The Oberweis Octagon Stock Selection Strategy focuses on small and medium-sized businesses that meet eight criteria for value, growth, and momentum. For the patient investor with the ability to withstand the increased short-term volatility and risk of small- and mid-cap stocks, there is the potential for strong long-term returns.
As of May 28, AAII’s Oberweis Octagon screening model has an annual gain since inception (1998) of 12.7%, compared to 9.0% for the S&P SmallCap 600 Index and 9.4% for the S&P MidCap Index. 400 in the same period.
Investing in Small Businesses with the Oberweis Octagon Display
AAII Oberweis Octagon’s strategy seeks fast-growing small and medium-sized companies that trade at attractive prices, a process that Oberweis Asset Management, an independent investment management firm, calls “AGARP:” aggressive growth at a reasonable price. AAII Oberweis’ selection strategy integrates value, growth, and momentum factors arising from eight points that make up the Oberweis Octagon, including:
- Rapid annual revenue growth (sales)
- Rapid annual growth in income before taxes
- Recent (quarterly) “favorable” trends in revenue and earnings growth, ideally showing acceleration
- Under Earning rate over price relative to the underlying growth rate
- Under price-sales ratio
- Strong price force relative to the market
- Products or services that offer the potential for strong future growth
- Review of the financial statements of the company, especially the footnotes, to try to identify future problems.
The Oberweis Octagon screen seeks to identify and capitalize on pricing inefficiencies involving small and medium-sized businesses experiencing rapid growth. Oberweis’s approach begins by limiting the equity universe to publicly traded micro, small and mid-cap companies. Exchanges have listing requirements that set minimums for company size, stock availability, and financial strength.
AAII Oberweis screen focuses on “small” companies with market capitalization (share price multiplied by number of shares outstanding) below $ 1 billion and “medium” companies between $ 1 billion and $ 8 billion in market capitalization. There are specific criteria that apply to these two groups of companies.
By focusing on smaller companies, the Oberweis approach tries to find companies with greater potential for high growth. No company can sustain a high growth rate indefinitely; over time, its size begins to overwhelm her. Large companies simply cannot sustain the high growth rates that smaller, fast-growing companies can achieve.
It is important to note that there are unique risks when investing in small businesses. Some of these risks include limited product lines, markets, and financial resources. In addition, stocks in small companies tend to trade more sparsely than stocks in larger, more established companies. Therefore, the prices of these shares can be subject to sudden and significant movements.
Income and profit growth
Rapid and steady growth, specifically in revenue and earnings, stands as the cornerstone of Oberweis’s Octagon approach. Sales are important because they drive growth in results (earnings) and because sales tend to be more difficult to manage or manipulate than earnings. The AAII Oberweis screen looks for small companies with a market capitalization below $ 1 billion to have growth rates in sales and income before taxes during the last 12 months of at least 30%, while requiring medium-sized companies with a market capitalization between $ 1 billion and $ 8 billion. be increasing sales and income before taxes at a rate of at least 20% during this same period.
Early acceleration of earnings
One of the objectives of the Oberweis Octagon strategy is to identify fast-growing companies in the early stages of their life cycles that, in turn, will generate excess profitability in the long term.
Selection criteria that focus on “favorable” trends in earnings and sales require that both sales and earnings per share from continuing operations in the last fiscal quarter be higher than in the same quarter last year. Additionally, sales and earnings for the prior fiscal quarter must also be higher than the same quarter of the prior year.
When looking at annual results for a company, the screen also requires that sales and earnings per share from continuing operations for the last four quarters (12 months) are higher than the last fiscal year.
Value elements: low relative price-earnings ratio and low price-sales ratio
Identifying fast-growing companies with prospects for continued growth in the future is only part of the Oberweis stock selection methodology. From the universe of companies in strong growth, the strategy looks for those that have a reasonable price. Specifically, the AAII Oberweis screen analyzes stock market valuations, especially price-earnings and price-sales ratios.
To isolate reasonably priced companies from the universe of fast-growing companies, the Oberweis Octagon selection methodology makes use of a PEG ratio which compares the price-to-earnings ratio to the projected growth rate in earnings for the next year, which is the percentage change in earnings forecast for the current fiscal year compared to the level of earnings reported for the last fiscal year.
For smaller companies, the Oberweis display requires that the price-earnings ratio be less than the estimated growth rate in earnings per share, while for medium-sized companies the price-earnings ratio cannot exceed the projected growth rate. year in earnings per share. .
The other value element of the Oberweis approach considers the price-to-sales ratio. This relationship compares the current price of the shares with the sales of a company. The Oberweis Octagon methodology considers companies with reasonable price-to-sales ratios based on the underlying growth prospects and profit margins of the company. For this screen, the price-to-sales ratio of a company is compared to that of its industry. The display requires that the current price / sales ratio be less than the average value of the price / sales ratio for the respective industry.
Strong price strength relative to the market
Research confirms the benefit of looking for stocks with high relative strength, especially when combined with other fundamental selection characteristics such as size and value. Momentum is not only for short-term traders and those who rely on technical analysis, but also for those who focus on fundamental analysis.
Price momentum is typically measured by comparing a stock’s price change over a specified period relative to a benchmark, such as the S&P 500 index, or a segment of stocks; the resulting number is called the relative strength.
Oberweis’s approach looks for companies that have outperformed at least 75% of other stocks on the market in the past 12 months. Therefore, the Oberweis screen requires a company to have a 52-week relative strength figure that sits in the top 25% of stocks.
Future growth potential
While AAII Oberweis Octagon’s stock selection process is relatively “mechanical”, Oberweis Asset Management incorporates two additional elements into its selection process that are subjective in nature. The AAII Oberweis approach does not consider these subjective elements on your screen.
One of these subjective elements involves identifying a company’s future growth potential, specifically targeting companies with products or services that offer “substantial” future growth potential. This element can be considered as a company that has a lasting competitive advantage over its competitors that allows it to protect its market share and profitability.
Another way the Oberweis methodology looks to the future is through a careful examination of a company’s financial statements. Specifically, Oberweis Asset Management reviews a company’s quarterly and annual reports filed with the U.S. Securities and Exchange Commission (SEC), paying particular attention to the footnotes that accompany these filings to try and identify issues. or future threats.
The footnotes serve to augment the information provided in the financial statements and contain supplementary information and disclosures. The footnotes provide information on the accounting methods used, as well as the underlying assumptions and estimates of management. Disclosures found in footnotes generally relate to areas such as fixed assets, inventories, pensions and other post-employment benefit plans, lawsuits and other contingencies, marketable securities and other major investments and clients and sales to related parties.
The AAII Oberweis display cannot evaluate these two items through a mechanical display. This point underscores the need for further analysis once you have applied any type of mechanical screen to a universe of stocks.
Stocks Passing the Oberweis Octagon Screen (Ranked by 52-Week Relative Strength)
Actions that meet the criteria of the approach do not represent a “recommended” or “buy” list. Due diligence is important.
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