The HG-Type Screen

The Hidden Gems (HG)-Type Screen is named for the Motley Fool Hidden Gems stock newsletter, and was originally developed by looking at the company fundamentals of some of the best performing newsletter picks and seeing if it would be possible to write a screen that captured the essence of the dynamics of those businesses, on the theory that small or micro-caps hold some promise for substantially market-beating gains. The screen looks for companies that are in the beginning stages of substantial growth as evidenced by accelerating growth in sales, improving product economics as shown by increasing gross margin, positive and increasing operating cash flow, a decent balance sheet and current asset management, strong insider ownership and limited institutional ownership, and reasonably priced. An 8-quarter history of company fundamentals is used to provide this information and much of the screen consists of looking at year-to-year changes. Turnarounds, growing companies, and stable companies with improving internal fundamentals (margins) are all good candidates. Most are very small, under $200 million in market capitalization, but occasionally large and well-known companies pass the screen.

Weekly updates of the screen results are posted to the Motley Fool Dynamic Value Investing discussion board with short analyses of new companies appearing on the list. More detailed analysis of some of the companies is occasionally done to identify good potential investments.

The raw weekly screen output (without further commentary) is posted on Sunday or Monday.

The screen has evolved over time and is on its third major version. Each version, based on historical back testing, has substantially improved results over the previous version. Although the changes have not altered the general nature of the screen, the companies passing change substantially from one version to the next. These pages only report the methodology and results of the most recent version which was put into operation on April 25, 2005.

Screen Description and Methodology

HG-Type Screen Portfolios

Two general sets of portfolio results are investigated and reported here: Current and Historical.

Current portfolios consist of stocks picked on a weekly basis starting June 01, 2004 and posted to the Screening For Gems discussion board. A stock is added to a Current portfolio the first time it appears in the screen output in a discussion board post. They are therefore free of any potential data mining or back testing related issues and are a reliable indicator of the screen’s real-time performance. All the Current portfolios are manually maintained.

Historical portfolios are constructed by mechanically running the current version of the screen on historical databases of fundamental data, and using a simple method of selecting stocks: placing a stock in the virtual portfolio once when it is first picked by the screen. All portfolios reflect purely mechanical applications of the screens described here. All buy prices are the closing prices of the first trading day after the screen’s database date.

Note that all portfolio results assume: 1) equal dollar amount purchases of each stock; 2) zero cash balance at all times; 3) infinite funds available to invest (i.e. no forced selling due to capital limitations). In other words, portfolio results are the most optimistic possible.

Although a purely mechanical stock selection method generating high returns is certainly an ideal outcome, it is very unlikely to be successful. The final investment decision needs to be made after in-depth analysis. The flavor of analysis that seems most successful in weeding out losers is to determine whether the factors causing the company to pass the HG-Type screen are sustainable, and not a one-shot, cyclical, or fluke occurrence. This is best done by digging into the company’s SEC filings, news releases, etc. for in-depth fundamental business analysis.

Always do your own analysis to determine whether to invest in any of the companies mentioned on this web site! Nothing here is a recommendation to buy or sell any securities, and I am not licensed or approved in any way to give that kind of advice. All decisions you make on the basis of any information here are strictly your own responsibility!

Current Portfolios

The Current Portfolios are manually maintained and give the actual performance of the portfolio picks as posted to the Screening for Gems discussion board, as if someone had purchased the all the stocks mentioned in the posts the first time they were mentioned (and were able to buy the full position at the close price of the first trading day after the list was posted). The Current Portofolios are reviewed regularly to identify and adjust for any corporate actions such as mergers and acquisitions, delistings or relistings, ticker changes, bankruptcies, etc. There is no survivorship bias in the Current Portfolios.

The HG-Type Screen has undergone a number of significant changes since it was first described on 06/01/2004. Although some changes have had significant effects on which companies were picked by the screen, the underlying philosophy behind the screen has remained consistent all along. The Current Portfolios therefore are somewhat of a hodge-podge of different types of screen results, but reflect what an investor might have achieved if they had simply bought the stocks mentioned in each week’s post. To help analyze if some versions of the screen provide significantly better or worse results than others, this page describes the significant changes that have been made.

Further filtering of the screen picks is also investigated with the Current Portfolio by manually applying a simple Technical Analysis filter as developed by Motley Fool contributor NukeJohn (described here ), called NJTA.