A portfolio for sustainable growth
These 10 stocks meet the disciplined earnings strategy developed by Martin Zweig.
By John Reese, Validea
Our latest Guru Spotlight is a bittersweet one. While it's always interesting to examine the great Martin Zweig's approach, we're also commemorating his passing; he died in February at the age of 70.
His Zweig Forecast was one of the most highly regarded investment newsletters, and Zweig Dimenna Partners has been ranked in the top 15 of Barron's list of the most successful hedge funds.
Zweig was a growth investor, and his methodology was dominated by earnings-based criteria. The strategy he used to compile that cash was a disciplined, methodical approach.
- Trend of Earnings: Earnings should be higher in the current quarter than they were a year ago in the same quarter.
- Earnings Persistence: Earnings per share should have increased in each year of the past five-year period; earnings per share should also have grown in each of the past four quarters (vs. the respective year-ago quarters).
- Long-Term Growth: Earnings per share should be growing by at least 15% over the long term; a growth rate over 30% is exceptional.
- Earnings Acceleration: Earnings per share 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). Earnings per share 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.
While Zweig's earnings per share focus certainly put him on the "growth" side of the growth/value spectrum, his approach was by no means a growth-at-all-costs strategy. He also included a key value-based component in his method.
He made sure that a stock's price-to-earnings ratio was no greater than three times the market average, and no greater than 43, regardless of what the market average was.
In addition, Zweig wanted to know that a company's earnings growth was sustainable over the long haul. And that meant that the growth was coming primarily from sales -- not cost-cutting or other non-sales measures.
My Zweig model requires a firm's revenue growth to be at least 85% of earnings per share growth. If a stock fails that test but its revenues are growing by at least 30% a year, it passes, however, since that is still a very strong revenue growth rate.
Like earnings growth, Zweig believed sales growth should be increasing. My model thus requires that a stock's 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).
Finally, Zweig also wanted to makes sure a firm's growth wasn't driven by unsustainable amounts of leverage (a key observation given all that's happened in recent years).
Realizing that different industries require different debt loads, he looked for stocks whose debt/equity ratios were lower than their industry average.
My Zweig-inspired 10-stock portfolio has been a very strong performer since its July 2003 inception, returning 118.6%, or 8.4% per year, while the S&P 500 has gained just 56.3%, or 4.7% per year (through March 26).
The portfolio is having a strong start to 2013, already up nearly 15%. It tends to choose stocks from a variety of areas -- it goes where the growth is. Here are the portfolio's current holdings:
USANA Health Sciences (USNA)
Sturm, Ruger & Company (RGR)
Lululemon Athletica (LULU)
World Acceptance Corp. (WRLD)
First Cash Financial Services (FCFS)
The TJX Companies (TJX)
Netease, Inc. (NTES)
Questcor Pharmaceuticals (QCOR)
Oracle Corporation (ORCL)
V.F. Corporation (VFC)
What I really like about the Zweig strategy is that, while it certainly would qualify as a growth approach, it doesn't look at growth in a vacuum.
It examines earnings growth from a variety of angles, making sure that it is strong, improving, and sustainable. In doing so, it allows you to find some fast-growing growth stocks that are not paper tigers, but instead solid prospects for continued long-term success.
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John Stumpf acknowledges that growth has been slow, but he says he's still optimistic.
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