Investing Like Martin Zweig: Growth With A Conservative Streak

Money manager Martin Zweig's great moment came on Oct. 16, 1987, when he told Louis Rukeyser that a big market crash was coming. The crash would come be soon. It would be vicious. And, what many people forget, but he also said the crash would also be short-lived.

Zweig was right on all counts that Friday. The Dow Jones industrials fell 508 points the following Monday, its worst one-day decline until the fall of 2008, and the legend was made.

Zweig's performance as an investor in 1987 was legendary in its own right. He had prepared for the crash. He had taken a huge position in put options, betting the market would go down. And when that awful October ended, Zweig's portfolio was up 8.7 percent. For the year, the portfolio had gained some 50 percent.

And Zweig's "vicious" crash? It did prove relatively short-lived. The Dow fell nearly 41 percent between its August 1987 peak and bottom. The index recovered all of the loss, however, by October 1989.

Zweig is admired as one of the great investors, in the same league as Warren Buffett, Benjamin Graham and Peter Lynch. That's because his Zweig Forecast investment newsletter produced risk-adjusted returns of 15.9 percent annual returns over the 15 years that the Hulbert Financial Digest monitored it. Zweig stopped writing the newsletter in 1997. His book, Martin Zweig’s winning on Wall Street, is considered a classic.

In addition, he developed the put-call ratio, which compares the daily trading volume of put options with that of call options. It has proved a reliable measure of investor sentiment. A reading above 1 suggests traders are bearish. It was just below 1 on Feb. 14.

Then, of course, there was the call for the crash.

His success as an investor reflected his training in business and math at the University of Pennsylvania's Wharton School, the University of Miami and Michigan State University.

Ask any investor the secret to smart investing, and the answer will include "Buy low, sell high."

Zweig endorsed the idea, but he preferred growth stocks because he believed they offered the potential for significant gains. But as John Reese of Validea.com notes, Zweig was "a growth investor with a serious conservative streak."

With Zweig, a stock selection required a number of steps, all dependent on the data. 

Unlike Peter Lynch, who liked to say he didn't care what the stock market overall was doing, Zweig -- who died in early 2013 -- cared a lot about the market's condition.

He used a number of market indicators to start his buying or selling process. He worried about interest rates, following the Federal Reserve's discount rate, the bank prime rate and whether installment debt, as measured by the Fed every month, was rising or falling.

He watched market momentum using the advance/decline indicator from the New York Stock Exchange. If advancers are ahead of gainers, stocks are worth considering. Add to that "up volume." If 90 percent of the market's volume is up, meaning investors are buying heavily, that's a signal of a big gain ahead. Another key buy signal was if the Value Line Composite Index rose four percent in a week.

Those indicators also helped him judge if the market was likely to weaken. A four percent decline in the Value Line Composite was a sell signal.  Ditto if volume trends turned to the negative.

Then, he screened stocks every which way possible. But there were two key indicators that Zweig focused on:

• A company's earnings must rise consistently for four or five years. (Lynch uses a similar measure in his thinking.) The situation can't have changed recently.
• Then, he worried about price-to-earnings ratios. He liked stocks with PE ratios slightly stronger than the market overall, because he favored growth stocks over value stocks. If the market PE was 10, he would consider stocks with PE ratios of 12 to 14. He would not consider a stock with a PE under 5.

He would not buy a stock with a PE above 20 except in the most extreme circumstances. And he would worry if a proxy PE for the market was over 20. That suggests a good chance of a sell-off.

For those who are wondering, the PE ratio of the Standard & Poor's 500 Index on Feb. 14 was 19.5. A bit pricey, using Zweig's methodology. And there are plenty of others who believe the stock market was overpriced on Dec. 31 and still believe it's overpriced.

Lastly, and this is important: Zweig did not believe in buying and holding. He would ride a stock up and sell when he thought it had peaked. He usually put a stop loss in on a position at 10 percent to 20 percent below the market price so the downside on an investment was limited.

That's one reason why many Zweig watchers thought he was a perpetual market bear. Actually, his friend Liz Ann Sonders of Charles Schwab & Co. wrote that Zweig was a "perma-worrier." If you watch his conversation with Louis Rukeyser in October, the worry about the market (for good reason) made him look nearly exhausted. 

Of course, there was good reason to be worried.

If you use Zweig's world view, you could buy just about anything. A 10-stock portfolio that Validea.com built using Zweig principals currently includes:

• Mutual-fund company Waddell & Reed Financial WDR
• Gun maker Sturm, Ruger & Co. RGR
• Transportation and shipping company Echo Global Logistics ECHO
• Apparel-story operator TJX Companies TJX
• Engineering and construction company Argan AGX
• Insurance company HCI Group HCI
• Debt-collection company Portfolio Recovery Associates PRAA
• Biotech company Myriad Genetics MYGN
• Semiconductor maker Skyworks Solutions SWKS
• Alliance Fiber Optics AFOP, maker of fiber optics components.

Zweig may have worried a lot, but he wasn't humorless. He enjoyed his life hugely. He was a life-long poker player. He made so much money that he spent $21 million to buy the most expensive apartment in Manhattan, the three-floor penthouse at the Hotel Pierre Hotel.

It went on the market after his death for $125 million; the price was recently cut to $95 million.

He built a fantastic collection of American memorabilia. It included the sequined dress Marilyn Monroe wore when she sang "Happy Birthday" to John F. Kennedy, the Harley Davidson Hydra-Glide motorcycle Peter Fonda rode in "Easy Rider," singer Buddy Holly's guitar and a Brooklyn Dodgers jersey Jackie Robinson wore in his 1947 rookie season.

Being a successful investor has its plusses.