Can Screening For Stocks Still Generate Alpha?

This article is an overview of screening; in subsequent articles I will be doing deep dives into some classic screens such as those by Benjamin Graham, William O’Neil, Joel Greenblatt, Joseph Piotroski, and James and Patrick O’Shaughnessy.

Hundreds of thousands—perhaps millions—of investors use screens as a first step to picking stocks. Sometimes the screens have very simple and straightforward rules; sometimes they are very complicated, using multifactor ranking systems (my screens are like that) or head-scratching technical indicators.

How can you tell if a screen “works”? The conventional way is to backtest it. (There are a number of websites, brokers, data providers, and subscription services that allow you to do this; I use Portfolio123.) Typically, if a screen beats the market, it works; if it doesn’t, it doesn’t.

But what do you do with periods like the last three years, when “the market”—the S&P 500—has beaten everything in sight? In order to write this article and the articles that will follow it, I tested dozens of established screens designed by or based on the ideas of investment experts with a wide variety of approaches, and fewer than 15% of them have beat the S&P 500 over the last three years. Screens are usually at least partly based on value ratios and value stocks have been hugely disadvantaged lately; screens are often designed to hunt up smaller and little-known stocks and large caps have trounced small caps recently.

How, then, should we approach stock screening? Is it a technique that has outlived its purpose? Or are there other ways to think about it?

Personally, I use stock screens every night in order to place my trades for the next day. My own returns over the last three years have been pretty good: a CAGR of 21%, compared to 9% for the S&P 500, and a lower drawdown during the market crash this year. So it’s not impossible to use screens to beat the market. But it’s getting hard.

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