There are thousands of companies on the public markets. So the natural starting point for stock investors is usually a stock screener.
It boils down to finding companies that meet whatever criteria you are looking for. Although using a screener is easy, it poses two risks to the unwary investor:
- Including companies which aren’t what they appear to be
- Excluding companies by mistake
Here are some popular screening factors, their risks, and solutions…
Country and Sector
This is a normal starting point. But it can also trip you up. Before narrowing down the data with these options, ask yourself why are you using them? Say for example that you think the South Korean economy has great potential. So you choose Korea as a filter in a screener and it gives you a list of companies registered in Korea.
This leads to the 2 risks mentioned because:
- A company registered in one country isn’t necessarily getting most of its business from that country. It might only be registered there because of tax considerations. Or maybe it was founded there but now gets its business from somewhere else.
- A company might be registered in a different country, but getting its business from the country you’re interested in. In this example, it might be registered in Japan but generating 80% of sales from Korea.
Either way, you are not necessarily looking at companies which are benefiting from the economy you are interested in.
This can also be a problem when screening by sector. A company isn’t always listed with the sector classification that you’d expect.
Solution: Consider searching through ‘groups’ of countries and sectors. Or use other criteria first, and then come back to country and sector when you’re down to a handful of choices.
Looking for current financial statements is popular with fundamental investors. Some technical analysts consider these too.
The downside is that this method doesn’t account for the possibility of re-statements. Sometimes, firms big and small need to issue an adjustment to historic statements. Even Berkshire Hathaway has had to do this. The way the two risks apply in this case is:
- Including companies now, which won’t meet the criteria after the adjustment has been published
- Excluding companies which would’ve met the criteria, if you’d run the search after the adjustment
Also, many screeners will only apply the criteria to the most recent year. The company may have met your criteria for a few years before that, and maybe for the coming years. But you risk ignoring it because its most recent performance didn’t meet exactly what you’re looking for.
Solution: Instead of just looking at the most recent performance, review at least 5 years of data. Be prepared to give a 2nd look at companies which you’ve previously disqualified.
I’m not a fan of forecasting. Sometimes it is necessary though, so that a company can try to plan ahead. If you screen on forecasts, you risk:
- Including companies which have misleadingly optimistic forecasts
- Excluding companies with pessimistic forecasts (maybe they’re just being cautious)
Solution: Search for the companies historic forecasts and see how they’ve turned out. Do they have a history of not delivering on rosy promises? Or do they always talk down their future earnings and still do well anyway?
This is an interesting area. The price is updated daily, with the occasional delay to an extra day or two. So you know you’re dealing with the most up-to-date data. Although normally used by technical analysts, fundamental analysts sometimes look at price charts. The question becomes, “How fair is the price? Is it high or low, relative to the intrinsic value of the company?”
I won’t try to cover valuation in a single blog post. But when it comes to screeners it’s good to always remember how far popular sentiment can push a stock.
Solution: Check recent news coverage about the company and sector. If there is a lot of negative press, public pessimism might be punishing the stock price unfairly. If there is a lot of positive press, public optimism might be raising the stock price unjustifiably.
Taking into consideration the limitations, a screener is still a great place to start. It narrows down the thousands of investment-grade stocks in the world to a number small enough to manage. With 5 to 10 companies to look at (instead of 5,000 to 10,000), you can spend your valuable time examining only the kinds of stocks you want.