BITS > MARCH 2002

Screening for Stocks: A Walk-Through Example

Editor's note: Special thanks to Brian Lewis for contributing this article on stock screening. An NAIC member since 1994, Brian is a founding member of NAIC's Online Investor's School and has presented a number of classes online. He has taught a variety of NAIC classes in the Seattle area since 1999 and has published several articles in BITS and Better Investing. Brian is a director of the NAIC Puget Sound Chapter and a member of two investment clubs: the EPIC and the Coast-to-Coast Investment Club. He can be reached at brianle@nwlink.com As always with BITS editorial features, this article is presented for its educational value with no investment recommendation intended.

Normally when you hear the term "stock screening," it refers to the use of a computer to sift through a huge number of stocks to find a few that fit specific criteria that you've established. For example, you might tell the computer to show you a list of companies that have had earnings growth greater than 10 percent over the past five years, that have at least twice as much equity as they have debt, and whose pre-tax profit margins are above their industry average.

In its most general form, a stock "screen" is just any method we use to narrow down a large group of stocks to a more manageable "most interesting" list. My own favorite ideas for finding stocks to study were published in the April 2001 issue of BITS. This in turn came from an Investor's School online presentation in February 2001; like other Investor's School presentations, you can find the transcript online, this one at the transcript archive.

But this is a BITS article, so let's just focus on using a computer to do it! Better yet, we'll go through a specific example. Note: you'll understand and get a lot more out of this if you "play along at home," so don't just sit back and read through this, but try out some of these techniques as you go along.

Where to Find More About Stock Screening

I won't try to tell you everything there is to know about stock screening; this topic has been well covered already. There have been a number of stock screening articles published in Better Investing. You can read back issues up to two years in the past by going to NAIC's Web Site, http://www.better-investing.org/ and looking in the "Members Only" area on the left of the screen. (Editor's note: On the new Web site, go to "Publications.") Bonnie Biafore's regular 'Web Watch' column focused on stock screening in the January and February issues of 2002, as well as in the September 2000 issue. Bonnie also gave some screening-related ideas in her columns in the October and November issues of 2000, and in her February 2001 column. Brian Goodhart wrote an article on stock screening as well, in the August 2001 issue of BI.

Finally, you can read about stock screening at these online locations:

Smart Money

Business Week

Zacks

Screening at MSN Money Central

Bonnie's articles talk about using the Quicken, Morningstar, and WSRN sites, and Brian Goodhart's article illustrates Marketguide.com's screener. For my example I decided to choose yet another tool: Microsoft's Money Central. I started out at http://moneycentral.msn.com and clicked on the "investing" tab towards the top, then on the left under 'Stocks' I clicked 'Stock Screener,' which took me to http://moneycentral.msn.com/investor/finder/predefstocks.asp

By the way, I ran through this example late in January 2002. Web sites can change pretty quickly, and company data even faster, so you might find that things don't work exactly the same for you. The general approach should work just fine, however.

There are actually two general approaches to doing stock screening: either use a "predefined" search according to someone else's criteria or specify all the variables yourself.

Something I really like about the Money Central screener is that its "deluxe" predefined searches can be modified, so I decided to choose one of those that's based on a philosophy similar to mine, and then modify it to become my own custom search. Note that the first time you try to run a "deluxe" search, you might be required to download and install a little software. This went quickly and easily for me.

A couple of the "deluxe" searches looked like good places to start. I chose the "Contrarian Strategy." I just clicked the link and that put me at a screen that's the same as if I had started a custom screen from scratch, except that it had the Contrarian Strategy criteria already put in for me, and a list of companies that meet all those filters (see Figure 1). I recognized several of the 20 companies that showed up, and I even own shares in one of them!

Click to enlarge.

Figure 1

Hint: click on the 'Enlarge/Reduce Screener' link toward the top and in the middle of the page to improve your view.

