Finding a Stock Winner:
First Step Screening
John M. Bajkowski
President
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 Strategies
1st step = Screening Process
• Approach should match your investment philosophy
• Establishing criteria to narrow a large stock
universe to 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
• Provide framework for buy/hold/sell process
2nd step = Valuation Process
• In-depth examination of a company to establish if its
stock price reflects a fair value
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VS.
Buy Low, Sell High
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Buy High, Sell Higher
Long-Term Performance by Approach
Long-Term Performance
1928 to 2014
Large
Large
Small
Small
Growth
Value
Growth
Value
Ann'l Return
(%)
9.1
11.3
9.4
14.1
Standard
Deviation (%)
20.0
27.4
32.8
32.3
Long-Term Performance By Approach (% )
1920s* 1930s 1940s 1950s 1960s
Large Growth
8.1
1.5
7.3
17.6
7.9
Large Value
9.0
-5.5 17.2 22.2 10.7
Small Growth -13.3
7.4
11.6 17.7 10.7
Small Value
-4.8
-0.3 21.0 20.0 15.4
*Based on the period 1928-1929
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1970s 1980s 1990s
3.4
15.8
19.9
12.2 20.2
13.9
5.8
10.8
15.0
15.0 21.1
14.5
Source: Morningstar &
2000s 2005-14
-1.8
8.5
0.3
6.7
-1.1
8.2
10.6
8.0
CRSP
Long-Term Performance by Size
Ann'l
Return
Decile
1 - Largest
9.4
2
10.7
3
11.1
4
11
5
11.7
6
11.5
7
11.6
8
11.7
9
11.6
10 - Smallest
13.5
Large Cap, S&P 500
10.1
Mid Cap, 3-5
11.2
Small Cap, 6-8
11.6
Micro Cap, 9-10
12.3
Treasury Bills
3.5
Inflation
2.9
Source: Morningstar & CRSP
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1926 to 2014
No. of
Standard
Serial
Firms
Deviation Correlation
19.1
0.07
185
21.7
0.01
199
23.8
(0.03)
194
25.8
(0.03)
221
26.4
(0.03)
215
27.3
0.01
265
29.2
0.01
317
33.3
0.00
417
37.4
0.06
395
42.8
0.14
948
20.1
0.02
500
24.6
(0.03)
630
28.9
0.01
999
39.1
0.08
1343
3.1
0.91
4.1
0.64
Largest
Stock
% of Total
Market
Cap.
$591.0 bil
$24.3 bil
$10.1 bil
$5.8 bil
$3.7 bil
$2.5 bil
$1.7 bil
$1.0 bil
$548 mil
$300 mil
$591 bil
$10.1 bil
$2.5 bil
$548 mil
64.3
14.1
6.9
4.5
3.0
2.5
2.0
1.5
0.8
0.6
78.3
14.4
5.9
1.3
Recent Performance by Size
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Data as of 4/30/2016
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Recent Performance by Style
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Data as of 4/30/2016
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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
Davide Dreman, Peter Lynch,
John Neff
Value with price momentum
Lakonishok, Value on the Move
Earning estimate element
Dreman with Est Revisions
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Strong-Performing Growth & Value Screens
Data as of 4/30/2016
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Value Screen: John Neff
• While serving as portfolio
manager of the Vanguard
Windsor Fund from 1964 until
his retirement in 1995, Neff
employed a value investing
approach using a stringent
contrarian's viewpoint
• Approach presented in his book
"John Neff on Investing"
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Screening Process
1) Construct and refine primary criteria
2) Construct secondary criteria to determine if companies
passed the screen for the right reasons
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Primary Neff Value Filter: Price-Earnings
• Price divided by earnings per share
• Ratio embodies the market’s expectations
of future company performance
– Stocks with high growth prospects trade with
high P/E ratios, while those with low ratios are
expected to have low growth or high risk
• Seek out stocks with low price-earnings
ratios with the belief that the market may
be over-discounting the negative news or
oblivious to company’s potential
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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
high earnings,
increasing
earnings figure
= higher P/E
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peak
expansion
Anticipation of
earnings decline,
larger earnings =
low P/E
trough
Expectation of
improving earnings,
earnings below $1 or
negative
= high P/E or NA P/E
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P/E Ratio: Screening Strategies
• Low absolute price-earnings screens
• Relative price-earnings screens
– Below market P/E ratios
– Below industry norms
– Below company historical average
• P/E to growth ratio (PEG ratio) screens
– P/E divided by EPS growth
• Future vs. historical earnings growth
• Adding dividend yield to growth rate
– Look for low ratios
– Identify stocks with earnings growth prospects that
are not fully recognized by the market as measured
through the price-earnings ratio
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• P/E Ratio = 10, EPS Growth = 5%
– PEG = P/E ÷ Growth = 10 ÷ 5 = 2.0
• P/E Ratio = 10, EPS Growth = 10%
– PEG = P/E ÷ Growth = 10 ÷ 10 = 1.0
• P/E Ratio = 10, EPS Growth = 10, Yield =
5%
• Div Adj. PEG = P/E ÷ (Growth + Yield)
= 10 ÷ (10 + 5) = 0.67
• For further info see AAII stock screen “A
Combination Approach: Value on the Move”
www.aaii.com/stock-screens/screendata/ValueEstGrowth
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Screening Using Stock Investor Pro
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The ratio of the price-earnings ratio to the sum of the estimated growth in
earnings and dividend yield (div-adjusted PEG ratio) is less than or equal to
half the median value for the entire database
Current
Market PEG
Avg: 3.48
Median: 1.80
Stocks: 1,675
219 firms
passing
from a total
of 6,813
companies
(data as of
6/6/2016)
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The estimated growth rate in earnings per share is greater than or equal to
7% and less than or equal to 20%
• Neff wants companies with strong projected earnings growth, but not too high to
avoid high risk stocks
1,321 firms
passing
independently,
114
cumulatively
Note only
2,359 stocks
with long-term
growth
estimates
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The five-year growth rate in sales is greater than or equal to 7% and less than
or equal to 20%
• Growing sales leads to growing earnings
• Strong, but reasonable growth
1,341 firms
passing
independently,
30 cumulatively
20
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Free cash flow over the last 12 months and the last fiscal year (Y1) is positive
• Free cash flow is cash from operations left over after satisfying capital
expenditures and dividend payments
• Excess cash generation will hopefully be used to benefit investors: stock
repurchase, increase dividends, strategic acquisitions, expansion, etc.
