I believe the best way to beat the market is to learn from Professionals (Market Gurus) who have done so time after time. That is why one can consider following a stock picking criteria based on one of the recognized strategies of well known stock market professionals.

This time I will elaborate on one of the most recognized modern investing Gurus on Wall Street – Martin Zweig and his time proven stock picking strategy.

Introduction

Martin Zweig was born in 1942 in Cleveland, Ohio. He took his first degree at the University of Pennsylvania's Wharton School of Finance, then an M.B.A. at the University of Miami, studying by night and working as a stock-broker by day. He completed his formal education in 1969, with a Ph.D. in finance at Michigan State University. Shortly after completing his Ph.D., Zweig invented the puts/call ratio, a well-known market indicator.

Zweig’s most famous quotes:

"I measure what's going on, and I adapt to it. I try to get my ego out of the way. The market is smarter than I am so I bend."

"To me, the "tape" is the final arbiter of any investment decision. I have a cardinal rule: Never fight the tape!"

"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."

Between 1970 and 1972, Martin Zweig wrote several articles for Barron's magazine. In each, he made a successful prediction for the coming direction of the market.

The resulting public demand led him to begin small-scale publishing of The Zweig Forecast, a market letter. After he advertised The Zweig Forecast in Barron's, it took off.

The Zweig Forecast was the top market advisory for the 15 year period between 1980 and 1995. Zweig Forecast delivered a 16 percent per annum compounding return, the highest risk-adjusted return of any market advisory service during that time.

According to the AAII (American Association of Independent Investors), out of more than 50 stock-screens it operates, the Martin Zweig Stock Screen has been its top performer in the last eight years - up more than 1,700 percent between 1998 and 2006.

In short Martin Zweig's basic stock market strategy is to be fully invested in the market when market conditions are positive and to sell stocks when conditions become negative. Risk minimization and loss limitation are a crucial part of Zweig's investment style. His book, "Winning On Wall Street" describes how Zweig determines whether to be in the market or not.

Zweig’s Stock Picking Strategy

When picking stocks, Zweig goes strictly by the numbers. As he writes in his book, "If a company can show nice consistent earnings, I don't care if it makes broomsticks or computer parts." Zweig is focusing on three main criteria to fish out potential winners:

1. Strong historical sales and earnings growth.

2. Reasonably priced.

3. Strong price movement relative to the market.

Zweig is avoiding stocks that have recently disappointed the market, and he dislikes companies with high debt. While he does not want to overpay, Zweig is willing to pay more for strong stocks. According to Zweig, "buying on strength gives you an edge. You must pay a premium, but you increase the probability of being right."

Long-term growth

Zweig prefers consistent sales and earnings growth, going back four or five years. He considers 15% annual earnings growth acceptable, but prefers more. For this screening criteria set average annual sales equal or greater than 15% and set earnings-per-share growth, measured over the past five years also equal or greater than 15%

Recent growth

Martin Zweig avoids stocks with decreasing growth rates. He prefers to see the most recent quarter's year-over-year EPS (Earnings Per Share) growth rate in the same range as the long-term rate and even higher. However, Zweig is not dogmatic and is willing to reduce this requirement a little bit, depending on market conditions. In the stock screen set the most recent quarter's year-over-year EPS growth to be at least 75% of the long-term growth rate and set the most-recent quarter's year-over-year revenue growth be equal or greater than 85% of the long-term revenue growth rate.

Revenue Pace

In theory, earnings growth should track revenue growth. Revenues growing faster than earnings reflect declining profit margins, which is a signal that market conditions are becoming more competitive, but earnings growing faster than revenues say that the growth is coming from cost cutting rather than growing sales. If this is the case, the company will run out of steam to cut costs, and earnings growth will slow down. Zweig likes to see stocks with revenue and EPS long-term growth rates in the same range. To mimic those criteria, set screen so that long-term revenue must be equal or greater than 75% of earnings, and vice-versa.

Fair Price

Zweig does not want to overpay for a stock. Zweig uses price-to-earnings ratios to measure valuation. Zweig’s definition of overvalued depends on the market conditions. In his book, Zweig accepts fast-growing companies with price-to-earnings ratios with 50% higher than the market. In the stock screen set current P/E ratio to be equal or less than 50% S&P 500 Average current P/E Ratio

Don't Buy Cheap

As much as Zweig doesn't want to overpay, he also is avoiding stocks that are too cheap. Very low price-to-earnings ratios signal that investors are leaving and perhaps for a good reason. Zweig advised to disregard stocks with P/Es below 5. For the stock screen set minimum current P/E ratio to be equal or greater than 5% or to be equal or greater than 40% of S&P 500 average current P/E ratio.

Winners

Relative strength measures a stock's performance compared with the overall market over a specified time frame. Zweig prefers stocks that are outperforming the market or performing at least as well as the market. Zweig does not mention a specific time frame, but from his book, one would have guessed that six months could be the right measure. A 55 relative strength indicates a stock performing even with the market or slightly above. Set the stock screen’s 6-month Relative Strength to be equal or greater than 55.

Debt

The debt-equity ratio, which is long-term debt divided by shareholders' equity, is the most-commonly used debt measure. Zero values signal no long-term debt, and the higher the ratio, the higher the debt. Zweig dislikes high-debt firms.

Since acceptable debt levels vary by industry, and in order not rule out companies with acceptable debt-equity the stock screening parameter shall be set for Debt to Equity ratio to be equal or less than Industry Average Debt to Equity ratio.

Market Surprises

Zweig rejects stocks that had recently disappointed the market by reporting earnings below forecasts. So, rule out stocks with recent negative earnings surprises.

Conclusion

When following any stock screening strategy, it is important to remember that the process is only a first step. Martin Zweig's principles help to reveal a collection of companies exhibiting strong earnings and sales growth, reasonable price-earnings ratios relative to the overall stock universe, and strong relative price strength that can prove to be an interesting starting point. Zweig advises selling a stock if it drops roughly 15% below the purchase price. Otherwise, plan on holding these stocks for one year and then selling.

Stock Screening resources by herewith mentioned stock picking criteria can be found on my web site under Research section.