Beating the Market With

Charles Kirkpatrick
By Wayne A. Thorp, CFA

he market downturn over the

last year or so has been a nightmare for many investors. On one
end of the spectrum are the buy and
hold investors who saw their portfolios battered by the broad-based decline in equities. On the opposite end
are those who abandoned the equity
market completely after taking large
losses and who are still sitting on
the sidelines. For those needing their
money in the next five to seven years,
such a move makes perfect sense.
However, those with a longer time
horizon are probably kicking themselves now that the Wilshire 5000 is
up over 40% since its lows
of early March. Others are
paralyzed by the prospects
of a double-dip market
decline.
Charles Kirkpatricks book,
Beat the Market: Invest
by Knowing What Stocks
to Buy and What Stocks
to Sell (FT Press, 2008),
seems to have been written
exactly with this scenario in
mind. Kirkpatrick believes
that the stock market is still
the best investment vehicle
available, but also thinks it
is impossible to predict the
market, or the economy.
He outlines stockpicking and portfolio management strategies that he
believes individual investors can follow to outperform the market while
reducing the risk of capital loss.
Kirkpatrick is president of Kirkpatrick & Co., Inc., which specializes in
technical research, and he publishes
the Kirkpatrick Market Strategist
stock advisory newsletter. Kirkpatrick
has been a director of the Market
Technicians Association (MTA) and
holds the Certified Market Technician (CMT) designation. He is also
an instructor at the Fort Lewis
College School of Business Administration and a two-time recipient
of the Charles H. Dow Award from
the MTA for excellence in technical

research.

Better Off Going It Alone?

Kirkpatrick begins the book by

laying out his case as to why he feels
investors are better off investing on
their own in individual stocks. As
the investment industry has become
more specialized, investors have been
forced to take on a more active role
in the investment process. He notes
that the shift to defined-contribution retirement plans requires us to
decide the makeup of our investment
portfoliosstocks versus bonds,
foreign versus domestic, small-cap

fund.]
Extending these results over 50
years, the study found that $10,000
invested in the average mutual fund
would have grown to a respectable
$470,000, while $10,000 invested in
a market index would have grown to
$1.17 million. John Bogle, founder
of the Vanguard Funds, concludes
from the study: Our hypothetical
fund investor has earned $1,170,000,
donated $700,000 to the mutual
fund industry, and kept the remaining
$470,000.
Kirkpatrick, who sells his own
stock advisory letter, goes on to say
that the fee structure of mutual funds negates the incentive for mutual fund managers
to act in your best interest. He
points out that the fees you
pay to own a mutual fund
sales loads, redemption fees,
management fees, distribution
(12(b)-1) fees, etc.are not
dependent on the performance
of the mutual fund; you pay
these fees whether the fund
rises or falls. Even if a fund is
performing poorly, he notes,
it can still generate profits as
long as new assets are added
to the fund pool.
As a result, Kirkpatrick believes that, with only an hour or so of
work every week or month selecting
individual stocks, investors can free
themselves from underperformance
while protecting themselves from
substantial investment losses. He suggests that an alternative to investing
in individual stocks would be to buy
low-fee, no-load index funds.

The stock market is the sum

of all information known and
anticipated, interpretation
of that information, and
emotional reactions to that
information, right or wrong.
versus large-cap, etc. Unfortunately,
as Kirkpatrick points out, most individuals are not investment professionals, making the task even more
difficult.
For most investors, mutual funds
are the investment vehicle of choice,
either in retirement plans or in their
own personal investment portfolios.
However, Kirkpatrick paints a lessthan-flattering picture of investment
managers, specifically mutual fund
managers. He cites a Motley Fool
study which found that, between
1963 and 1998, the average mutual
fund underperformed the market by
2% a year. [Interestingly enough,
however, this has not stopped Motley
Fool from starting its own mutual

September On-line Exclusive 2009

Market Behavior and Investor

Emotions

After investing for over 40 years,

Kirkpatrick has come to believe that
markets trade on facts, the anticipation of new facts, and emotion. As
he puts it, the stock market is the
sum of all information known and
anticipated, interpretation of that
1

information, and emotional reactions to that information, right or

wrong. However, he points out that
individual investors are competing
against institutional investors, who
are more knowledgeable and better
equipped to capture and analyze that
information. As a result, Kirkpatrick
doesnt believe it is possible to beat
the professionals at their own game.
Instead, he advocates developing a
mechanical process that depends on
indisputable facts to minimize the
effects of emotions.
Kirkpatrick believes that investors
face several biases that have an
adverse impact on their financial success: These include impatience, the
fear of being wrong, the need
for perfection, and a lack of
discipline. In order to overcome his own biases, Kirkpatrick has spent a great deal of
time testing specific investing
methods. Based on these
tests, he chose those methods that showed a history of
performing well. He cautions
against relying on rumors,
financial advisors, or investment gurus when making
investing decisionsexcept
himself, of course.