2,216 firms
passing
independently,
13 cumulatively
21
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The operating margin over the last 12 months and last fiscal year is greater than
or equal to the industry’s median operating margin
• Robust margins point to competitive advantage
• Comparison should be made against industry norm because margins are very
industry specific
2,362 firms
passing
independently,
12
cumulatively
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Stock Investor Pro - Screening data date: 5/6/2016
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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
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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C=Current Quarterly Earnings
• Strong and improving quarterly EPS performance—at least
18% to 20%
• Important to compare a quarter to the same quarter from the
previous year
• O’Neil looks at earnings from continuing operations
706 firms
passing from
a total of
6,813
companies
(data as of
5/6/2016)
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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
164 firms
passing
independently,
41 cumulatively
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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
Screen for
stocks within
10% of their
52-week
high
1,531 firms
passing
independently,
18 cumulatively
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S=Supply and Demand
• Firms with a smaller number of shares outstanding
should increase more quickly
• O’Neil recommends looking at “float”
– Shares outstanding less shares held by insiders
Screen for float
of less than 20
million shares
outstanding
2,493 firms
passing
independently,
7 cumulatively
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L=Leader or Laggard
• Look for market leaders in rapidly expanding industries
– Buy among the best two or three stocks in a group
• Use relative strength to identify market leaders
Screen for 52week relative
strength rank
above 70%
2,009 firms
passing
independently,
6 cumulatively
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I=Institutional Sponsorship
• A few institutional sponsors are needed for
above-market performance, but not too many
• Look at record of institutions
Screen for at
least 5
institutional
shareholders,
consider cap
5,041 firms
passing
independently,
5 cumulatively
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M=Market Direction
• The trend of the overall market will have a
tremendous impact on the performance of
your portfolio
• O’Neil tends to focus on technical
measures when determining the market’s
overall direction
• O’Neil suggests that any good technical
analysis program or study of Investor’s
Business Daily should be sufficient
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Stock Investor Pro - Screening data date: 5/6/2016
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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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Potential Pitfalls of Stock Screening
• Dependent on the accuracy of the underlying data
• Limited mainly to quantitative factors
• 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
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Potential 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
–
–
–
–
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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
Provides framework for buy/hold/sell decision
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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Don’t expect miracles
• Maintain reasonable expectations
• Market is reasonably efficient
• Micro-cap stocks tend to have consecutive periods of
overperformance and then underperformance
• Important to maintain diversified portfolio and consider all
asset classes, and foreign markets as well as domestic markets
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Common Elements
• 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
• Unique Niche
• Strong Financials
• Price Momentum
• Earnings Revisions
• Disciplined Investment Approach
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Article on Screening Process
http://www.aaii.com/stock-screens/constructingwinningstockscreen
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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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Screens are
located within
the “Stock
Screens” 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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
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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
Top Screening Systems
GuruFocus
Morningstar Premium Stock Screener
StockCharts.com
Zacks.com
Portfolio 123
Profitspi
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Stock Investor Pro
• (800) 428-2244 – www.aaii.com/stockinvestorpro
• Systems: Windows Vista or higher, including Windows
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• Price:
– $198/year (AAII Member)
– $299/year (Non-AAII Member)
• Universe: Approximately 7,000 U.S.–traded stocks
• Number of Data Fields: 2,200+
• Fields for Screening: 2,200+
• Data Sources: Thomson Reuters, I/B/E/S
• Frequency: Weekly
• Distribution: Internet
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Morningstar Premium
Price: $189/year or $22.95/month; 14day free trial
At a glance:
-Current and historical screening
parameters for time series analysis
-Screen on proprietary appraisals and
style categories
-Deep library of fundamental
screening variables
-Roughly 10,000 companies, over
1,800 screening parameters
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Portfolio 123
Price: $29/month or $83/month; 15-day
free trial
At a glance:
-Backtest screening strategies
-One of the largest libraries of
fundamental screening variables and
predefined screens
-Create custom screening variables
-8,000 companies, 1,200 screening
parameters
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Thank you very much for attending this presentation.
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