Finding a Stock Winner:

First Step Screening

Jaclyn N. McClellan
Editor, Computerized Investing
Associate Financial Analyst, AAII

[email protected]

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 Discussion Overview
• A computerized screening program can be used to
locate/analyze stocks in an organized, systematic and
disciplined fashion
• Discuss screening factors that help to highlight winning
stocks
– Value approach
– Growth approach
• Stock screening resources
– AAII Stock Screens
– Top Web Screeners
• Take home a feeling for some of the elements that help
to build successful portfolios

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 Stock Selection Process
Screening Process
– Screening approach should match personal investment
philosophy
– Establishing criteria narrow a large universe of stocks into
a few that hold promise and warrant further analysis
– Screening system identifies stocks that have common,
desirable traits
– Screening system adds discipline to the stock selection
and selling process
– Strategies need to be backtested to make sure they work

Valuation Process
– In-depth examination of a company to establish if its stock
price reflects a fair value

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 What is your investment strategy?
“Confronted with a challenge to distill the secret of sound
investment into three words, we venture the motto,
Margin of Safety.”
-Benjamin Graham

Write down what you look for in stocks: earnings growth,

return on equity, financial strength, dividends, price-
earnings ratio of x, etc.
How long would you say your investment period is?
What is the most you are willing to lose
on an investment?
How much time do you have to spend on research?
Do you care about price momentum?
Are you investing for income? (dividends)

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 See these on AAII.com
Stock Strategies
Value
Benjamin Graham, Walter Schloss

Growth
William O’Neil

Growth at a reasonable price

Peter Lynch

Contrarian
David Dreman

Value with price momentum

Lakonishok
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 Recent Performance by Size Data as of 1/31/2018

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• The smaller the market cap, the higher the return
• The lower the price/book, the higher the return

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 Recent Performance by Style Data as of 1/31/2018

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 Data as of 1/31/2018

Strong-Performing Growth & Value Screens

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 Growth of $1,000 (Semi-Log Chart)

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 Common Elements of Successful Screens
• Reasonable value
– Low P/E, P/Sales, P/Book, high yield, etc.
– Low P/E relative to growth
• Consistent growth
– Emphasis on consistency of growth in earnings,
sales or dividends
• Strong financials
• Price momentum
• Earnings revisions
• Disciplined investment approach
• Unique niche

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 Value Growth
Buy Low, Sell High Buy High, Sell Higher
• Investors do not always act • High sales and earnings
rationally, often assess growth will continue to
information emotionally, attract more investors,
creating price distortions that pushing up the multiple
can be exploited investors will pay for a stock
• Locate stocks whose market • Locate companies and
values are low relative to industries in stage of rapid
valuation measures such as and expanding growth with
dividends, earnings and assets earnings momentum
• Horizon: Typically longer term, • Horizon: Typically shorter
less need to monitor stocks term, higher turnover, need
tick-by-tick to monitor stocks closely

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 Screening Process
1) Construct and refine primary criteria
– Identify your universe of stocks
– Quantitative filters that identify the type of investments
matching your investment objective
• Value example: low price relative to earnings
• Growth example: high growth in earnings relative
to competitors
2) Construct secondary criteria to determine if
companies passed the screen for the right reasons
• Value example: strong financial strength, dividends
• Growth example: expanding profit margins, growth
in earnings, sales, cash flow

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 Understand what each metric means.
Liquidity/Financial Health
Availability to meet near-term Efficiency
obligations Is the company managing its
assets effectively?
Current ratio, quick ratio,
financial leverage, cash ratio Receivables turnover, inventory
turnover, asset turnover

Profitability
Firm’s use of assets and
Solvency/Leverage
control of expenses to
generate acceptable rate of How is the company’s debt
return relative to its assets and
equity?
Return on assets, return on Debt to assets, debt to equity,
equity, return on invested interest coverage
capital, operating margin, profit
margin What does it mean and
why would you use it?
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 Value Screen: David Dreman
His name is synonymous with “contrarian”

“Psychology and the Stock Market” 1970

“Contrarian Investment Strategy –
The Psychology of Stock Market Success” 1979
-revised in 1982 under the title
“The New Contrarian Investment Strategy”
“Contrarian Investment Strategies: The Psychological
Edge” 1998

Psychological biases interfere with sound investment

decisions.
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 The Dreman Approach
1. Choose from a universe of medium- to
large-sized companies
Primary
criterion
2. Buy low price-earnings ratio stocks
-bottom 40% of stock universe

3. Hold equal amounts of 15 to 20 stocks that

are in 10 to 12 different industries ***

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 Dreman Approach

Secondary criteria
• High dividend yield that can be maintained or,
preferably, raised (above 1.5% in the screen)
• Liabilities to assets equal to or below sector
median
• Growth in earnings per share above median of
stock universe
• Estimated earnings are greater than current and
last reported fiscal year’s earnings

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Market cap in the top 70% of the entire database

Mid to large-cap companies are subject to less “account gimmickry”

because they are more “in the spotlight”

Median market cap: $434 million

Average market cap: $7.1 billion

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P/E ratio in the lower 40% of the entire database
P/E is a function of expectations – higher P/E for greater expectations.
Low P/E group is out of favor with the market, but they aren’t always
deserving a lower multiple.