prospects for making money than

how widely its price fluctuates.
For Kirkpatrick, drawdown is a
more realistic measure of risk. It
is the peak-to-trough decline of an
investment and measures how much
capital loss an investment suffers.
For example, if an equity strategy
reaches a peak value of $125,000 before reversing course and eventually
reaching a low of $95,000 before it
starts winning again, drawdown from
the peak value to the trough value
is 24%. Drawdown doesnt consider
the time it takes to go from peak
to trough; it doesnt matter if this
24% drawdown took place over five
weeks, five months, or five years.

of stocks to bonds or cash, which

prevents managers from selling off
their equity positions during market
declines. In Kirkpatricks opinion, the
easiest and cleanest way to avoid
significant losses is to go to cash.
Table 1 includes a section outlining
how Kirkpatrick adjusts his portfolio
to account for market risk.

Prediction Versus Reaction

Kirkpatrick reiterates his opinion

several times in Beat the Market
that it is not possible to predict
markets. He bases his argument on
the fact that professionals with more
timely and accurate information fail
at the endeavor, so it us unrealistic
for individual investors to
think they can succeed where
the professionals fail. Instead,
he feels that a more successful alternative to predicting
the markets is a strategy of
reaction.
Reaction, for Kirkpatrick,
means waiting for the market
to indicate what it is going to
do and then (re)act accordingly. Kirkpatrick reacts when
his dataeither fundamental
or technicalshow a pattern
that has proven successful in
the past. When he sees such a pattern, his reaction follows three steps,
which he terms STRACT:
Setup
TRigger
ACTion
To illustrate the STRACT method,
Kirkpatrick offers the following
example: Say a study shows that
when stocks advance to new 52-week
highs, their chances of advancing
an additional 10% are 70%. Any
stock you are following that nears its
52-week high enters the setup stage.
However, at this point, no action is
taken as you wait for the triggerin
his example, the stock hitting a new
52-week high. Once the trigger is
initiated, your action would be to buy
the stock.

W hen all stocks are

declining, Kirkpatrick
advocates some bailout
point below which investors
sell all stocks.

Risk

In Beat the Market, Kirkpatrick

takes exception to the concept of risk
as it is used by investment professionals and academics. In his opinion,
popular risk measures are completely wrong, as they only take into account the possibility that a stock may
fluctuate widely and do not consider
capital loss. The result, he notes, is
that a stock trading in a straight line
carries with it less risk than one that
is oscillating. Furthermore, he says
a stock that is rising in price can be
labeled just as risky as one whose
stock price is declining. However,
he asks the question: Which would
you prefer, a rising or declining
stock price? Taking a more practical
viewpoint, Kirkpatrick defines risk as
the possibility of capital loss. He is
more concerned with an investments
2

Maximum drawdown simply is the

largest drawdown experienced over
whatever period is being examined.
While maximum drawdown cant tell
you the maximum loss a strategy will
experience in the future, it does allow
you to compare the inherent riskiness
of different strategies.
Finally, Kirkpatrick points out that
capital loss due to a broad market
decline, such as was experienced
over the last year, is rarely considered
by professionals. When all stocks
are declining, Kirkpatrick advocates
some bailout point below which
investors sell all stocks. While he
acknowledges the risk of stocks
turning around quickly, he feels the
small amount you lose offsets the
potential of further market declines
hurting your capital position. Kirkpatrick notes that most mutual funds
try to adhere to some constant ratio

Meeting the Relatives

Kirkpatrick states that the first

Computerized Investing

Table 1. Charles Kirkpatrick Relative Stock Selection Process in Brief

Philosophy and Style
Charles Kirkpatrick believes a mechanical approach to investing will help investors avoid their own biases that ultimately
cost them money. He further believes that it is impossible to
predict market movements. Instead, he follows the STRACT
(setup, trigger, and action) technique that helps him react
to individual stock movements. His buy and sell triggers are
based on relative data elementsprice-to-sales, reported
earnings growth, and price strength. His analysis has led him
to three investment modelsGrowth, Value, and Bargain.
By following his buy and sell triggers, Kirkpatrick feels that
individual investors can outperform the market by investing
in individual stocks with a minimal time commitment.

