Background
Martin Zweig was a highly respected investor in the 1970’s-90’s, with one of the most widely followed stock recommendation newsletters at the time: The Zweig Forecast. From 1980-95 this newsletter returned an average of 15.9% a year, during which time it was ranked number one on risk-adjusted returns by Hulbert Financial Digest – earning him stock picker of the year 2 years in a row.
He also wrote the investment cult classic: ‘Winning on Wall Street’, founded one of the longest standing hedge funds: Zweig Dimenna associates, and famously predicted the 1987 stock market crash with his stock market timing model.
His investment success brought him untold wealth. This allowed him to enjoy a notoriously “eccentric and lavish” lifestyle according to Forbes magazine. At one point, he owned the most expensive apartment in America, atop The Pierre on Fifth Avenue in Manhattan. It was worth $125m at his time of death in 2013.
With these credentials, it is hard to ignore the lessons imparted by the great ‘Marty’ Zweig. This article will shed light on these lessons, with a particular focus on his investment style and screening approach.
Investment Approach
Top-Down (Stock Market Timing)
Zweig not only had a system to pick stocks, but also one to help him time the market.
This was based on rigorous backtesting of different macroeconomic and technical indicators.
If his model told him market conditions were bullish, he would be fully invested, but if it turned bearish, he would be out. This helped him avoid the infamous market crash in 1987.
Therefore, his was not a buy-and-hold strategy. He would use his timing model to inform a directional view on markets, which would help him minimise risk and limit losses.
“People somehow think you must buy at the bottom and sell at the top to be successful in the market. That’s nonsense. The idea is to buy when the probability is greatest that the market is going to advance”
The “Super Model”
This top-down model is what Zweig called the “Super Model”. It was based on monetary indicators such as debt and interest rates, as well as technical indicators measuring market breadth and momentum.
Specifically, the monetary indicators tracked levels and changes in the loan prime rate, the FED funds rate, and loan demand for consumer instalment debt.
The theory being that monetary conditions affect the flow and opportunity cost of money, which in turn exerts a strong influence on stock prices.
The model turned more bullish when interest rates were falling and loan demand was rising, which primarily took their cue from Federal Reserve monetary policy. Hence Zweig’s famous saying: “Don’t fight the FED”.
The technical indicators were made up of the market’s advance/decline ratio, up volume, and 4% indicator. Zweig believed that all big bull markets start with a spike in buying volume and market breadth (the percentage of companies rising vs. falling).
The incorporation of technical analysis and price action into his models took inspiration from one of his favourite investors, Jesse Livermore, who would always advocate: “Don’t fight the tape”. Zweig reinvented this sentiment with his own, similar adage: “The trend is your friend”.
Zweig devised a scoring system for each of these indicators, resembling an oscillator that moved up or down with changes in the underlying metric. He then aggregated these scores in the Super Model to compute an ultimate oscillator, which would tell him whether to be fully invested, moderately invested, or out of the market all together.
Bottom-Up (Stock Picking)
“My stock-picking procedure involves a search for the following variables: strong growth in company earnings and sales; a reasonable price-to-earnings ratio given the company’s growth rate; buying by corporate insiders, or at least the lack of heavy selling by insiders; and relatively strong price action in the stock itself”
Growth at Reasonable Price (GARP)
Martin Zweig followed what is known as a GARP investment style, which is an acronym for ‘growth at reasonable price’.
Therefore, his stock selection process involved picking companies with exceptional earnings growth, where he was deemed to not be overpaying for this growth.
This is a similar strategy to Peter Lynch, which you can read more about in this Peter Lynch stock screener article.
Growth Persistence
Moreover, Zweig would like this earnings growth to be consistent over the last few quarters and years, and accompanied by just as strong and consistent sales growth. Strong sales growth ensured that earnings were not being driven by cost-cutting measures – which are unsustainable long-term.
“I try to look for some stability in the direction [of earnings trends]. If the earnings are increasing at a steady 15% rate each and every year, that’s great. If earnings are up 30% one year, up 5% the next, up 40% the next, down 2% the next, and up 20% the next, the long-run growth rate might be fine but the lack of stability is a negative.”
This preference for growth persistence is something shared by fellow investment guru, William O’Neil, in his CANSLIM investing strategy.
Growth Momentum
In addition, he wanted growth to be accelerating in recent quarters, and the most recent quarter’s growth to be above the long-term average – just to make sure nothing had gone wrong recently.
To do this, he would make sure that the most recent quarter’s year-on-year growth rate was greater than the previous quarter’s year-on-year growth rate – with both above zero (growth persistence).
Then, he would make sure the most recent quarter’s growth rate was above a longer-term average like the 5-year compounded annual growth rate (CAGR).
There is empirical evidence that suggests stocks with upwardly revised earnings estimates – a proxy for growth momentum – perform exceptionally well in the near future. Therefore, an earnings revisions screen is something you could incorporate into your Zweig criteria.
Price-to-Earnings
He accepted that he might have to pay a premium for stocks with strong and stable growth, however he would avoid paying too much over the market average P/E.
“Since my approach emphasises stable and reasonable growth, I am very unlikely to find an extremely low P/E associated with that … Most of the stocks I select have P/E’s near the average for the market or somewhat above it.”
Martin Zweig was wary of companies that looked excessively cheap however, as there was usually a reason for this e.g., risk of bankruptcy.
“Indeed, if I come across a stock with excellent growth that has a very low P/E, I immediately get suspicious. I will check further to see if there’s a problem on the balance sheet or if the backlog of orders has dropped off, or if there is some other outstanding negative; there often is.”
