February 1st, 2022

Stock Screening Strategies to Avoid

As any experienced investor knows, stock screening is one of the first steps in buying and selling stocks.

As any experienced investor knows, stock screening is one of the first steps in buying and selling stocks. After all, there are a multitude of stocks available out there. And stock screening is the only way to filter the right options. However, using a stock screener might not be of that much value if you are unsure about what not to do with it. Making wrong moves using a stock screener is as easy as making a valuable investment with it. So, what are the stock screening strategies that you need to avoid at all costs? Here are the five suggestions that we have in this regard. 


#1 Following The Stock Screening Strategy of Someone Else 


Though stock screeners are really useful, they can be highly daunting. There are multiple variables to figure out within a limited time. So, where does a stock investor start? Well, certainly not by looking at the stock screening strategy of someone else, regardless of how expert you think they are. 

Start with your goals. The goals you set for money tend to dictate the stock screen variables you pay attention to. For example, when your goal is to grow the portfolio aggressively, you might plan to screen for stocks using a higher beta. The higher beta stocks come with greater volatility. It can have above-average returns compared to the broader market when you are okay with taking above-average risks. 


#2 Paying Attention to Only Short-Term or Technical Indicators


When you’ve a buy and hold plan, a good idea is to look to start screening by fundamental indicator, instead of short-term or technical indicators, such as daily price movements. 

Such growth-oriented investors may focus on the company financials through the variables like high earnings growth rate or high revenues. In the meantime, the value-oriented investors might consider screening for the companies with lower price multiples, such as price-to-earnings and price-to-book. 

Let's give you an instance of the stock screen that a value investor might resort to: 

  • P/E < market P/E 
  • Dividend yield > 2 percent 
  • Price-to-book value < 2 
  • Market capitalization > $10 billion 
  • Stock price > $5 
  • PEG (or P/E ratio / the expected five-year growth rate) < 1.5 

Now, market capitalization is crucial as it is a proxy for liquidity. Stock screeners can produce the thinly traded funds or stocks that tend to be more volatile than what you might like. Smaller market caps and wider spreads can both be a sign of a potentially volatile or illiquid stock. It is important to not jump straight on the bandwagon. While screening for the stocks, think of the names that you might not identify. They can be more lucrative than those names that make headlines.


#3 Starting Narrow and Broadening the Criteria Later


Regardless of what is important to you, the best thing you can do is to start broad and narrow down the criteria. For instance, begin with the geographical region, before moving on to dividends, industries, sectors, market caps, and more. As such, you can break down different factors that you can screen into top four categories: 

  • Technical variables 
  • Quality variables 
  • Momentum variables 
  • Value variables 

While using the stock screeners, the best thing you can do is to include the variables in all the categories as they look at the stocks in varied ways. For instance, value variables may be criteria like P/E or the more complicated variables, such as free cash flow and EBITDA. However, in general, it is important to remember that simpler seems better in case of value variables. 


At the same time, when it comes to momentum, price momentum works pretty well when you keep it simple. If possible, consider price momentum with about a thirty-day delay for screening out the short-term price variations. Also, it is necessary to consider the analyst earnings revisions to check if the estimates are going down or up. But every feature is not available on all stock screens, and that is completely fine. 


When it comes to translating quality in an objective measure, PNC takes a look at the standard deviations of EPS. Now, the companies that have stable earning patterns usually do not go down too much when the market starts declining. Also, the lower standard deviation of the EPS also offers higher confidence regarding future earning and continuity in moving forward. Some of the other quality measures are improvements in debt-to-assets, debt-to-equity, and return on equity. Moreover, S&P comes with the kind of financial strength rating that is commendable. 


Now, let’s talk about technical analysis. We saved this one for the last as it involves stock charts that need interpretation. Thus, technical analysis can be a lot more subjective than you think. This subjective part of the investment procedure has to be the last step is stock screening. Thus, after you have screened for quality, momentum, and value, you can start going through the stock charts. 


#4 Not Considering the Limitations of the Stock Screens


The realm of subjectivity can be pretty dangerous, even though it continues to be a crucial part of the stock selection. Though stock screeners are effective when trying to scrub an entire list of stocks, they are not at all effective when analyzing critical, but abstract, details about the companies. 


So, you will find information like the position of a company with respect to its patents and other such intellectual property, along with the development and research efforts of the competitors. On the other hand, one should definitely not think of investing in the companies that can pass the initial screening process. The initial screening process needs to identify the firms that demand more attention. 


#5 Not Using Stock Screens Before Selling the Stocks


One of the biggest mistakes you can make is to not use a stock screen before selling your stocks. So, before pressing ‘buy’ on those final choices, you need to ensure that you know what is going to make you sell those stocks you have. An experienced investor knows that a stronger sell discipline is way more important than a good buy discipline. As such, a ‘sell’ discipline is completely based on the objective factors that force you to do all those things that you do not want to – probably a good thing in many ways. The stock screen variables can help to inform the sell discipline.

For example, think that you are purchasing a stock for valuation reasons such as that it is in the bottom docile when considered with regards to P/E. So, maybe you can go ahead and sell it when the P/E goes over the general industry average. 


The Endnote 


Your stock screener will be a lot more profitable to you if you know the exact strategies that you need to avoid. Hopefully, you have found some direction in that regard today. So, remember these five points the next time you start stock screening.