Universe of Stocks
The only restrictions he imposes are share price and market
capitalization minimums. For all three models, Kirkpatrick
requires a minimum share price of $10. For the Value Model,
he requires a minimum market cap of $500 million, and he
uses a $1 billion minimum market cap for the Growth and
Bargain Models.

Criteria for Initial Consideration

Growth Model

Relative price strength (as defined by current weekly

closing price divided by the 26-week moving average
of weekly closing prices) ranks in the 90th percentile or
higher

Relative reported earnings growth (as defined by the last

four quarters of reported operating earnings divided by
the four-quarter total of reported operating earnings one
quarter prior) ranks in the 90th percentile or higher

Value Model

Relative price strength ranks in the 90th percentile or

higher

Relative reported earnings growth ranks in the 90th

percentile or higher

Relative price-to-sales ratio ranks in the 30th percentile

or lower

Bargain Model

Relative price strength ranks in the 97th percentile or

higher (may consider lowering to no more than 90th
percentile to increase number of passing companies)

Relative price-to-sales ratio ranks in the 17th to 42nd

percentiles

Secondary Criteria
For the Growth Model, Kirkpatrick uses point & figure charts

September On-line Exclusive 2009

to help in the buy and sell decision process. He only buys

stocks for the Growth Model when they are in an upward
trend, as indicated by two higher highs in a three-point reversal point & figure chart.

Adjusting for Market Capital Risk

Kirkpatrick does not believe in buy and hold investing.
Beyond following the sell triggers for individual stocks, he suggests two methods to reduce market capital risk in a portfolio.
This first is to select the maximum number of stocks you wish
to hold (he mentions 20 as a reasonable number) and then
divide this into the amount of money you wish to invest (lets
say $50,000). This means you will invest $2,500 in each of 20
stocks. However, if you can only find 10 stocks in which to
invest, you will only put $25,000 into the market and hold the
rest in cash.
The other method involves monitoring the moving average of
your model or hypothetical portfolio (not your actual portfolio). If the current model portfolio declines below its 12-week
moving average, Kirkpatrick sells 25% of the portfolio; if the
model portfolio value falls below the 26-week moving average,
he sells down so that he is only 50% in stocks; if the model
portfolio value declines below the 52-week moving average,
he sells everything. The process is then reversed for buying
back into the market should a downturn force you to move
completely to cash.

When to Sell
Growth Model

Relative price strength ranks in the 30th percentile or

lower

Relative reported earnings growth ranks in the 70th percentile or lower

Chart break of two previous important lows

Value Model

Relative price strength ranks in the 30th percentile or

lower

Relative reported earnings growth ranks in the 50th percentile or lower

Stocks are not sold for extraordinarily high relative priceto-sales ratios

Bargain Model

Relative price strength ranks in the 52nd percentile or

lower

Relative price-to-sales ratio ranks in the 7th percentile or

lower or in the 67th percentile or greater

investment problems we face are deciding what to buy and how to do so

without having to predict anything.
He uses three principle methods for
selecting stocks:
Value,
Growth, and
Price strength.
Kirkpatrick begins his analysis by
collecting data from the immediate
past. Value and growth investing
require accurate fundamental data for
each stock in his investing universe.
His price strength analysis requires
a history of prices for each stock; it
measures how a stock price behaves
against its immediate pastif a stock
is high versus its immediate past, it is
said to have price strength.
For his analysis, Kirkpatrick looks
at relative datadata compared to
other data. For example, when he is
looking at value, he looks not only at
the value of an individual company,
but also at its value relative to the
value of all other companies. He then
attempts to maximize his profits by
looking only at those companies with
the best value.

Value

When looking at a stocks value,

Kirkpatrick uses the price-to-sales
ratio, which is the ratio between a
stocks price and the last four quarters of reported sales for the company. He began using the price-to-sales
ratio based on James OShaughnessys
analysis in the book What Works on
Wall Street and because sales data
is less likely to be manipulated by
company management.
Kirkpatricks analysis involved first
calculating the weekly price-to-sales
ratios for every stock over the period
from 1998 to 2006. He then sorted
the companies by price-to-sales ratio
and then ranked them into percentiles, where the companies with the
highest price-to-sales ratios were in
the highest percentiles. Once the
companies were placed in percentiles
based on their valuation, he calculated the relative price performance
for each percentile for the proceeding
three, six, and 12 months.
4

What he discovered was that there

was an inverse relationship between
the relative price-to-sales ratio percentile and the relative performance
three and six months forward. In
other words, as the price-to-sales
percentile increased, the future performance decreased. For periods of
12 months, the relationship between
relative valuation and price performance dissipated. Kirkpatrick took
his findings to suggest that investors
should not focus on periods longer
than a year.

