Stock Screening & System Backtesting With Zacks Research Wizard

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By Wayne A. Thorp, CFA

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tock screening has become a popular means for individual investors to identify potential investment candidates. This type of rulebased investing involves applying a set of quantitative filters to a database of stocks to isolate those companies that meet or pass the various filters. For example, a value-based filter may search for companies that rank in the bottom 20% of the stock universe in terms of price-to-bookvalue ratio. Many Web sites offer stock screening modules, which vary greatly in their sophistication and fee structure. The comparison article in the May/June 2008 issue of Computerized Investing highlighted 10 on-line stock screening services. This article is available on-line at the CI Web site (www.computerizedinvesting.com). For most investors, the goal of investing in individual stocks is to outperform the broad market or some index mutual fund. The Stock Screens area of AAII.com tracks the performance of over 50 different stock screening methodologies using our Stock Investor Pro program. We arrive at the performance of these different screens through a process called backtesting.

gies. In fact, backtesting is a term more frequently used in the field of technical analysis. Technical analysis is the study of price and volume behavior in securities—stocks, mutual funds, commodities, etc.—to attempt to predict future price movements. Whereas backtesting of technical trading strategies requires only price and volume data, which is compiled by numerous data vendors, there are only a handful of vendors offering similar historical databases of com-

“While past performance is no guarantee of future performance, backtesting is an imperfect means of identifying promising investment techniques.”

What Is Backtesting? Backtesting is the method by which you identify the trades a rules-based investment strategy would have generated using historical data. The motivation for backtesting is to gauge the success of a system using historical data to see if it may be worth following going forward. While, as investors, we often see the disclaimer “past performance is no guarantee of future performance,” backtesting is an imperfect means of identifying promising investment techniques. The problem for most individual investors is that there are few backtesting resources at their disposal for testing fundamental screening strate22

by the price tag, which ranges from $1,800 to $3,000 a year, depending on which backtesting database you choose. While few of us have probably ever spent that much money on a piece of software, you must consider it in the context of its functionality as well as your overall investment portfolio. For someone with a $300,000 portfolio, the annual cost of the software is only 1% of the portfolio. By comparison, the average mutual fund has an expense ratio of around 1.3%.

pany financial data. Perhaps the most widely known screening database for academic and institutional research is Compustat from Standard & Poor’s. However, this product carries with it an intuitional price tag—thousands of dollars a year—that is beyond the means of the typical individual investor. Companies that market financial databases such as Thomson Reuters, which supplies the data for AAII’s Stock Investor program, also cater to institutional clients and price their products accordingly.

Zacks Research Wizard For individual investors looking for an all-in-one stock screening and strategy backtesting platform, Zacks Investment Research offers its Research Wizard software. Many casual investors might be scared off

Company Universe Table 1 provides an overview of the data features and functionality of Research Wizard. The Research Wizard database consists of approximately 8,300 companies traded on the New York, American, NASDAQ, Pacific, and Toronto stock exchanges. The database also includes roughly 3,000 over-the-counter (OTC) stocks, 600 ADRs (American depositary receipts), and nearly 300 Canadian-based firms.

Screening Database Content To filter the universe of companies, Research Wizard offers over 600 separate data fields for screening. Furthermore, there are several different screening and backtesting databases from which to choose, each with varying data periods covered. Research Wizard’s Advanced Backtesting database offers screening data going back as far as five years, 20 quarters, 60 months, or 260 weeks, depending on the data field. All told, Research Wizard’s various databases have over 118,000 individual data points. Given that Zacks research centers on analyst earnings estimates, Research Wizard also offers some of the broadest estimates-based screening of any consumer screening service. In all, about 20% of the screening variComputerized Investing

