Who is Jim O'Shaughnessy, and what is the O'Shaughnessy Small Cap Growth & Value Screen?
James O'Shaughnessy, the quantitative investor behind "What Works on Wall Street" and the founder of O'Shaughnessy Asset Management, laid out four cap-specific strategies in his 2006 book "Predicting the Markets of Tomorrow." The O'Shaughnessy Small Cap Growth & Value Screen is the one aimed at smaller companies, and he described its target plainly: cheap stocks on the mend. It boxes the search to small and mid-sized firms, insists they trade at a modest valuation with growing earnings, and then requires that the price already be climbing across several time frames before a stock makes the cut.
The core idea
Value and momentum usually get pitched as rivals; this screen uses them as partners. The value side is straightforward — a price-to-sales ratio under 1.5 and positive earnings growth over the past year keep the list to reasonably priced companies that are actually earning more than they were. The momentum side is where the screen gets particular. Rather than trust a single price change, it demands above-average relative strength over both the last 13 weeks and the last 26 weeks, then ranks the finalists by their full 52-week price gain and keeps the top 25. Three overlapping windows raise the bar: a stock has to be turning up recently, over the past half-year, and over the past year, which screens out one-week bounces that fade.
What the O'Shaughnessy Small Cap Growth & Value Screen looks for
- Relative price strength over both the last 13 weeks and the last 26 weeks above the database average for each period.
- Companies based outside the United States are excluded, as are over-the-counter stocks.
- Market capitalization in the latest fiscal quarter between $200 million and $2 billion, using 2006 as the base year and raising both bounds 3% a year for inflation.
- Price-to-sales ratio less than 1.5.
- Positive earnings-per-share growth over the trailing 12 months.
- The final portfolio is the 25 companies with the highest 52-week relative strength.
Why the O'Shaughnessy Small Cap Growth & Value Screen can work
Smaller companies have more room to re-rate than large ones — a mid-sized firm the market has written off can double if the story turns, where a mega-cap rarely will. The price-to-sales limit keeps you from paying up for that potential, since O'Shaughnessy found low price-to-sales ratios produced higher returns across every size band. Requiring momentum on top of cheapness is the screen's way of waiting for confirmation: a cheap small cap can stay cheap for years, and the three-window relative-strength test tries to buy only once buyers have started to show up. Inflation-adjusting the size band each year keeps the screen honest, so it keeps hunting in the same slice of the market instead of drifting larger as prices rise.
What to keep in mind
Small caps are volatile and thinner to trade, so the same names that offer more upside can be harder to exit when a position sours. Because momentum is a requirement here rather than a tiebreaker, you are buying after a run — and runs reverse, sometimes violently, in exactly this part of the market. Twenty-five holdings help, but single-name risk is still real when the companies are small. The $2 billion ceiling can also work against you by forcing a sale of a winner precisely because it grew into a mid-cap. As with the rest of O'Shaughnessy's screens, this one surfaces candidates on price and a couple of ratios; it does not read the balance sheet or the business behind them.
Sources
Predicting the Markets of Tomorrow: A Contrarian Investment Strategy for the Next Twenty Years, James P. O'Shaughnessy, Portfolio, 2006.
American Association of Individual Investors (AAII) — Stock Investor Pro screen definition.