RSS feedYou might be able to do these stock screens in Yahoo! Finance, but I personally prefer to use the MSN Money Investment Toolbox. Unfortunately, the only way to get it is to use Internet Explorer. Go to an MSN Money Power Search and click the link for “Customize This Screen with our Deluxe Screener.” You’ll have to go through a bit of an installing process and you’ll only be able to use this with Internet Explorer. Just bookmark it or save it as your homepage and go back to Mozilla. That way you won’t have to bear too much with IE when you want to screen for stocks.
Anyways, as a sort of continuing wrap up of the last few fundamental analysis posts, I will be proposing two simple value screens. One will be for finding absolute value and the other for relative value.
Absolute Value Screen
A simple screen that will put the odds of finding an undervalued stock in your favor might go as follows. The theory behind this screen is that we are looking for stocks which give us the best return on the amount that we pay for the stocks. Thus, we will use different measures of yield in order to pare down the stock universe and find likely outperformers.
A savings account will typically yield 3-5%. An investment grade corporate bond can yield 6-7% in the current market. Since investing in a company is more risky, let’s say we want at least 8% maybe even as much as 12% return on the price we pay for a company.
The first criteria is earnings yield (basically P/E inverted). If we were to put money into owning our own company, we could look at a company as a typical investment (like a savings account) and the earnings the company gives would then be the equivalent of “interest.” An earnings yield of 8% corresponds to a P/E of 12.5, 10% to a P/E of 10, and 12% to a P/E of 8.33. For the cases of this example, we’ll stay broad and screen for stocks with a P/E lower than 12.5.
The second criteria is return on invested capital. This is the return the company earns on capital that it invests. Net Income minus Dividends divided by Total Capital. Typically speaking, a company needs its ROIC to be higher than its weighted average cost of capital (WACC) for its capital investments in the business to be worthwhile. We won’t take the time to get into this right now, but it basically means the interest the company must pay on the money it borrows. WACC is just a particular way of measuring it. For simplicity’s sake, we’ll just assume a company must pay 6-8% (taken from the amount that an investment grade bond typically yields). Thus, we want to look for ROIC greater than this. For the cases of this example, let’s use ROIC greater than 10%.
Third, we’ll use Return on Assets for a final look at the company’s ability to return on what is invested in it. This is the money the company generates from the money invested in its assets. As we’re going on the theme of us being an owner and paying for these assets in hopes of return, we’ll once again use 12.5% as the minimum.
These criteria actually yield a plethora of companies. In order to pare this down, we’ll add in a few more criteria. Price to book less than 1.6 (from Tweedy Browne’s What Has Worked in Value Investing) and Market Cap above $500 million and most importantly EPS over the last 12 months greater than $0.01 to ensure that we are, in fact, looking at profitable companies.
This screen yields 16 results but several are trusts and funds which do not fall under the valuation strategy we are attempting here. Those that are actual operating companies include: Owens Corning, Evercore Partners, Uranium Participation Corp, Avatar Holdings, Capital Southwest, Petroleo Brasileiro, Kayne Anderson MLP, Real Networks, Central Securities Corp, Gazprom OAO, and Tri-Continental Corporation. I think I might put these on my watch list. If anyone has any thoughts on these, do comment.
Ultimately, with an absolute value screen, I like having very pared down results. You’re looking for the best of the best here. Stocks trading at low multiples regardless of the industry they are in and, hopefully, in spite of decent to good (or at least improving) earnings numbers. After doing this screen, a fair amount of research must be done to ensure that your eventual picks have good upside potential while also insulating you from downside risk. A concentrated portfolio of these types of picks is nothing to be afraid of so long as you do your homework.
Relative Value
Screening for relative value using the MSN screener is simple. The criteria are basic and you’ve probably seen them before - Price to Earnings, Price to Sales, and Price to Book. MSN’s screener allows you to simply choose to screen for P/E and P/S ratios less than industry average. It will then report both the stock’s P/E and P/S ratios as well as its industry average P/E and P/S ratios. To pare down these results, we add in a simple P/B between 1.0 and 1.4 as well as a 12-Month EPS from continuing operations greater than 0. Make sure to display industry average and then select how many stocks you’d like MSN to find for you. There were actually over 200 stocks which matched these criteria, but MSN Money is good in yet another way. You can click “Edit -> Copy Results to Clipboard” and you can bring all the data into Excel and manipulate it as you like. Make sure to add to your criteria “Industry Name” and then head on over to Yahoo! Finance’s Industry Center. At the industry center, you can check which industries are the best performing and use this to continue to pare down your results.
With a relative value screen, it could be a good idea to create a larger basket of stocks and play the probabilities. As you are not dependent on true valuations, some of the stocks you pick may not pan out. Or, maybe an industry as a whole will correct and, while your stock had a lower than industry average P/E, this may not be enough to insulate you from the risk of a broad correction. A good example of this might be some of the current laggards on a valuation basis in the financial services or homebuilder industries. These industries are getting hit hard and even those that might look attractive on a multiple basis are not spared.
The best way to mitigate risk, outside of individually analyzing each and every company on your screen, is to choose those which look the most undervalued throughout many uncorrelated industries. By diversifying your holdings through various industries, you will be able to mitigate non-stock market risk as well as industry risk. Furthermore, a good mix of stocks will keep extraordinary events risk down to a minimum as not all the companies you invest in should be equally affected by surprising current events. A little bit of extra thought can actually go a long way to helping to smooth out your volatility and keep you from being too heavily invested in stocks which move in sync with each other (are too correlated). The lower than average valuations set forth in this screen should then put the odds of good returns in your favor.