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Screening

Table 1. Zacks Research Wizard Company Web Address Price Data Source Number of Stocks/Data Fields for Screening Create Custom Data Fields Company Company Web Link Information DRP Plan Industry Grouping Description Length Employees Estimates— Source Earnings & Quarterly Revenues Annual Growth—Long Term Surprise Revisions/Trend Consensus Analyst Recommendations Consensus Analyst Rec.—Changes/Trend Valuation Fundamental Ratios Leverage Liquidity & Coverage Return on Investment Multiples Margins Turnover Growth Rates Elements Periods Total/Annualized Price & Share High/Low/Close/Volume Data Average Volume Relative Strength (Benchmark) MPT Stats Short Interest Share Data Insider Holdings Insider Trading Institutional Holdings Industry Comparisons SEC Filings Number of Data Points for Screening/Backtesting Against Constant Values Against Other Data Fields Against Benchmarks (Industry/Sector, Index, etc.) Number of Data Fields for Sorting Save Custom Screens # of Predefined Screens Browse Table Financial Statement Presentation Individual Company Summaries Charts/Graphs Export Results to a File Statistical Summaries

Database Content

ables in the program deal with consensus earnings and sales estimates—including surprise data; long-term, annual, and quarterly projected growth rates; number of analysts; and estimate revisions. Research Wizard does allow users to screen on company data, such as financial statement data and financial ratios and multiples, although not quite to the same degree as with estimate-related data. Table 2 lists the income statement, balance sheet, and statement of cash flows data available with Research Wizard’s fundamental databases. Other screening variables available with Research Wizard are a respectable variety of return on investment, leverage, liquidity, and valuation ratios. Most variables in these categories have screening data going back 20 quarters or 260 weeks (five years in all). A rarity found in Research Wizard is screenable short interest data (short interest, change in short interest, and short interest as a percentage of shares outstanding).

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Screening

To start you on your way with stock screening, Research Wizard provides over 90 predefined “screen definitions,” or stock screens. To create your own screens, you have over 600 data fields at your disposal. You can create filters using constant numeric values as well comparisons against other data fields and industry, sector, and S&P 500 benchmarks. You can also save your custom screens for future use. Furthermore, the program allows you to combine September/October 2008

the criteria of one or more screens, a unique feature among stock screen-

Zacks Investment Research www.zacksrw.com $1,800/yr. for 6 years of backtesting data; $3,000/yr. for Advanced Backtesting w/9 years backtesting data; free 14-day trial Zacks Investment Research 8,300+ active stocks/100,000+ data fields 4 4 4 (Zacks) 40-60 words 4 Zacks Investment Research 4 (EPS: 4 qtrs; sales: 4 qtrs) 4 (EPS: 3 yrs; sales: 2 yrs) 4 (EPS: 3-5 yrs, ann’l for next 4 yrs & 4 qtrs) 4 (EPS: 28 qtrs; sales: 9 qtrs) % change in ann’l & qtrly sales & EPS est. last 1, 4, & 12 wks; # up/down revs in ann’l EPS est. over last 4 wks; # up/down revs in curr qtr & next 2 FY sales est. Zacks Rank & consensus broker rating 4 (trend in Zacks Rank & broker rating last 144 mos) 6-12 month price target long-term debt/equity, deby/total capital quick, current, payout, cash, interest coverage return on assets, return on equity, return on investment P/E, P/S, P/B, P/CF, yield, fwd PEG, rel P/E pretax margin, profit margin, operating margin total asset, inventory, receivables sales, EPS, net income, divs, book value, cash flow 1-qtr, 1-yr (same qtr), 12m, 5-yr 4 4 (52-wk high/low, 13 mos of month-end prices, 5 yrs year-end prices, current price) 4 (20-day) 1-, 4-, 12-, 24- & 52-wk, YTD (S&P 500) 4 (beta) 4 (shares, ratio, % shares outstdg, % change) 4 (market cap, shares outstdg, float, split date) 4 (%) 4 (chg in % hldgs & # buys & sells last 12 & 24 wks) 4 (%) 4 4 100,000+ for screening; 50,000+ for backtesting/Advanced Backtesting 4 4 4 (universal, industry, sector, S&P 500) sort on fields used in screen 4 90+ 4 total $ 4 4 4 4