Median P/E: 20.9

Average P/E: 36.8
545 pass cumulatively, 1393 independently
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 Price-Earnings Ratio: Drawbacks
It’s important to understand the possible drawbacks of the metrics
you use.
• Low P/E stocks without additional qualifiers may only highlight risky
or troubled firms
• Quality of earnings: earnings influenced by management
assumptions trickling through the account statements
• Negative earnings & temporary developments—such as costs of
new product rollouts or general cyclical slowdowns—can distort P/E
*** Be cautious of cyclical and financial firms when it comes to P/E

Expectation of
peak
high earnings, Expectation of
increasing expansion improving earnings,
earnings figure earnings below $1 or
Anticipation of
= higher P/E negative
earnings decline, trough
larger earnings = = high P/E or NA P/E
low P/E

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Total liabilities to total assets ratio is below sector median
Dreman feels that a contrarian stock should have a strong financial
position. This will enable a company to weather periods of operating
difficulty, which low price-earnings stocks sometimes experience. A
strong financial position also helps to ensure the safety of a company’s
dividend payment.

Median L/A: 60.7

Avg L/A: 77.9
234 pass
cumulatively,
2983
independently

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Dividend yield greater than or equal to 1.5%
Dividend that can be sustained and possibly raised. Dividend will
provide protection against price decline and contribute to total return.

Median dividend yield: 0.0%

Average dividend yield: 1.4%
172 pass cumulatively, 1803 independently
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1-year continuing EPS growth above median for database
Looking for stocks that don’t deserve their low valuation – need a
reason to increase in price. Earnings drive stock price over long term.

Median Y1 continuing EPS growth: 10.7%

Average Y1 continuing EPS growth : 9.8%
100 pass cumulatively, 2961 independently
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12-month continuing EPS growth above median for database
12 trailing months is more recent than 1-year. Y1 can be over a year old
depending on fiscal year-end

Median 12m continuing EPS growth: 13.0%

Average 12m continuing EPS growth : 11.2%
83 pass cumulatively, 2,945 independently
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Est EPS for current fiscal year (Y0) greater than reported EPS for
the last fiscal year (Y1)
Look at the general direction of earnings – want companies that are
expected to grow

Median 3-5 year EPS growth estimate: 11.7%

Average 3-5 year EPS growth estimate : 11.2%
38 pass cumulatively, 3,043 independently
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 Analyzing the Dreman Screen
Last metric is next fiscal year’s estimated EPS to be higher than the
current fiscal year.

38 companies passing as of 2/27/2018

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 Data as of 4/29/2005

Data as of 1/31/2018
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 Analyzing the Dreman Est Rev Screen

15 companies passing as of 2/27/2018

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 Data as of 1/31/2018

Dreman with Estimate Revisions

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 Value Summary
• Produces consistent, long-term success, but can fall
behind other approaches on occasion, particularly in the
strongest portion of a bull market or during economic
transitions
• Value strategy has worked at all market-cap levels—
micro cap to large cap

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 Growth Screen: CAN SLIM
William O’Neil developed his growth
stock approach through study of
company characteristics prior to their big
stock price increase
Approach presented in second
edition of “How to Make Money
in Stocks: A Winning System
in Good Times or Bad”

With all the options you have as an

investor, why settle for stocks with little to
no growth in earnings per share?

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 CANSLIM in Stock Investor Pro

N
S
L

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 C=Current Quarterly Earnings
Strong and improving quarterly EPS performance
—at least 18% to 20%
• Important to compare quarter over quarter
• Earnings from continuing operations

A=Annual Earnings Increases

Significant and steady increase in annual earnings
• Increase in EPS for each of the last five years
• Strong annual growth rate of 25% or greater over the last five
years
N=New Products, Management, Highs
Catalyst to start a strong price advance
• New product or service, management team, technology
• Stocks reaching new high after consolidation period

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S=Supply and Demand L=Leader or Laggard
Firms with a smaller number of
shares outstanding should Look for market leaders in
increase more quickly rapidly expanding industries
• O’Neil recommends looking • Buy among the best two
at “float” or three stocks in a group
(Shares outstanding less • Use relative strength to
shares held by insiders) identify market leaders

