Believe it or not, the laws of probability always have and
always will rule everything we do. From interpreting the meaning of
that Neanderthal girl's smile she flashes while collecting berries,
to the French soldier who loads his musket on that Belgium plain in
1815, to the pedestrian attempting to cross 4 lanes of traffic on a
busy 21st Century street, the likelihood of an event has governed
our thinking and actions from the beginning of time. That rings
true for the stock market as well because probabilities are heavily
involved in any investment process. And, I imagine, that's why
you're reading this article.
With respect to stock investing, the main prospect we concern
ourselves with is picking the winners over losers. So if, for
example, you throw darts or use your pet monkey to pick stocks,
you're basically using a random process, and may expect the number
of winners and losers to be approximately equal over time. Indeed,
that would be true if there were equal numbers of winners and
losers. However, in reality the average stock tends to go up over
time, so a purely random process would still pick winners about
52.8% of the time on a monthly basis.
That means, just by default, your simian companion is really going
to be right almost 53% of the time for any given month. But, if you
have a stock-selecting process that actually adds value, then, over
time, you hopefully have a winning percentage above 52.8%. The
higher, the better, obviously. And let's get this straight right
now; while everything in life is theoretically possible, the odds
that yours or anyone else's win ratio will be 100% or anywhere near
that are infinitely small. That's perfection and we all know
nobody's perfect.
What's a "good" win ratio?
So, you might ask "what's a reasonable win percentage that we
should strive for?" Let's take a look at a couple of examples. I
looked at the monthly win ratios for the Strong Buys of both the
Zacks Rank and the average broker rating from 2002-2011. The
average broker rating was picked because it's a representation of
the "value" provided by Wall Street analysts.
The Zacks Rank Strong Buys showed a monthly win ratio of 55.1%
while the broker rating Strong Buys were winners 52.1% of the time.
So while brokers' Strong Buys, on average, picked winning stocks,
your dart throwing would have found winners more often. (I guess
that's why they used to have that contest of analysts versus the
dart board, which apparently painted a too painful reality to
continue.) The Zacks Rank is a proven stock picker, so anything
with a win ratio at or above 54-55% on a monthly basis is pretty
darn good. Remember,
stock investing has a thin line
, so monthly win ratios above 55% are very rare.
What else matters?
The win ratio is only one side of the investment return equation,
however. The magnitudes of the wins and losses are also very
important. For example, if you have a strategy that picks winners
two-thirds of the time, yet the losers lose more than twice as much
as the winners do, you'll have a losing strategy. So the average
gain to a strategy is just as important as how often it selects
winners.
Let's look back at the Zacks Rank and average broker Strong Buys.
The average winner and loser for the stocks with Strong Buy broker
ratings was 10.9% and -9.6%, respectively, per month. That means if
you pick a broker Strong Buy that subsequently turns out to be a
winner, you could expect an average monthly return of 10.9%.
However, if that broker Strong Buy turns out to be a dud, you could
lose -9.6%. The Zacks Rank #1s showed a 9.3% monthly return for
winners and -7.9% for the losers. So while you might gain a little
more with a broker Strong Buy winner (10.9% v 9.3%), the odds are
lower (52.1% v 55.1%) that you would actually pick one, and,
therefore, you are more likely to pick a worse loser (-9.6% v
-7.9%).
Let's see what happened when we put both the win ratio and return
magnitude together and look at average monthly returns to the
broker Strong Buys and the Zacks Rank #1s. The average overall
monthly return was 0.94% for the broker Strong Buys and 1.44% for
the Zacks Rank #1s. This annualizes to 11.9% for the brokers and
18.8% for the Zacks Rank. You can see that the winning percentage
and magnitude of the Zacks Rank clearly outperforms the average
broker rating and you don't have to win much more often than
average to have very profitable returns.
Another win ratio
The
Zacks Research Wizard
provides another way to calculate a win ratio, defined as the
percentage of winning periods over the total number of periods. For
example, from 2002-2011, the S&P 500 had a positive monthly
return 61% of the time, while the strategy that uses the Zacks Rank
I outline below won money in 64% of those months. Here's more
detail on the performance comparison:
Read on for a screen that uses the Zacks Ranks to find winning
stocks:
- First, select only those stocks with a
Zacks Rank equal to 1.
