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Abstract
The American Association of Individual Investors (AAII) offers a variety of screening tools to help investors select stocks. We analyze the effectiveness of these tools. While we find support for AAII's statement that 91% of their screened portfolios beat the S&P 500, we note that this overstates the effectiveness of their screens. Many of the return differences are not statistically significant, and their analysis ignores transactions costs and risk differences. Our analysis reveals that when transactions costs are considered, 32% significantly beat the S&P 500, and 26% of low transaction cost strategies significantly beat their best-fit indices. © 2008 Academy of Financial Services. All rights reserved.
Keywords: Stock screens; Market efficiency, Abnormal returns; Investment strategies; Behavioral finance
1. Introduction
Over the years a handful of investors have become well known for their skills at consistently identifying portfolios of stocks that "beat the market." These include such well recognized names as Warren Buffett, Peter Lynch, David Dreman, Martin Zweig, John Neff, and William O'Neal. The interest of individual investors in trying to duplicate the performance of these market marvels is high as witnessed by the overwhelming volume of books in the popular press that deal with investor success stories and how to duplicate their performance. Financial advisors get wealthy from providing advice and so do authors of investment books. Trying to duplicate the performance of these authors is a daunting task very few can master.
A recurring issue is if there is an easier and less expensive way to try to out-perform the market, especially for the average investor. In this article, we evaluate one approach that is of very low cost and available to anyone with some time at the end of each month to rebalance their portfolio. Specifically, we analyze the performance of a number of screening techniques identified and offered by the American Association of Individual Investors (AAII), a nonprofit investment education organization based in Chicago. Through their Website (www.aaii.com) and several print publications, AAII attempts to educate individual investors and offers a number of tools to help investors build wealth. One of the tools offered is stock screening. AAII screens stocks to create 61 portfolios designed to take advantage of popular investment techniques. Regarding the screening process, AAII states:
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