Advancing Versus Declining Markets

Kirkpatrick also wanted to see how
his various relative values performed
in both advancing and declining
markets. As we have learned over the
last year, the direction of the overall
market can play an important role in
the performance of individual stocks.
He used a very simple methodology to define advancing and declining markets. He begins by adding
together the closing values of the
S&P 500 index for each of the last 12
months and creating an average by
dividing the total by 12. At the end
of the next month, the oldest monthly
value is dropped from the total and
the latest monthly close is added and
again the average value is calculated.
When the S&P 500 monthly close is
above its 12-month moving average
closing price, Kirkpatrick considers
the market as advancing; when the
monthly close is below the 12-month
average closing price, the market is
declining.
Returning to his price-to-sales
relative analysis, the relationship
between the valuation and the future
price performance was only about
one-third as strong during advancing markets as it was over all market
conditions. However, the inverse
relationship between valuation and
price performance strengthened by
about 25% during declining markets.
This indicated to Kirkpatrick that
relative valuation is a more important
selection criterion during a declining
market.

Growth

When looking at growth factors,

Kirkpatrick prefers to look at growth
in reported earnings, not predicted
earnings. While he admits that
reported earnings are not error-free,
Kirkpatrick does question the validity
and accuracy of forecasted earnings.
In Beat the Market, Kirkpatrick
describes the way in which he calculates the reported earnings relative
rankings for each stock:
I take the last four quarters of
reported earnings for each company
and calculate a ratio of this total to
the four-quarter total one quarter
earlier.
Kirkpatricks goal is to avoid seasonality, which is why he uses reported earnings over a full four quarters.
Also, by using operating earnings,
he eliminates the impact of special
charges or non-recurring items.
He calculates the reported earnings
growth for all companies with positive earnings over both four-quarter
periods and then ranks them into
percentiles, with the companies having the highest growth being in the
highest percentile.
As with the study of price-to-sales
ratio percentile rankings, Kirkpatrick examined the three-, six-, and
12-month price performance of each
percentile. He found, as expected,
that there is a positive correlation
between earnings growth and subsequent relative price performance.
Interestingly, however, the relationship was not as strong as it was for
relative price-to-sales. This indicates
that reported earnings growth may
not be as useful a selection criterion
when testing over all market periods.
Furthermore, performance turns below-average for stocks with the very
highest reported earnings growth.
While Kirkpatrick was surprised by
these results, they echo the sentiments of investors such as John Neff,
who are more interested in strong,
but sustainable growth. Companies
with high levels of growth cannot
be expected to continue at that level
over time.
According to Kirkpatricks reComputerized Investing

Table 2. Charles Kirkpatrick Screen Criteria for Use With AAIIs Stock Investor Pro
Data Category

Field

Operator Factor Compare To

Growth List Screen Criteria

Custom Fields*
Null Rel Price Strength
Equals
Custom Fields*
Relative Price Strength
>=

Custom Fields*
Null Rel Earnings Growth Equals
Custom Fields*
Relative Earnings Growth
>=

Price and Share Statistics Market Cap Q1
>=
Price and Share Statistics Price
>=

1
Adjust value until approx. 10% of companies that passed
Null Rel Price Strength criterion pass this filter
1
Adjust value until approx. 10% of companies that passed
Null Rel Earnings Growth criterion pass this filter
1000
10

Value List Screen Criteria

% Rank
% Rank-Price/Sales
<=
Custom Fields*
Null Rel Price Strength
Equals
Custom Fields*
Relative Price Strength
>=

Custom Fields*
Null Rel Earnings Growth Equals
Custom Fields*
Relative Earnings Growth
>=

Price and Share Statistics Market Cap Q1
>=
Price and Share Statistics Price
>=

30
1
Adjust value until approx. 10% of companies that passed
Null Rel Price Strength criterion pass this filter
1
Adjust value until approx. 10% of companies that passed
Null Rel Earnings Growth criterion pass this filter
500
10

Bargain List Screen Criteria

% Rank
% Rank-Price/Sales
>=
17
% Rank
% Rank-Price/Sales
<=
42
Custom Fields*
Null Rel Price Strength
Equals
1
Custom Fields*
Relative Price Strength
>=
Adjust value until approx. 3% of companies that passed Null

Rel Strength Price criterion pass this filter (relax for more

total passing companies)
Price and Share Statistics Market Cap Q1
>=
1000
Price and Share Statistics Price
>=
10

*See Table 3 for information on creating Custom Fields.