ing services. However, note that, by default, the screening results of any

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Feature between 0.01 and 1,400.00, Balance Sheet (Continued) with a mean 24Q, 12Y Total Assets 24Q, 12Y (average) 24Q, 12Y Notes Payable 24Q, 12Y value of 26.78 24Q, 12Y Accounts Receivable 24Q, 12Y and a median 24Q, 12Y Current Portion of Long-Term Debt 24Q, 12Y or midpoint 24Q, 12Y Current Capital Leases 24Q, 12Y value of 24Q, 12Y Other Current Liabilities 24Q, 12Y 15.95. The 24Q, 12Y Total Current Liabilities 24Q, 12Y histogram 24Q, 12Y Minority Interest 24Q, 12Y 24Q, 12Y chart proLong-Term Debt 24Q, 12Y 24Q, 12Y Non-Current Capital Leases 24Q, 12Y vides a visual 24Q, 12Y Other Long-Term Liabilities 24Q, 12Y representa24Q, 12Y Total Long-Term Debt 24Q, 12Y tion of the 24Q, 12Y Total Liabilities 24Q, 12Y price-earnings 24Q, 12Y Preferred Stock Equity 24Q, 12Y distribution 24Q, 12Y Retained Earnings 24Q, 12Y among the 24Q, 12Y Common Equity 24Q, 12Y stock uni20Q, 12Y Shareholders' Equity 24Q, 12Y verse. 24Q, 12Y Total Liabilities & Equity 24Q, 12Y Once you 24Q, 12Y Book Value Per Share 20Q, 5Y 24Q, 12Y run a screen, Statement of Cash Flows 24Q, 12Y Net Change in Working Capital 24Q, 12Y you can 24Q, 12Y Cash From Operating Activities 24Q, 12Y save the list 24Q, 12Y Investments 24Q, 12Y of passing Cash From Investing Activities 24Q, 12Y companies as 24Q, 12Y Issuance of Equity Shares 24Q, 12Y a Ticker List. 24Q, 12Y Issuance of Debt 24Q, 12Y You can then 24Q, 12Y Dividends & Distributions 24Q, 12Y run addi24Q, 12Y Cash From Financing Activities 24Q, 12Y tional screens 24Q, 12Y Exchange Rate Effect 24Q, 12Y against this 24Q, 12Y Cash Flow (Net Change in Cash) 24Q, 12Y Ticker List as 24Q, 12Y Beginning Cash 24Q, 12Y 24Q, 12Y Ending Cash 24Q, 12Y well as gener24Q, 12Y ate a variety of reports One other unique feature of Reusing this group of companies. search Wizard worth mentioning is Furthermore, you can also combine the “Item Summary” function. When multiple Ticker Lists without having creating a screen, it is important to to re-enter ticker symbols. set appropriate operators and values in order to arrive at meaningful Custom Expressions screening results. Using the Item Users can also create custom Summary, you can see how the comdata fields and calculations, called panies in the entire database universe “expressions,” using the Calculation are distributed based on any nuExpression feature. This is one of merical field in the program. Figure 2 the most robust expression builders shows the Item Summary display for we have run across. Users can build the current price-earnings ratio using expressions by selecting data fields, 12-month earnings per share. The time periods, and mathematical database has a universe of 10,323 operators and functions. However, companies, but of these 6,681 have it is disappointing to note that the “N/A” values—either the company program does not allow you to save has negative or missing 12-month custom fields you use in custom exearnings per share or it does not have pressions. This means that you must a current share price. For the remainrecreate custom fields every time you ing 3,642 stocks, their price-earnwish to use them in a screen. ings ratios are distributed in a range A calculation expression consists

Table 2. Historical Financial Statement Data for Zacks Research Wizard Income Statement Sales Cost of Sales Gross Income Research & Development SG&A EBITDA Depreciation & Amortization EBIT Interest Expense Pretax Income Income Taxes Minority Interest Investment Gain/Loss Income From Continuing Operations Extraordinary Items Net Income Net Income Available to Common Average Basic Shares Average Diluted Shares EPS Basic EPS Diluted Common Dividends Preferred Dividends Accrued Balance Sheet Cash & Equivalents Accounts Receivable Inventory Notes Receivable Other Current Assets Total Current Assets Net Property, Plant & Equipment Intangible Assets Other Non-Current Assets

combo screen are the combined set of companies passing each individual screen. The passing companies list is not those companies passing all of the filters of the combined screens. A unique search element with Research Wizard is the Historical Search option, which allows you to screen on several data periods for the same data field. For example, if you want to screen for companies that have generated positive earnings surprises for each of the last 19 fiscal quarters, you don’t have to enter in 20 lines of screening criteria. As Figure 1 shows, you create the filter EPS Surprises (%) > 0 and then specify the period between the last fiscal quarter and 19 quarters ago. Lastly, specify that you want a positive EPS surprise for every one of the quarters in the test range. 24