I=Institutional M=Market Direction

Sponsorship The trend of the overall market will
have a tremendous impact on the
A few institutional sponsors are performance of your portfolio
needed for above-market
performance, but not too many • O’Neil tends to focus on
technical measures when
• Look at record of institutions determining the market’s overall
direction

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 Average Number of Holdings and Turnover

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 Growth Summary
• Requires close monitoring; beyond the ability of many
individuals
• Look beyond high expected or historical growth and
consider stability of earnings and ability to achieve
expectations
• Relative strength works reasonably well independently or
when combined with value factors

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 Things to Consider When Screening
• If not many stocks pass, you may be able to change
some of the parameters. (problem: no way to know the
effect without backtesting)
• Does your screen apply to financials/REITs/ADRs?
Chinese stocks? OTC stocks? Some of these need to
be screened out
• Verify the source of data for the screening program
you’re using
• Does your screen produce enough results for you to
invest in after you winnow down the results with your
analysis?
• “Sell” criteria is not always the opposite of the “buy”
criteria
• Look at your favorite mutual funds and ETFs – what do
they look for?

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 Things to Consider When Screening
• Be aware of where you are in the business cycle and
how that may affect ratios (change parameters based
on market conditions)
• Different screening tools will produce different results
• Beware of negatives (growth rates)
• When in doubt it’s good to compare to industry/sector
• Use quarter-over-quarter or year-over-year to eliminate
seasonality
• Double-check figures (50% growth rate going from
$0.02 to $0.03 EPS)
• Screening can also apply to ETFs, mutual funds
• Percentile ranking: “What Works on Wall Street”

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 Benefits of Stock Screening
• Discover potential investment opportunities you
might not have otherwise noticed
• Avoid wasting time on companies that don’t
meet your basic criteria
• Adds a level of discipline to your investing
– Forces you to develop and hone investing parameters
– Helps you to think more clearly about your investing
style
– Helps to keep your emotions in check

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 Potential Pitfalls of Stock Screening
• Dependent on the accuracy of the underlying data
• Limited mainly to quantitative factors
– Factors such as quality of management, brand strength,
competitive position, etc., must be evaluated separately
• May still be missing good companies that meet most but
not all criteria
• Introduces you to companies you are not familiar with
and that require further analysis
– Screening is only the first step!
– Stock screening only isolates companies with similar
characteristics
– You need to decide whether the
stocks belong in your portfolio

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 Keys to Long-Term Success
• Many approaches to investing can be successful, but
failure to identify an approach and follow it will eventually
lead to disaster
• Pick sell rules and stick to them!
• To succeed with a individual stock approach:
– Need enough time to manage a stock portfolio
– Need to manage diversification of portfolio
– Need an interest in managing a portfolio—in good
times and bad
– Need discipline to follow the program once you have
committed to it
Don’t forget transaction costs!!

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 Popular Approaches

• AAII Journal and Computerized Investing have

examined the characteristics of successful
investors
• Tracking performance of our interpretation of
these approaches in Stock Investor Pro
• Companies passing screens and chart of results
available on AAII website within
“AAII Stock Ideas” area

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 Screens are
located within
the “Stock Ideas”
area of the
website

Sort order of
table can be
changed by
clicking on tabs

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 Members can
download
spreadsheets that
detail performance
by month or year

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 „ Members
subscribing to the
“AAII Stock
Screens Update”
email receive a
monthly email alert
when the Stock
Screens area is
updated
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 Selecting a Screener
• Data source?
• How many metrics in the database?
• How often is the data updated?
• Learning curve/ease of use
• Customer service options if you have
questions
• Any videos/training?

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 Top Online Screeners
GuruFocus
Morningstar Premium Stock Screener
StockCharts.com
Zacks.com
Portfolio 123
Profitspi
FinViz

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 Stock Investor Pro
• (800) 428-2244 – www.aaii.com/stockinvestorpro
• Systems: Windows 8 or newer, including Windows 10
• Price:
– $198/year (AAII Member)
– $299/year (Non-AAII Member)
• Universe: Approximately 6,300 U.S.–traded stocks
• Number of Data Fields: 2,200+
• Fields for Screening: 2,200+
• Data Sources: Thomson Reuters, I/B/E/S
• Frequency: Daily
• Distribution: High-speed internet

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Morningstar Premium
Price: $189/year or $23.95/month;
14-day free trial
At a glance:
-Current and historical screening
parameters for time series Portfolio 123
analysis Price: $35/month to $299/month; 15-
-Screen on proprietary appraisals day free trial
and style categories
At a glance:
-Deep library of fundamental
screening variables -Backtest screening strategies
-Roughly 10,000 companies, over -One of the largest libraries of
1,800 screening parameters fundamental screening variables and
predefined screens
-Create custom screening variables
-8,900 companies, 1,330 screening
parameters

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