Discover the Value Screen by Kirkpatrick
Despite the success of his growth model, Kirkpatrick was concerned that its performance had occurred during one of the strongest bull markets in history. To protect against the inevitable market reversal, he wanted to strengthen the system against capital losses. His belief was that relative price strength would not be effective in a market downturn and could be the source of significant capital losses. Kirkpatrick's alternative was to reduce portfolio risk by starting with a group of low-valued stocks. His reasoning was that since the low valuations were likely due to price declines, the downside risk had been reduced. Kirkpatrick arbitrarily selected only stocks in the 30th percentile or lower using relative price-to-sales percentiles.
He tested his value model from 1998 to 2007. It outperformed the growth model and the S&P 500 Index.
Kirkpatrick's Value List mimics the Growth List. However, instead of using a chart pattern stop, it uses the relative price-to-sales ratio to reduce risk.
Rule #1 Price Strength
In Beat the Market, Kirkpatrick calculates relative strength by dividing the current weekly closing price by the 26-week moving average of closing prices. We only keep the company in the top 10%.
Top 10% of Relative Price Strength
Rule #2 Reported Earnings Growth
Kirkpatrick uses a non-standard calculation for earnings growth, which compares operating income over the last four fiscal quarters to the four-quarter total of operating income one quarter earlier. His goal is to eliminate the effect of seasonality on a company's earnings.
Growth in Operating Income
Rule #3 Price and Market Cap
For the Value List, Kirkpatrick relaxed his market cap requirements to include companies with a market capitalization of $500 million or more. However, he maintained the minimum share price of $10.
Share Price > $10
Market Cap > $500 million
Rule #4 Relative Valuation
For his Value List, Kirkpatrick selects stocks with relative price-to-sales ratios in the 30th percentile or lower.
Top 30% for Relative Price/Sales
Rule #5 Sell Criteria
After buying a stock for his value list, Kirkpatrick used these rules to determine when to remove a stock from the portfolio:
- Relative price strength percentile of 30 or less,
- Relative reported earnings growth percentile below 50, and
- Stocks NOT removed for extraordinarily high relative price-to-sales ratios.