The Cornerstone Growth Screen is an impressive growth screen which combines relative strength, earnings consistency and a price-to-sales value measure.
O'Shaughnessy wrote the seminal 1996 book "What Works on Wall Street”. In it, the Cornerstone Growth stock screener implements a strategy he developed in the 1990s using Standard & Poor's Compustat database to back-test the performance of dozens of stock-picking strategies between 1954 and 1996.
He was the first to test over such a long period a large number of simple growth screens like high profit margins, high return on equity, high one year and five year earnings growth and high relative strength. His conclusion was that, with the exceptions of relative strength and earnings growth, most simple growth strategies did not compensate investors adequately for the risks involved. After studying the results, O'Shaughnessy came up with his own formula called the "United Cornerstone" strategy. This approach is a combination of two models: a momentum/earnings growth-focused method called "Cornerstone Growth" and a value-focused method called "Cornerstone Value.". His conclusions were published in the book, What Works on Wall Street”, an in-depth quantitative stock market study and bestseller.
Does the Cornerstone Growth Screen Work?
According to “What Works on Wall Street”, O'Shaughnessy found that his growth strategy outperformed the market producing an annual compound return of 18% from 1954 to 1996, compared to 8.3% for the S&P 500 Index (this beat his value strategy which achieved 15%, although it was more volatile).
For more recent data, it is possible to track the subsequent performance of the mutual fund that O’Shaughnessy set up and subsequently sold to Neil Hennessy to become the Hennessy Cornerstone Growth Fund (HFCGX). According to CXO Advisory Group, unlike its sibling Value Fund, HFCGX materially outperformed both its benchmark Russell 2000 Index and the S&P 500 Index in the past decade:
“The fund outperformed the S&P 500 Index by about 5% per year, compared to the backtested average annual outperformance of about 10%. Its slightly higher standard deviation of annual returns (23.1% versus 21.4% for the Russell 2000 Index) seems not to offset the benefit of the higher return”.
The American Association of Individual Investors also present some more recent performance data for this screen, showing an 18% return vs. 0.7% for the S&P 500 over the last decade (as at February 2011). Although the Cornerstone Value strategy has not done as well, the two should perhaps not be viewed in isolation. O'Shaughnessy argued that the best bet on a risk-adjusted basis was a portfolio made up of both the CVS and CSG - the idea being that, when the CVS strategy (which tends to pick larger capitalization names with steadier returns) stops working, the CSG strategy (which prefers small to mid-cap names with more volatillity) will perform better and vice versa.
We are not aware of any performance analysis of this screen for the UK market.
How can I run this Screen?
Calculation / Definition
In his "Cornerstone Growth" approach, O'Shaughnessy used the following criteria:
- Size - The screen was applied to the all-stocks universe on tbe basis that smaller stocks have greater growth potential than large caps. However, a market capitalisation threshold of $150 million was applied to screen out illiquid stocks.
- Earnings growth consistency - A filter was applied for 5 years of consecutive EPS growth (regardless of magnitude). O'Shaughnessy found that the rate a growth stock's earnings grew wasn't as important as the persistence of growth over time.
- Price to sales - The growth requirement was balanced by using a maximum price-to-sales ratio of 1.5x. While the P/E ratio is the touchstone of stock analysts, O'Shaughnessy actually found that the relationship between a stock's price and its sales, rather than its earnings, was the most likely predictor of future success.
- Relative Strength - Finally O'Shaughnessy ranked the passing companies for highest relative price strength over the previous year and choose the top 50. Relative strength compares the price performance of a stock to its corresponding Index (stocks outperforming have positive relative strength). This is because he found that a company which is a winner tends to continue winning, while losers tend to continue along that path.
Although this screen is called a growth strategy, it is actually a mixed approach which combines the more predictive value factor O'Shaughnessy identified, i.e. the price/sales ratio, with the strongest growth factor i.e. relative strength. That's because one of the interesting things he found was that all of the successful strategies he studied included at least one value-based criterion. The screen helps identify stocks that the market is embracing (as shown by the high relative strength) but supposedly without overpaying (hence low price/sales). The reasoning was that shares with low valuations but momentum / relative strength were in the process of "being discovered" by the market.
Watch Out for
Although his approach is purely quantitative, O'Shaughnessy also does emphasize the importance of having the right mindset when putting money to work.
"Generally speaking, when things are going against you, as they inevitably will, you have to stick to the underlying strategy… Only by doing so will you be around for when it comes rebounding back."
From the Source:
The 2005 version of "What works on Wall Street" is available on Amazon. It's also worth referring to the “What Works on Wall Street” website. His more recent book is “Predicting the Markets of Tomorrow: A Contrarian Investment Strategy for the Next Twenty Years” (2006).
- Wikipedia on James O'Shaughnessy
- Forbes Article: O'Shaughnessy's Keep-It-Simple Stock
- Forbes Article: A Portfolio to Beat Buffetts
- Silicon Valley AAII presentation: O’Shaughnessy Screens
- Validea Article: O'Shaughnessy's Tried & True One-Two Punch