Table 3. Custom Fields for Use With AAIIs Stock Investor Pro
Custom Field Name

Relative Earnings Growth

Null Rel Earnings Growth*
Relative Price Strength
Null Rel Price Strength*

Formula

GrowthRate(IIF([Gross operating income Q1] + [Gross operating income Q2] + [Gross operating income Q3] +
[Gross operating income Q4] > 0,[Gross operating income Q1] + [Gross operating income Q2] +
[Gross operating income Q3] + [Gross operating income Q4], Null),IIF([Gross operating income Q2] +
[Gross operating income Q3] + [Gross operating income Q4] + [Gross operating income Q5] >
0,[Gross operating income Q2] + [Gross operating income Q3] + [Gross operating income Q4] +
[Gross operating income Q5], Null), 1)
IsFieldNull([Relative Earnings Growth])
([Price] / (([Price M001] + [Price M002] + [Price M003] + [Price M004] + [Price M005] + [Price M006]) / 6)) * 100
IsFieldNull([Relative Price Strength])

*The IsFieldNull function will convert a data field into either a 0 value if the field is Null or a 1 value if it is a valid number.
Stock Investor Pro subscribers can download a text file of these fields at www.aaii.com/ci/200909/customfields.txt for cutting and pasting into the Custom Field Editor.

search, the further you go out in

time, the weaker the relationship
becomes between reported earnings growth and subsequent price
performance. This further raises the

question in Kirkpatricks mind of

whether reported earning growth is
an effective selection criterion.
As he expected, advancing markets
help stocks reporting above-average

September On-line Exclusive 2009

reported earnings growth. Again,

there is a drop-off in performance
at the highest levels of growth, but
stocks with ultra-high growth still
experienced above-average price
5

performance during advancing markets. Kirkpatricks research suggests

that reported earnings growth is an
effective stock selection tool during advancing markets. During bear
markets, he found no statistical relationship between reported earnings
growth and price performance.

Price Strength

Kirkpatricks research indicates that

relative price strength is the most reliable short-term stock selection technique. There are a number of ways
to calculate relative price strength.
Some calculations compare the percentage change in stock price over a
defined period to the percentage change in a stock index,
such as the S&P 500, over the
same period. However, these
measures do not necessarily
protect you in a down market,
as a stock can be falling and
still have strong relative
strength if it is not falling as
rapidly as the index.
Kirkpatrick is concerned
about capital loss, so his
relative strength calculation
involves dividing the current
weekly closing price by the
26-week moving average of closing
prices. He adds up the week-ending
closing prices for each of the last 26
weeks and divides this total by 26.
For each subsequent week, the oldest
price is dropped and the latest weekly
close is added to calculate the moving average. He then ranks all the
stocks so that those with the highest
relative strength are in the highest
percentile rank.
Once again, he found that there is
a very strong positive relationship
between relative price strength and
forward price performance. As Kirkpatrick writes in the Beat the Market book, Relative strength seems
to breed more relative strength.
While, over time, this relationship gradually deteriorates, it is still
significantly stronger than relative valuation or reported earnings
growth. Eventually, moving forward
12 months, the relationship between

26-week relative strength and subsequent price performance all but

evaporates.
During an advancing market,
Kirkpatrick found that relative price
strength should be your primary
selection criterion, bettering relative valuation and relative reported
earnings growth. This carried over to
declining markets as well.

Stock Selection Using Relatives

In Beat the Market, Kirkpatrick
outlines three different selection
strategies he has been testing
Growth Model, Value Model, and
Bargain Model. Using AAIIs Stock

calculates relative strength by dividing the current weekly closing price

by the 26-week moving average of
closing prices. To attempt to capture
the essence of Kirkpatricks measure
we created a custom field in Stock
Investor Pro that is the ratio of the
current stock price to the average of
the last six monthly closing prices.
The numerator will fluctuate with the
weekly closing price but the denominator will only change with the end
of each month.
After calculating our own relative
price strength field, we are confronted with screening for those stocks in
the top 10% of the database (90th
percentile or higher). Since
we are screening with a custom field we do not have the
ability to screen on percentile
ranks like we can with many
of the pre-built fields in the
program. However, a little
trial and error enabled us to
isolate the top 10%.
As of August 14, 2009,
8,982 of the companies in the
database had a valid (nonnull) value for the relative
price strength field. Setting
the relative price strength
level at 159% or higher gives us 898
companies; this is the top 10% of the
companies with valid price strength
data.

