Basic stock screening: plus a plug for Finviz!

Well, I haven’t posted for quite a while, but I thought I’d pick it up with a quick description of how I pick some of my stocks. This is not my only method, but I do use it to pick stocks when I need some investment ideas.

First, I use a screener to find potential investments. I have used several in the past, but right now I prefer the one found at www.finviz.com.

Finviz divides its screens into 3 broad categories. They are descriptive, fundamental, and technical. Before we begin the screening, we can see a total of 6730 stocks available to us.






I start with descriptive screens. I tend to leave all options blank except for the following: Dividend yield, Average volume, and option/short.

I start by setting dividend yield to >0. I prefer to have a stock pay some sort of dividend even though theoretically and logically, dividend payments should not make any difference to an investor. Only free cash flows should matter, not the manner they are paid out.
Next, I set average volume to Over 1M. 1 million shares trades on average is not extremely fluid, but I don’t want to limit our pool to only the most traded stocks either. Still, choosing stocks with low volume has its costs. Bid/ask spreads are bound to be wider, and we are likely to see surprise jumps in prices over what we expect to pay with market orders. This extra cost is called slippage, and is the reason I tend to make limit orders only. I lose opportunities from time to time, but I find limit orders to be well worth the occasional loss of a trade.
Finally, I set the option/short bar to option: This limits the presented stocks to those with option contracts available. I like to be able to sell covered calls, as well as hedge positions on occasion.
I understand that these three screens might be somewhat controversial. If you don’t care about dividends or options, there is definitely no problem with removing them from your screen. Using them in your screen no doubt removes some great potential trades/investments, but they are integral to my trading style, so I’ve included them. As for volume, you can determine what you consider a tolerable average, but I think you should have some kind of cap.

With these screens in place, we’ve limited our selection to 628 stocks (see below).







I next enter the fundamental screens. These screens are the heart of finding a good “underpriced” stock.

There are three aspects I am going to screen stocks for: price, profitability, and solvency.

To screen for price (we want a low price to performance ratio) I use 2 basic screens.

The first screen is the infamous P/E ratio. I set P/E ratio to 15 or less. I would have to have 12 or less, but this is not an option. Since the average P/E ratio for the S&P 500 over the last 130 years has been 12 (according to Jeremy Segal in “Stocks for the Long Run”), I would prefer to find stocks with P/E ratios of 12 or less.

The next screen I use is Price/FCF. I set Price/FCF to 15 or less. Since rational investors should base investment valuations on free cash flow, it only makes sense that free cash flow should be taken into account somewhere in our screener. Besides, the Earnings (the e in p/e), can be manipulated through overleveraging or accounting shenanigans. The lower the number in this case, the less you are paying per $1 of free cash flow generated per share.

Next, we set out to measure profitability. I like to measure profitability of a company by measuring Economic Value added (which is a company’s profit minus its costs of capital). Such a measurement is very hard to manipulate. Unfortunately, EVA is not an option on any screener I can find, so we will need to settle for return on equity.

I set my return on equity screen to over 10%. 10% return is my required rate of return, so any company I invest in had better be able to return more than that on their owner’s stake. Any earnings reinvested into the company should be grown at this rate, which is why ROE is important. Unfortunately, it can be distorted or manipulated through share repurchases, large writeoffs, or by increasing leverage. Therefore, take high ROE numbers with a grain of salt.

Finally, I prefer to own stock in a company that is not flirting with bankruptcy. Therefore, I have three tests for a company’s solvency.

First, I prefer a company with a debt to equity ratio under 40%. However, if the company is performing according to the prior screens, I can tolerate a little more debt.

So I input a screen of debt/equity Under 0.5. While debt provides tax benefits because a company’s interest is deductable, too much debt raises costs of debt and limits a company’s options during hard times.

In addition, I run another screen to eliminate any companies that are experiencing cash flow issues. By testing a company’s current ratio. The current ratio (current assets/current liabilities) tests a company’s abilities to pay short term debt with liquid assets. Anything over 1 should be healthy.

I set my screen up as Current Ratio: Over 1.5

A final, if redundant test is the quick ratio. Quick ratio is calculated as Current Assets - inventories/current liabilities. Quick ratio also measures a company’s ability to pay back liabilities with its most liquid assets. Because the quick ratio takes into account inventory, it may be a more appropriate measurement of liquidity than the current ratio for some business models.

I set Quick Ratio: Over 1
With these inputs, we’ve narrowed our pool down to 20 stocks. Unfortunately, I’ve found no technical screens that seem remotely reliable. So we now must sort through our 20.



We are far from done at this point.  At this point, order the stocks according to your needs.  I look for those with the lowest overall price and lowest price/free cash flow.  In addition, you may choose to look at industries that have either been beaten up or an industry you do not own stocks in.  Portfolio theory may have its flaws, but diversification still makes sense. 

What I do at this point is as follows:

1.     1.   First, I look through recent financial statements.  I’ll save the description for another post, but in short I’m looking for growth in assets, and falling liabilities.  I also try to make sure that cash flow is coming from business activities, and that the income statement doesn’t contain large numbers under vague categories.

2.     2.    If I am investing large amounts of money, I can run what I call a accounting shenanigan check.  This also deserves its own post, but it requires looking over 10 years of financial statements and comparing rate of growth of revenue or sales etc to expenses.  By doing so, we can look for abnormal jumps in certain entries, and discard equities that cannot explain such jumps satisfactorily within public statements to investors.

3.    3.   Finally, I run through recent posts on yahoo message boards, or other boards.  I know this sounds crazy, but I get an idea of what investor sentiment is through the posts.  I’m looking for intelligent posts, discussing pros and cons with investing.  I’m also looking for links to news stories regarding the company that I was not aware of.  I don’t mind seeing a lot of negative posts regarding the stock, as long as there is little substance to the posts.  However, negative posts with supporting evidence should be investigated thoroughly.   Most importantly, I try to avoid building an opinion on whether the stock is a winner or not.  If the stock passes the screens, and the three steps above I consider it as an investment that has a better than 50% chance of increasing the value of my portfolio.  If an investor becomes too attached to a stock, than it is easy to discount any news that contradicts the investors world view of the stock.  We should always be as objective as possible in weighing our risks of purchasing and then holding our investments.  There are too many risks that we will not even know about to ignore the one’s we are aware of.

T.R.