for the Martin Zweig ranking system

Backtest results

Figure 1 and Table 1 show the results of a five-year backtest that ran through 1/12/10 which assumes rebalancing every four weeks and selection of the top 15 stocks as per the screen sorted on the basis of the Martin Zweig ranking system.

Figure 1

Click here for more information on Portfolio123.

The material herein, while not guaranteed, is based upon information believed to be reliable and accurate. Neither Prism Financial, Inc., owner of Portfolio123.com, nor Marc H. Gerstein, an independent contractor working with Prism (a) guarantee the accuracy, completeness or timeliness of, or otherwise endorse, the information, views, opinions, or recommendations expressed herein; (b) give investment advice; or (c) advocate the sale or purchase of any security or investment. The material herein is not to be deemed an offer or solicitation on our part with respect to the sale or purchase of any securities. Our writers, contributors, editors and employees may at times have positions in the securities mentioned and may make purchases or sales of these securities while this report is in circulation.

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