(We want only the Zacks Rank Strong Buys.)
- Over the last four weeks, the company should have
a positive increase in the current year's earnings
estimate.
(Increasing annual earnings are good.)
- Finally, the
four week change in the current quarter's earnings
estimate should be positive.
(Increasing quarterly earnings are a good thing as well.)
Here are five of the stocks that passed our screen this week
(6/22/12):
ISLE
- Isle of Capri Casinos, Inc.
Isle of Capri Casinos, together with its subsidiaries, develops,
owns and operates gaming facilities and lodging and entertainment
facilities in the United States. This company rates as a Strong Buy
on the Zacks Rank and has experienced an over 50% improvement in
estimates over the last 4 weeks for both its current quarter and
annual earnings. On June 7, the company beat expectations on
revenues and earnings by 27%, which attributes to the top Zacks
Rank.
RJET
- Republic Airways Holdings Inc.
Republic Airways provides scheduled passenger services on
approximately 1500 flights daily to 133 cities in 42 states and
North America. With a Zacks Rank #1, this company has seen
quarterly and annual earnings estimates increase by over 21% and
10% respectively. Republic is also looking to offload Frontier
Airlines, which makes good sense because of Frontier's losing ways
and diminishing prospects.
TM
- Toyota Motor Corporation
Toyota engages in the design, manufacture, assembly, and sale of
passenger cars, minivans, and commercial vehicles. The company has
had its ups and downs over the last couple of years, but is on the
rebound now with a top Zacks Rank, a 36% increase in quarterly
earnings estimates, and nearly a 7% increase in annual earnings
estimates.
PDC
- Pioneer Drilling Co.
Pioneer Drilling, through its subsidiaries, provides contract land
drilling services and major oil and gas operators in the United
States and Colombia. This company is the master of surprises
because, over the last five reported quarters, they've averaged a
59% EPS surprise. No wonder the stock is a Zacks Rank #1 and
analysts have finally gotten the point and are increasing their
earnings estimates for this company.
USCR
- US Concrete Inc.
US Concrete, a Houston-based company, engages in the production and
sale of ready-mixed concrete, pre-cast concrete products, and
concrete-related products for use in commercial, residential, and
public works construction projects in the United States. Within the
last four weeks, this company's annual earnings estimates have
increased by 19% and the current quarter's has improved by 12%. The
stock is also rated a Strong Buy by the Zacks Rank.
Improve your prospects
Probabilities are evident in love, war and very much all aspects of
life be they exhilarating or mundane. Lucky for us, the stock
market is a very thrilling place where win ratios can be improved
to increase your investment returns.
I encourage you to use the
Zacks Research Wizard
to test your current strategy and see if you could improve its
winning percentage. The Research Wizard contains hundreds of
different data items available for you to test or use one of our
pre-built strategies.
Starting today, you are invited to use it free of charge. You'll
have 14 days to create, tweak, and backtest your strategies. At the
same time, you can see the latest picks from pre-loaded winning
strategies with average gains of up to +67.4% per year.
Learn more about your
Research Wizard
free trial >>
Let's make some money!
Kip
Kip Robbins is a Quantitative Analyst with Zacks.com. He
analyzes screens and strategies for Zacks customers and for use in
Zacks Research Wizard
which empowers individual investors to use market-beating screens,
build their own, and backtest their results.
ISLE OF CAPRI (ISLE): Free Stock Analysis
Report
ISLE OF CAPRI (ISLE): Free Stock Analysis
Report
PIONEER DRILLNG (PDC): Free Stock Analysis
Report
PIONEER DRILLNG (PDC): Free Stock Analysis
Report
REPUBLIC AIRWAY (RJET): Free Stock Analysis
Report
REPUBLIC AIRWAY (RJET): Free Stock Analysis
Report
TOYOTA MOTOR CP (TM): Free Stock Analysis
Report
TOYOTA MOTOR CP (TM): Free Stock Analysis
Report
US CONCRETE INC (USCR): Free Stock Analysis
Report
US CONCRETE INC (USCR): Free Stock Analysis
Report
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