Kirkpatricks research
indicates that relative price
strength is the most reliable
short-term stock selection
technique.

Investor Pro fundamental stock

screening and research database, we
attempted to replicate these models.
As of August 14, 2009, our database included 9,809 companies.
Table 2 lists the specific criteria that
subscribers to Stock Investor Pro
can use to build the screens. Also,
Table 3 lists the custom fields used
in the screen process. [Stock Investor Pro subscribers can download a
text file of these fields at www.aaii.
com/ci/200909/customfields.txt for
cutting and pasting into the Custom
Field Editor.]

Growth Model

In 1982, Kirkpatrick began testing

a hypothetical portfolio of stocks using relative earnings growth, relative
price strength, and a chart pattern.

Price Strength

In Beat the Market, Kirkpatrick

Reported Earnings Growth

Kirkpatrick uses a non-standard
calculation for earnings growth,
which compares operating earnings
over the last four fiscal quarters to
the four-quarter total in operating
earnings one quarter earlier. His goal
is to eliminate the impact of seasonality on a companys earnings.
Once again we must create a
custom field to capture Kirkpatricks
screening methodology. Our custom
field uses operating income, just as
Kirkpatrick does, to avoid the special
charges or adjustments to earnings.
Furthermore, since Kirkpatrick only
considers companies with positive
earnings, our custom field eliminates
those firms with negative operating
Computerized Investing

Table 4. Companies Passing the Kirkpatrick Screens

Company (Exchange: Ticker)

Rel
Earnings
Grth
(%)

EPS Relative Rel Strgth Price-to- Sales

Grth Price
% Rank
Sales Grth
5-Yr Strgth
26-Wk
% Rank 5-Yr
(%)
(%)
(%)
(%)
(%)

Description

Growth List
STEC, Inc. (M: STEC)
291.7
(2.3) 218.0
99
87
1.4
Home Inns & Hotels Management (M: HMIN) 43.6 111.2
201.9
95
78
na
SXC Health Solutions Corp. (M: SXCI)
48.6
na
174.9
86
43
na
Massey Energy Co. (N: MEE)
114.8
29.2
166.4
83
44
13.7
Ashland Inc. (N: ASH)
29.8
15.0
161.7
97
19
1.3

memory drives
hotel chain in China
healthcare benefit mgmt
coal producer
specialty chemicals

Value List
Clearwater Paper Corp. (N: CLW)
Ashland Inc. (N: ASH)

206.2
29.8

na
15.0

226.6
161.7

97
97

25
19

na
1.3

pulp-based prods
specialty chemicals

Bargain List
Solutia Inc. (N: SOA)
Oshkosh Corp. (N: OSK)
Protective Life Corp. (N: PL)
Ternium S.A. (ADR) (N: TX)
Jones Apparel Group, Inc. (N: JNY)
Goodyear Tire & Rubber Co. (N: GT)
Lincoln National Corporation (N: LNC)
Hertz Global Holdings, Inc. (N: HTZ)
Hartford Financial Services (N: HIG)
Electrolux AB (ADR) (O: ELUXY)
Armstrong World Industries (N: AWI)
Rockwood Holdings, Inc. (N: ROC)
W.R. Grace & Co. (N: GRA)
CBS Corporation (N: CBS)
International Paper Co. (N: IP)
Ashland Inc. (N: ASH)
Wyndham Worldwide Corp. (N: WYN)
Swiss Re (ADR) (O: SWCEY)
CB Richard Ellis Group, Inc. (N: CBG)

23.0
nmf
nmf
(51.0)
nmf
nmf
nmf
nmf
nmf
10.7
(28.6)
nmf
(55.1)
nmf
nmf
29.8
nmf
nmf
nmf

22.3
(1.3)
(17.0)
4.3
(41.2)
41.3
(43.9)
(49.3)
(93.7)
(8.0)
29.0
(11.6)
32.0
(73.3)
(49.9)
15.0
(43.3)
(19.9)
(84.1)