Computerized Investing

Feature of several elements. Data elements or “items” are part of a specific category. The fields in Research Wizard are numbered and when you create a calculation expression, the formula only displays the field numbers, not the actual field names. Figure 3 shows a calculation for free cash flow [net income + amortization & depreciation – changes in working capital + (increases in) property, plant, & equipment]. Seeing only the field numbers makes it difficult to decipher a given calculation expression. With calculation expressions, you can also specify the time period of a given data item, with the most current being “recent,” or you can choose a specific time period, depending on the data item you are using. Additional options include the operator category, operator and, if need be, function category and function name. Another useful expression function that is available in Research Wizard is rank. The ranking functions allow you to classify companies within the full stock universe or within a sector or industry. There are three ranking functions available in Research Wizard—ordinal, uniform, and histogram. Ordinal ranking will rank items by their values, based on the number of tickers in the group (universe, sector, or industry). Uniform ranking places an approximately equal number of companies into fractiles, which the user can specify. Lastly, histogram ranking creates equal-length intervals based on high and low values within each time period. Histogram ranking shows the distribution of values on the selected item. If an item has a wide range of values, with outliers or extreme values, histogram ranking will have a small number of companies in the top and bottom rankings and a large number of companies in each of the middle ranks.

Backtesting For backtesting purposes, there are two subscription levels. For access to six years of backtesting data, the anSeptember/October 2008

Figure 1. Historical Search

Figure 2. Item Summary Display

Figure 3. Building a Calculation Expression

nual fee is $1,800. Research Wizard’s Advanced Backtesting module, with backtesting data going back to 2000, costs $3,000 a year. Just like with its screening capabilities, the bulk of Research Wizard’s

backtesting rests with analyzing consensus earnings and sales estimates and ratings and the changes in these data over time. The Advanced Backtesting module offers over 50,000 data points for backtesting. 25

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Figure 4. Backtest Screen Definition Window

Figure 5. Results of Backtest

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However, over 33,000 of these fields deal with analyst consensus figures and broker ratings. Those hoping to backtest strategies based on historical financial data or financial ratios and multiples will probably be disappointed, as backtesting data in this area is sparse. While the backtesting databases are accessible on-line, meaning you don’t have to store the data on your on PC, users of the Advanced Backtester do have the option of downloading the backtesting database for “local” access. This means you can perform your analysis without having to be connected to the Internet. However, you will need a high-speed connection, such as a cable modem or DSL, to download the backtesting database, as it is over 800 megabtyes in size. Figure 4 is the Backtest Screen Definition window in Research Wizard. The process of backtesting is very straightforward with the program—select the strategy you wish to backtest, specify the holding period (one, two, four, 12, 24 or 52 weeks), the benchmark index, and the backtesting time period. Since there is not a true one-month holding period, we selected a four-week holding period. Once the backtest is finished, Research Wizard generates a chart with the performance of your strategy and the benchmark you selected (Figure 5). There is also a summary report, listing the number of companies, total portfolio return, benchmark return, and excess return of the portfolio for each of the holding periods in the backtest. Summary performance statistics are given, including the total compound return (% and $), average number of stocks held, average return per holding period and maximum drawdown (largest peak-to-trough loss during the entire backtest period). The data in this table can be exported to Excel for further manipulation. You can also select individual holding periods to see the list of companies held for the period and their individual returns for that period. Computerized Investing

