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January 11, 1999

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Subject: Re: How to classify the workshop
Author: sparfarkle

"What underlying principles drive the different screens discussed on this board - RS-IDB, Keystone, Spark 5, PEG5 and KEV? I see some impressive backtesting going on and an initial post describing the screening technique but not a lot of discussion as to the underlying reasons why the screen are sorting the (Valueline) stock universe as effectively as they are. Why exactly do these screens work? As far as I can tell, most of the people here have full-time jobs and this message board (and their investments) is their hobby. However, some of these screens are generating returns that would attract the attention of the best professional money managers in the world if they knew about this niche and not only that, but it seems that in the last six months, major breakthroughs have been made in the screen creating process. Is the scope of the work being done here the first time anything like this has happened in the field of creating stock screens?"

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Let me tell you a little story. I started backtesting stock screens based on fundamental and quantitative criteria. long, long before this message board was around--in the early '90's. I started doing this long before Sheard wrote his book, and long before The Motley Fool existed, and before the first of O'Shaugnessy's books had appeared (Invest Like The Best)-----which came with a trial Value Line disk, for screening along the lines of the models recommended in the book, around 1992 or 3.

In the early '90's I worked as a journalist for some of the nation's largest computer magazines. My "beat" (every journalist has one) was financial software. I met regularly with Scott Cook, the CEO of Intuit. I met once with Bill Gates, to talk about Microsoft's Money product--which MS had very high hopes for at the time (they later tried to acquire Intuit). I met regularly with the Cruz brothers, who ended up developing the TradeStation product, and SuperCharts over at Omega Research (www.omegaresearch.com). I knew a lot about financial software, and software for stock screening. I evaluated it professionally.

"There was nobody to talk to about what I was seeing, testing, and experiencing with my own dollars. I felt sure it was important. This is a frustrating emotional dichotomy..."

Around 1994 or 5, some screens I had developed had started to gel in my mind, including an early version of Spark5 (based solely on higher market caps as applied to OS's Momentum Growth screen...at the time). I had read O'Shaughnessy's writings on "screen indexing" as he refers to it, and had seen in my own investing, that unemotionally letting good ideas run tended to beat my own ideas. All of this was before Sheard's book, or before TMF took off. There was nobody to talk to about what I was seeing, testing, and experiencing with my own dollars. I felt sure it was important. This is a frustrating emotional dichotomy: You know something to be true, but you have nobody to tell it to. I was VERY frustrated.

Here's what I did--and I SWEAR this is absolutely true. I wrote a three-page letter to one of the best-known mutual fund managers in the country. If the Wall Street Journal did a list of the highest-performing, and most-respected money managers in America, this person would be on the list. In the letter, I described several quantitative models I had built with the VL software--with returns ranging from 28% a year to 40% a year. I described why I believed in them, my professional experience with financial software, and I sent the annual returns for the models, laid out in great detail.

Two days later, I walked into my office at work, and there was a message on the machine from this person. He invited me to his office in San Francisco (the Bank of America Building, overlooking the Bay--swanky!), to come with a portable computer and run the screens, year-by-year in front of him. I did so, hands shaking.

"I left feeling he had been extremely impressed at watching a computer beat his own performance soundly, in front of his eyes, but I also left with the sense that this was a tie-wearing person who had NOTHING to do with what we are doing with these screens. He was not a free person, and did not seem so."

We talked for hours--hours and hours--about the idea of pure quantitative investing as opposed to making ongoing decisions. We discussed what he liked to read, and what I did. He threw out a lot of good ideas, and was occasionally flabbergasted by what he saw the screens doing--especially in up years. He had many "boutique" ideas concerning moving averages and how one ought to look at them in conjunction with momentum stocks. He was completely positive, and quite interested, in the idea of unemotional, mechanical models (and I think that's why he invited me in the first place). He had copies of Financial World magazine in his office, and I commented that their stock screens were kind of primitive. He said he often bought stocks for his fund based on them.

I left feeling he had been extremely impressed at watching a computer beat his own performance soundly, in front of his eyes, but I also left with the sense that this was a tie-wearing person who had NOTHING to do with what we are doing with these screens. He was not a free person, and did not seem so. He showed me his list of hundreds of stocks in his fund's portfolio, and we discussed the market caps, but I could tell that his own investment leanings had little to do with his fund's. What he had to say about investing, and tips for what I was working on, had little resemblance to his fund's workings.

He and I maintain a correspondence to this day, and the amount of money I have in mutual funds is zero.

Sparfarkle


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