226.5
209.4
189.1
188.0
180.1
173.9
173.5
173.2
171.5
166.7
166.2
165.5
163.5
163.1
162.7
161.7
161.5
161.3
159.4

92
95
94
91
97
92
78
88
72
na
75
90
90
79
94
97
96
na
94

33
22
31
40
22
17
39
29
28
23
30
29
24
31
21
19
38
34
37

(2.8)
30.0
5.1
51.6
(3.7)
5.2
13.3
7.5
(13.2)
(5.2)
0.8
33.5
10.9
0.6
2.3
1.3
10.1
(7.3)
25.8

chemical materials
specialty vehicles
financial servs holding co
invests in steel companies
brand apparel
manufactures tires
insurance & invest mgmt
car rental
insurance & finl servs
home & prof appliances
flooring products
specialty chemicals
specialty chemicals
mass media co
paper & packaging
specialty chemicals
lodging & vacation rental
reinsurance
commercial real estate

Exchange Key: A = American Stock Exchange, M = NASDAQ, N = New York Stock Exchange, O = over the counter.
Source: AAIIs Stock Investor Pro/Thomson Reuters. Data as of 8/14/2009.

earnings over either four-quarter

period.
As of August 14, 2009, 4,117 companies in the database had non-null
relative earnings growth values. A
growth rate of 25.9% isolated 411 of
those companiesthe top 10%.

Price and Market Cap

Lastly, Kirkpatrick looked for

growth companies with market capitalizations of at least $1 billion and
share prices of at least $10. We are
able to recreate both of these filters

using Stock Investor Pro.

Passing Companies
The first section of Table 4 lists the
five companies passing our Growth
List screen as of August 14, 2009.
These companies are ranked in descending order by their relative price
strength.
Sell Criteria
Once he had purchased a stock
for his Growth Model, Kirkpatrick
followed these rules to determine

September On-line Exclusive 2009

when to remove a stock from the

hypothetical portfolio:
Relative price strength percentile
of 30 or lower,
Relative reported earnings
growth percentile below 70, or
Chart break of two previous
important lows.
He explained the reason for the
chart pattern rule as twofold: First,
it confirmed that the stock was
actually rising in price and, second,
it automatically sold a stock if it
declined by a predetermined amount.
7

The chart pattern rule served as his

stop order. Kirkpatrick determined
the previous important support level
for the stocks in the portfolio. When
a stock in the portfolio broke two of
these important support levels, Kirkpatrick removed it from the portfolio.
He assumed that stocks were
added to the portfolio in equal dollar
amounts, so that the weekly performance of the portfolio was simply
the average of the weekly returns
for all the stocks in the portfolio.
The performance of his hypothetical
portfolios did not include transaction
costs or dividends. Each week he
added any new stocks that matched
his selection criteria and eliminated
those socks that failed.
Between 1982 and the end of 2007,
the Growth Model grew by more
than 100, versus 13 times for the
S&P 500. Over that time, the hypothetical portfolio turned itself over
almost twice a year. Kirkpatrick uses
this Growth Model to generate his
Growth List, which he publishes in
his weekly newsletter.
Kirkpatricks Growth List combines
quantitative filters for relative price
strength and relative reported earnings growth, and then requires point
& figure chart analysis to determine
whether the stock is in an upward
trend.

Value Model

Despite the success of his Growth

Model, Kirkpatrick was concerned
about the fact that its performance
had occurred during one of the
strongest bull markets in history.
He wanted to strengthen the system
against capital loss to protect against
the inevitable market reversal. He
believed relative price strength would
not be effective during a market
downturn and could lead to significant capital losses. For Kirkpatrick,
the alternative was to reduce the risk
of the portfolio by beginning with a
group of stocks with low valuations.
His reasoning was that, since the
low valuations probably were due
to a decline in price, the downside
risk had been reduced. Using relative
8

price-to-sales percentiles, Kirkpatrick

arbitrarily selected only those stocks
in the 30th percentile or lower.
He tested his Value Model from
1998 to 2007, where it outperformed
the Growth Model and the S&P 500
index.
Kirkpatricks Value List mimics
the Growth List, except that it uses
the relative price-to-sales ratio as a
means of reducing risk instead of using a chart pattern stop.
To begin our Value List screen,
we use the same screening criteria
we used for the Growth List screen
regarding relative price strength and
relative earnings growth.