Feature The Advanced Backtesting module also offers Automated Robustness Analysis, which provides you with the “best-case” and “worst-case” scenarios for a given backtest. If you are backtesting a strategy with a monthly holding period—buying at the beginning of the month and selling at the end of the month—the robustness analysis will show you the impact of buying at a different point in the month and holding the stocks for a different four-week period. Ideally, changing the timing of your strategy’s trades will not have a significant impact on its performance. The robustness analyzer will create a chart illustrating the performance of all the study periods, or users can specify selected studies for display. Furthermore, a statistical performance table is also generated, showing the average performance of all the differing time-period studies along with the best- and worst-performing runs and the time period with which they are associated. Beyond being able to backtest individual stock screening strategies, Advanced Backtesting also allows you to backtest multiple strategies together (combo strategies). Combo strategies, in effect, are portfolios of screening strategies. When backtesting a combo strategy, you can view the combo performance separately or with the performance of the individual strategies in the “portfolio.” Lastly, you can backtest combo strategies to “optimize” a screening strategy or see the impact of changing certain variables on performance. You can run a test for different values of a given data point to see how each would perform. The combo backtester also allows you to see the impact of removing a piece of criterion completely from the screen. More sophisticated investors will inevitably ask about the “survivorship bias” of these backtesting results. Survivorship bias skews perfor-

mance statistics when the data of companies that no longer exist due to mergers, bankruptcies, etc. are excluded from the testing database. Failing to include these “obsolete” firms in the historical data biases the results. According to Zacks, there is a partial survivorship bias in Research Wizard’s backtesting database. However, they are working to correct the problem, which they hope to have completed within the next two months. At this point, the backtesting database does not include delisted or acquired companies prior to December 3, 2004. It is encouraging to see that Zacks is taking steps to eliminate survivorship bias from their backtesting database.

Stock Research Anyone who has read one of my screening articles in the AAII Journal knows that I don’t advocate blindly buying the companies passing a stock screen. Stock screening merely allows you to isolate companies with similar quantifiable characteristics. It is up to you to perform the analysis necessary to help you decide whether the stock is right for your investment portfolio. Luckily, Zacks Research Wizard offers a wealth of company research to help you make these decisions. Company Snapshot Reports are one-page summary reports, featuring company descriptions, actual and forecasted earnings, company ratings against its industry, fundamental data, broker ratings, and price charts. There are also several expanded company reports that you can link to via the Internet, including fundamental data reports and tables, business description and management discussion reports, insider trading data, financial statements, and brokerage research reports.

Conclusion I was very impressed with the features and functionality of Re-

Wayne A. Thorp, CFA, is editor of Computerized Investing and AAII’s financial analyst. September/October 2008

search Wizard. It is well positioned as the only all-in-one screening and backtesting platform that isn’t priced beyond the reach of most individual investors. My biggest disappointment was that the screening and backtesting was heavily geared toward estimate and ratings data. Given that Zacks is a proprietor of this data, it makes sense that their database would rely heavily on it, as they are their own data supplier. The relative lack of financial statement data along with ratios and multiples, in my opinion, reflects the high costs of offering this data in a screening or backtesting database. While many will be drawn to Research Wizard’s array of features, others may find them to be an obstacle. Programs such as Research Wizard require a lot of time and effort to understand all the bells and whistles they offer. Realize that the program represents a not-insignificant financial investment and be willing to invest the time necessary to make it worthwhile. Luckily, the program itself is relatively easy to navigate and the menus are pretty straightforward. While there is an on-line help system, it tends to skim over some of the program’s more unique features. This led to a lot of trial-and-error, which some may find tedious. Overall, I do believe the price of Research Wizard is warranted, given its features and depth of backtesting data—especially if you focus on consensus estimates. For those willing to spend the time learning the program, its rewards could very well offset the cost. Zacks Research Wizard 4.0 System Requirements: Microsoft Windows (Vistacompatible); 9M of free hard disk space for Internet screening and backtesting or 830M for “local” Advanced Backtesting; Internet connection (highspeed connection recommended) Price: $1,800/yr.; Advanced Backtesting, $3,000/yr.; free 14-day trial Zacks Investment Research 111 N. Canal St., Suite 1101 Chicago, IL 60606 (800) 767-3771, ext.9392 www.zacksrw.com

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