Sifting Out the Gems

 | Dec 20, 2011 | 9:35 AM EST
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When you want to grab onto the tails of a consistently fine investor, you can't do much better than the estimable James P. O'Shaughnessy. His growth portfolio, in particular, is a standout: Since I started following it in 2004, it has gained 54.4% vs. a S&P 500 gain of 6.4%. Year to date, the portfolio has moved ahead 16.7%, while the S&P has fallen 3%.

Who is O'Shaughnessy? He was one of Wall Street's original quants -- strategists who rely heavily on quantitative analysis. He made his name in the mid-1990s with the publication of What Works on Wall Street, a statistical analysis of S&P data to which he was given access. (The book was updated in 2005.)

His accomplishments also include receiving, in 1999, the first patent ever given for an investment strategy: Automated Strategies for Investment Management. He's also been a mutual fund manager.

One component of his strategy focuses on growth, and is known as the Cornerstone Growth Strategy. This is what I will focus on here.

The growth strategy works so well, according to O'Shaughnessy, because it focuses on both high relative strength and low price-to-sales ratios. Relative strength is a measure of how well a stock has done during the past year vs. the overall market. A reading of, say, 82, means the stock has outperformed 82% of all stocks during the previous 12 months. Basically, then, this entails targeting stocks that the market is embracing.

But by also making sure a company has a low P/S ratio (which is actually a value characteristic rather than one relating to growth), the strategy assures you are not getting in too late with popular stocks, after they've become too expensive. As O'Shaughnessy has noted, this means you are buying just when the market realizes a company has been overlooked.

The four steps of The Cornerstone Growth Strategy are:

1. Market capitalization: This must be at least $150 million, which is a way of making sure the stock is not too illiquid, yet includes small growth companies.

2. Earnings-per-share persistence: EPS before extraordinary items must have increased in each of the past five years.

3. P/S ratio: This number be less than 1.5 to be acceptable.

4. Relative strength: The stock must be among the top 50 of those that have already passed the previous three criteria.

Here are four stocks that pass The Cornerstone Growth Strategy. When you invest in these, you are buying into solid companies that get a high passing grade from a proven strategy.

PriceSmart (PSMT): This firm operates 29 membership warehouse-type stores in Central America and the Caribbean. It was founded by Sol and Robert Price, founders of the first U.S. membership warehouse store concept, The Price Club (which was eventually purchased by Costco (COST)).

Cash America (CSH): Operates more than 1,000 pawnshops in the U.S. and Mexico

CACI (CACI): Provides information-technology services, primarily to the U.S. government, as well as state, local and foreign governments and large commercial enterprises. It is the eighth-largest government contractor.

NewMarket (NEU): This is a holding company for Afton Chemical, which manufactures additives used in gasoline, gear oil, engine oil, heating oil and other fuels. It's also the parent of Ethyl Corp., which makes gasoline additives that contain intake-valve deposit detergents that are added to all unleaded gasoline sold in the U.S.

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