Relative Valuation
For his Value List, Kirkpatrick
chooses stocks with relative priceto-sales ratios that are in the 30th
percentile or lower. In Stock Investor Pro, price-to-sales is one of the
fields that you can screen upon using
percentile rank. Therefore, for our
Value List screen, stocks must have a
price-to-sales percentile rank than is
less than or equal to 30.
Price and Market Cap
For the Value List, Kirkpatrick
relaxed his market cap requirements
to include companies whose market capitalization is $500 million or
higher. He did, however, maintain the
$10 share price minimum. We are
able to recreate both of these filters
using Stock Investor Pro.
Passing Companies
The second section of Table 4
shows the two companies passing our
Value List screen as of August 14,
2009. These companies are ranked
in descending order by their relative
price strength.
Sell Criteria
Once he had purchased a stock for
his Value List, these are the rules
Kirkpatrick followed to determine
when to remove a stock from the
portfolio:
Relative price strength percentile
of 30 or lower,

Relative reported earnings

growth percentile below 50, and
Stocks NOT deleted for extraordinarily high relative price-tosales ratios.

Bargain Model

Between January 2005 and December 2007 Kirkpatrick tested a new

model, called the Bargain Model, using the best triggers found in his testing of relative value, relative reported
earnings growth, and relative price
strength outlined earlier.
In 2007, the Bargain Model gained
77.3%, versus a gain of 25.3% for
the Value Model and a 43.0% gain
for the Growth Model. However,
Kirkpatrick admits that several more
years of testing are needed before
labeling the Bargain Model a successful stock selection methodology.

Price-to-Sales
While the Value List selects stocks
with relative price-to-sales in the
30th percentile or lower, Kirkpatricks testing of relative price-to-sales
ratio percentile rankings indicated
optimal performance in percentiles
greater than 17 but not higher than
the 42nd percentile. Relative valuations outside this range tended to
underperform the market.
Therefore, for our own Bargain
List screen, we required companies
to have a price-to-sales percent rank
that is greater than or equal to 17
and less than or equal to 42.
Reported Earnings
Kirkpatricks analysis of earnings
growth and future price performance
indicated only a weak correlation
between the two. As a result, he
decided to omit relative earnings
growth as a selection criterion for the
Bargain List.
Relative Price Strength
For both the Growth List and Value
List, Kirkpatrick had been selecting
stocks with relative price strength in
the 90th percentile or higher. When
he started the Bargain List, setting
the bar at the 90th percentile for
Computerized Investing

relative price strength resulted in too

many passing companies to manage
in a portfolio. To reduce the number
of passing companies, Kirkpatrick
upped the requirement to only include companies in the 97th percentile or higher.
Again we must manually adjust the
relative strength screening variable to
arrive at the desired number of passing companies. However, this time
we are looking to isolate only 3% of
the 8,982 of the companies in the
database with a valid (non-null) value
for the relative price strength field, or
approximately 269 companies. Setting the relative price strength level
at 219% results in 269 companies
passing the filter.
However, adding this filter to
the rest of the criteria Kirkpatrick
uses for the Bargain List results in
only one passing company. Using
the 159% minimum relative price

strength value from the Growth List

and Value List screens to capture
roughly the top 10% of companies
based on relative price strength nets
us 19 passing companies.

Price and Market Cap

Lastly, Kirkpatrick looked for
Bargain List companies with market
capitalizations of at least $1 billion
and share prices of at least $10. We
are able to recreate both of these filters using Stock Investor Pro for our
Bargain List screen.
Passing Companies
The last section of Table 4 lists the
19 companies passing our relaxed
Bargain List screen as of August 14,
2009 (relative price strength percentile of 90 or higher instead of 97 or
higher). These companies are ranked
in descending order by their relative
price strength.

Wayne A. Thorp, CFA, is editor of Computerized Investing and

AAIIs financial analyst. Follow him on Twitter @CI_Editor.

September On-line Exclusive 2009

Sell Criteria
Once he has purchased a stock for
his Bargain List, these are the rules
Kirkpatrick follows to determine
when to remove a stock from the
portfolio:
Relative price strength percentile
of 52 or lower, and
Relative price-to-sales ratio
percentile less than or equal to 7
and greater than or equal to 67.

Conclusion

Charles Kirkpatrick takes an

extremely mechanical approach to
stockpicking. To him, stocks are
merely symbols. He does not concern
himself with what the company does.
He merely allows his data analysis to
dictate when to buy and sell stocks.
By basing his selection process on relative variables that have tested very
well over an extended period of time,
Kirkpatrick believes he has found
strategies that will perform well in
both bull and bear markets and will
alert you to sell in time to avoid large
capital losses.