An Energetic Defense of Stock Screening

A recent article in Forbes levels a lengthy rebuttal against what the author describes as an “attack” on  stock picking as a viable investment strategy.

Contributor Marc Gerstein wrote in response to a January Forbes article that he said “blasted” stock screening strategies, suggesting that their use as a way to build wealth is “delusional” and investors should instead put the bulk of their money into index funds.

Gerstein cites a passage from his book Screening the Market (Wiley 2000) touting the advantages of screening methods to identify stocks “based on at least some objective showing of merit and without regard to what periodicals you read, what finance broadcasts you see or hear, what analysts you encounter, what tips your friends provide, or where you live, work or shop.”

Here are highlights of Gerstein’s argument:

  • Indexing, argues Gerstein, is not necessarily a passive investing strategy. He uses the example of the index-based ETF the S&P 500 SPDR (SPY): “Well, for one thing,” writes Gerstein, “picking SPY is not at all a passive choice. It’s an active decision to favor U.S. large-cap companies and to do so with a momentum bias.” He differentiates this from a “true smart-beta ETF” (referring readers to the writings of Rob Arnott and Research Affiliates).
  • Every stock screener, Gerstein points out, won’t beat the S&P 500, but that doesn’t mean none can. He quips: “Does the inability of everybody, or even a majority of people to be good at something meant that nobody should try to do better?”
  • Gerstein analyzes the performance data used to support the argument against screening, noting that there is never a clear-cut start or end date when looking at historical returns, “so it’s never proper to run one set of numbers and say one has the answer. One must instead run many sets of numbers and, using the constellation of all the answers, try one’s best to discern the differences between abnormal and normal occurrences.”
  • Using several case studies, Gerstein further challenges the criticism of stock screening, using screen shots of statements from his personal portfolio to advance the argument. He concludes, “As can be seen, I’ve been beating the S&P 500 for a long time. But I make no claim to having been gifted with unique genius.” He writes, “The reams of studies purporting to document the failure of active management…have nothing to do with screening or with what many quants nowadays do.”
  • Gerstein advises critics of non-index investing to be “extra careful about what, exactly, it is they bash, dig harder than in the past to try to get things right, and open their minds to new answers that might come from a proper research effort.”
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