Financial Strength
He avoided companies using excessive debt to finance this growth, so favoured stocks with healthy balance sheets. Since some industries are more capital-intensive than others, he would judge a company’s indebtedness in the context of that industry.
Insider Activity
Close attention was also paid to the transaction activity of insiders. Zweig preferred companies where insiders had been buying shares as opposed to selling.
“My philosophy is that where there is smoke there is fire. If insiders are heavily selling stock, no matter what their alleged reasons, I generally take a dim view … Conversely, if numerous insiders are buying stock at or about the same time, it’s usually an excellent sign.”
Strong Price Action
Lastly, Zweig liked stocks displaying strong price action. While he admitted to having no hard-and-fast rule for this (likening it to an art more than a science), he generally only picked stocks with strong price momentum relative to the market.
“My theory is that if a stock is really so good, it should be acting at least as well as the market. If it hasn’t been, that’s a caution sign in itself”.
A standard barometer of momentum is the 6 and 12 month price change of a security. Therefore, if a stock has outperformed the stock market over these time frames, it would likely meet Zweig’s requirements.
” In a very strong market, the very best kind of action is a clear uptrend on a chart where you see a series of higher highs and higher lows – sort of a stepladder on the way up.”
“Shotgun” vs. “Rifle” Approach
If a stock met all these preconditions, he would buy it regardless of its line of business.
“If a company can show nice consistent earnings for four or five years, I don’t care whether it makes broomsticks or computer parts”.
Zweig described this as a “shotgun” approach to stock-picking, as opposed to a “rifle” approach.
Martin Zweig Stock Screener Criteria
The table below summarises Zweig’s screening criteria for stocks. Read this article for more detail about how to use a stock screener.
Martin Zweig Stock Example: Regeneron
Below, I apply Zweig’s screening criteria to a real-world company: Regeneron.
The tables below show Regeneron’s earnings and sales growth for the last few years (top table) and quarters (bottom table).
The first thing to check is whether earnings and sales growth has been reasonable over the last few years. Our screening criteria defined this as the 5-year earnings CAGR being above 15%. Read this article for a more detailed explanation of the CAGR and other growth stock screener metrics.
As you can see, the 5-year earnings CAGR for Regeneron is 55.58%, which comfortably passes the test. We also require this earnings growth to be accompanied by just as strong sales growth. We defined this as being at least half of the earnings growth rate. 27.02% is slightly below, but it’s good enough.
Next, we need to make sure that growth has been stable over the last few years and quarters. Looking at the top table, we see that sales and earnings growth have been phenomenally consistent. Sales growth has rarely dipped below 20% in the last 7 years, with only one negative year in 2018. We can probably let that one go. Similarly, earnings growth hasn’t been negative in any of the last 7 years, with only one drab year in 2019. Again, this is showing persistent growth.
Now we do the same thing for the quarterly figures in the bottom table. There are no negative growth quarters in any of the last 8 for either sales or earnings. And what’s more, growth is remarkably strong in all of them. It is rare to find this, so don’t hold other stocks to the same high standards. If 80% of the quarters have positive growth over a reasonable lookback period (5+ quarters), this should suffice.
Moving onto growth momentum, we want to see a growth rate in the current quarter greater than the previous quarter, with current quarter growth also above the 5-year CAGR. Sales growth for Q4 was 104.4%, which is greater than previous quarter growth of 50.5% and the 5-year sales CAGR of 27.02%. Likewise, Q4 earnings growth was 137.3%, which is greater than Q3 growth of 90.6% and the 5-year earnings CAGR of 55.58%.
Now the question is whether we are paying a fair price for this growth. Zweig did this by comparing a company’s P/E ratio with that of the market’s. As of writing, it is about 22 for the S&P 500. Our screening criteria rules out any companies with a P/E ratio greater than two times the market average. Taking the current price of Regeneron as $700 and dividing that by its trailing 12-month earnings of $70.18, gives us a P/E of about 10. Therefore, this comfortably passes the value test.
One might wonder whether this is actually too low given how solid its growth profile is. Remember, Zweig was suspicious of high growth stocks that looked excessively cheap. We can do a second check by comparing to the industry average P/E, which is about 16 for the Biotech sector. Again, it is lower than the average, but not so low as to warrant caution.
Just to convince ourselves we’re not missing anything, we need to check the financial health of the business. Zweig did this by comparing a company’s total debt-to-equity ratio with its sector average. Regeneron has a debt-to-equity ratio of 14.4% which is much lower than the sector average of 33%. Another green light.
As an aside, Regeneron also excels on numerous other metrics of valuation, profitability and balance sheet strength. For example, its free cash flow yield is 9.5% vs. the sector average of 3.6%. Its return on equity and pretax margin are in the 50’s vs. around 12% for the sector. And its quick ratio is 3 compared to 2.8 for its peers.
Where Regeneron starts to slip is on insider trading. Zweig wanted to see more insider buyers than sellers over a reasonable lookback period. Looking at the table below from GuruFocus shows that this hasn’t been the case. Finviz and Ziggma are also useful services to obtain insider transaction data.
Lastly, we come to price action. The chart of Regeneron below shows a breakout from previous highs, with higher highs and higher lows along the way – the stepladder Zweig referred to. The red line in the top panel is Regeneron’s relative price vs. the S&P 500. When this line is advancing Regeneron is outperforming the market index. Since this is the case for the last 6 and 12 months, Regeneron passes the momentum test.
The chart below comes from MetaStock, one of the best technical analysis platforms in the industry. Read my MetaStock Review for more information about the charting, screening, backtesting, and forecasting capabilities of this technical analysis powerhouse.
