Quick Links
Save
Plan
Invest
ONLINE GUIDES View Full Library
How To
Invest
in Equities
ONLINE GUIDE
How To Save
and Invest Tax
Efficiently
ONLINE GUIDE
How to Save,
Plan and Invest
for your Family
ONLINE GUIDE
By: Tim Bennett
1.11.2019
Good stock pickers use screening systems to sort good ideas from bad. This week Tim explains how they work.
To Receive Tim’s videos straight to your inbox, please click here
How stock screening works
Stock picking is tough – how do you whittle down a huge universe of options to a more concentrated portfolio of ideas? The answer lies in a decent stock screen.
Background
Equity investors are constantly bombarded by distracting “noise”, whether in the form of adverts, website bulletins or stock research notes. A screening system can help, in so far as it allows an investor to weed out bad ideas and focus on the ones that fit with their core beliefs and preferences.
Walmart versus Costco
To see how big this challenge can be, especially for a novice investor, consider the problem of choosing between two well-known retailers, such as Walmart and Costco. Both are big brands. Both attract plenty of press and analyst commentary. However, one offers a much better return on invested capital (ROIC) than the other.
As an investor, you need to decide whether you will buy neither stock, just one, or both. Therefore, as Jason Fried puts it;
The Holy Grail
The key to making this sort of decision is to build a system you are confident in and then stick to it. For example, an investor might decide to focus on three core criteria;
Whilst there is a lot of work needed in practice at this stage, let’s take each of these briefly in turn.
Do I get it?
A key opening consideration for most investors is how well they understand a company and what it does. After all, how else will you know whether it is available at a good price or not (see below)?
Financial stability
Next, you may consider whether a firm is delivering on its key financial objectives. Whilst there is no definitive blueprint here, this might look something like the following slide for a value investor;
What’s more, you need evidence that these criteria are being satisfied consistently.
Wide moat
Then, an investor might look at the future sustainability of current profitability and cash flow – also known as the width of a firm’s “economic moat”.
Price
Lastly, there is the key question of how much you will be paying for all of this. Price and value are two different things and it is the latter that matters in most investing decisions.
To find out more
Feel free to email me on [email protected] or contact an Adviser.
