Stock Screening Education
How to ScreenStock Screening Defined
Stock screening is the process of applying numerical criteria to a broad universe of companies. Screening allows you to narrow the universe down to a list of a few stocks with high potential.
The Purpose of Screening
Screening for stocks is one of many ways to discover new investment ideas. Stock screening is a tool that is highly utilized by investment professionals. Most people only have the time to research a few companies a week. With thousands of companies mentioned in newspapers, magazines, and television shows every day, it can be difficult to filter the information and decide which compan ies to research. Stock screening saves you research time by allowing you to eliminate companies that clearly do not meet your objectives. While it is a highly useful tool, there are no magical screens. It is important to understand that while screening is a great place to start looking for stocks picks, further research should be done before making a buy or sell decision.
Stock screening is a multistage process, and it is important to spend time carefully analyzing each stage of the process. A well-constructed screen will lead to a list of companies meeting your basic objectives. This will save you hours of time in the research process by ensuring that you are only analyzing companies with high potential. However, a poorly constructed screen will likely generate companies that you are not interested in, and will lead to wasted research time. The steps in the screening process areas follows:
- Defining Your Objective
- Constructing Criteria
- Reporting and Picking Stocks to Research
Before you begin using the stockscreener, it is important to identify the types of stocks you are looking for. Your investment objective should include the characteristics of your ideal stock and should take into consideration your performance goals, your risk tolerance, and your investment philosophy. Common broad objectives include targeting growth stocks, value stocks, or momentum stocks. Objectives such as these can be found in the Zacks predefined screens section. For investors desiring a more precise objective, the Zacks custom screener is one of the top screeners on the Internet. It allows you to implement a focused, narrowly defined objective.
Suggestion: Stop and write down your objective on a piece of paper. It may be useful to come up with a bullet-point list of the characteristics of your ideal stock.
While it is often easy to come up with meaningful items to screen by, combining them to produce a useful screen can be challenging. You need to first come up with criteria based on your objective, and then evaluate the criteria to make sure they are not contradictory.
The most important screening criteria should evolve naturally from your objective. These criteria should attempt to filter out companies that do not meet your objective. Screening criteria filter out stocks by comparing a company's current value for a data point against a base figure. The base figure can either be absolute or relative. An absolute base figure is defined by the user (i.e. P/E ratio less than 10); while a relative base figure is usually based on a historical company average, a market average, or an industry average. Some criteria should only be used on a relative basis. Ratios such as margins and turnover are very industry-specific and become meaningful only when compared to industry norms or company trends. A company with a 10% profit margin in the retail industry may be considered one of the most efficient businesses in the industry, while a company with a 10% profit margin in the software industry is likely to be struggling relative to its competition. On the other hand, you can choose to compare a company's figure against a constant value that does not fluctuate over time. This can help you screen for stocks with particular characteristics, independent of outside factors. For example, a screen looking for stocks with a price/book value of less than 1.0 is popular among value investors. This screen will return potential value buys regardless of how the overall market is valued.
Suggestion: Pick the most important 1-4 items from your objective and translate them into basic criteria. If you are interested in performing more detailed screens (including more screening items and more advanced relative criteria) contact Zacks for in formation on the Research Wizard screening software.
Even if you succeed in defining a focused objective and translating it into basic criteria, you can still expect some companies that don't meet your objective to turn up in the results. Your growth screen may contain a company with a predicted long-term growth rate of 30%. However, that estimate may come from just one analyst who just revised it down from 40%. Trusting this estimate means placing an inordinate amount of faith in one person who just changed his mind. Your screen should include conditioning criteria to help validate your basic criteria. A screen for stocks growing at a certain rate is more useful when combined with qualifiers such as upward revision momentum and a minimum number of analysts.
It's also important to make sure that your criteria do not contradict one another. For example, a screen for growth stocks with high dividend yields is likely to be ineffective. Your basic screening criteria should be derived directly from your objective, and any other criteria should help validate your basic criteria.
Reporting and Detailed Research
Finally, you need to decide which items to include in your report. The reports from the Zacks Stockscreener are in table format and are fully customizable. After you are finished with the report, you can use the stock research pages on the Zacks web site to research fundamental company information, detailed analyst estimates, insider trading data, detailed company descriptions, and much more!
Suggestion: Include the most important screening items in your report, as well as other items that may be important in your investment decision. Then print out the report and use it as a starting point for further research. Select stocks from the report that look attractive based on the numbers in the report, and use the Zacks web site to find more detailed research on them.
Keep in mind that there are no magical screens that turn out guaranteed winners. The purpose of a screen is to provide you with a preliminary list of potential winners.
- Develop a focused, narrowly-defined objective
- Construct criteria to meet your objective
- Do a complete in depth analysis of a company, including both qualitative and quantitative factors, before making an investment decision.