Customizing a Predefined Screen

Next I modified some of the criteria to make this screen do what I wanted it to. You can see in Figure 2 (below) that for each criterion (row) there's a "field name," an "operator," and a "value." The idea is pretty easy once you've seen it in action. For any given row, you can click in any of these three areas to get a drop-down menu from which you select a criterion. For example, with a field name of "P/E Ratio: Current," the operator is "<=" (which stands for "less than or equal to") and the value is "S&P 500 Average P/E Ratio: Current." Note also that when you select a field name, the field description tells you something about it.

Click to enlarge.

Figure 2

Now I wanted to change the "value." I didn't want to compare the current P/E ratio to the entire collection of 500 stocks in that index. Instead, I clicked to drop down the choices for the "value," selected "Price Ratios" (because P/E is a price ratio), and from the resulting list I selected "Industry Average P/E Ratio: Current" (Figure 2 below). I think it makes more sense to compare the P/E ratio of a company to the average for the industry that company is in.

I left several of the Contrarian Strategy criteria alone. That's why I picked a strategy similar to what I'm interested in. I just deleted the "Current Dividend" criterion because it's not important to me -- I was hunting for growth stocks. To delete that row, I right-clicked at the far left of the row and selected "delete row." Note that instead I could have changed the operator to "display only," meaning that the dividend yield wouldn't figure into the screen, but it would show up in the table of results. I also deleted the last two criteria, as I didn't like those choices for comparing Earnings Per Share (EPS) growth.

Hint: either use the scroll bar just right of the value field to see all the rows or drag the bar down just below there to see more rows at once.

Next I put in a couple of additional criteria. To add a new row, scroll to see the bottom (empty) row, click in it, and select your criterion (see Figure 3). I added "5-Year Earnings Growth", chose the ">=" operator, and on the right side selected a custom value: 10% (the '%' sign isn't needed, however). Now, in addition to the other criteria I left in place, my screen would reject any stock with an EPS growth history over the last five years of less than 10 percent.

Click to enlarge.

Figure 3

As a long-term investor, I'm interested in management efficiency, so I added inventory turnover as a criterion under "management efficiency." I chose the operator and field value to require it to be as good as or better than the industry average. Be careful, however. It's easy to get carried away, either by putting in too many criteria and getting too few results, or by using criteria that you don't really understand.

Hint: Try the 'Help' link at the upper right of the Money Central screen and try searching on terms like "inventory turnover" to get a little better idea of what some of these things are.

Hint: if you want to learn more about some of the ratios that you can screen on, a great place to read or search is the Ratio Analysis Workshop from January 1998. You can find this at http://www.better-investing.org/ftp/i-club-list-files/ratio-analysis-workshop.txt.

My Custom Stock Screen Results

Okay, that's it. I clicked "Run Search" and got my results. Hint: You might want to add a column for the industry name for each of the screen results. One way to do this is to right-click on any of the column headings of the results table below, select "customize column set," expand one of the categories, add it to the column set and move it up or down as desired. The Industry Name is in the top category, "Company Basics."

Hint: I like to move the industry name all the way up. Then I'll just left-click on that column heading to sort the results by industry. I find this especially helpful when I've got a long results list or if I'm interested in doing an industry study.

On the day I ran this screen, I got a total of seven companies in my results list: Timberland Company, Qiagen N.V., Barr Labs, Scientific-Atlanta, Noble Drilling Corp., Cardinal Health and Nokia Corp.

I'm already familiar with Barr Labs, Cardinal Health, and Nokia, so maybe some of these others would also be worth a look. Hugh McManus did a thorough analysis of Qiagen in the Winter 2002 issue of BITS.

In addition, Qiagen doesn't show up among the Value Line 1700 stocks, so I chose to skip this biotech stock.

Hint: How did I know that Qiagen is not in Value Line without going to the library? I used the ticker symbol from my screen results and entered that in http://www.valueline.com/lookup/current.cfm. Be careful to stick to stocks that show up in Value Line's Standard Edition, at least unless you know that your library carries Value Line's Expanded Edition as well. Of course if you're using a different data source, these considerations don't apply.

After removing companies I was already acquainted with, I was left with Timberland (NYSE: TBL), Scientific-Atlanta (NYSE: SFA) and Noble Drilling (NYSE: NE). My next step was to take a quick look at each of these three to see if any were worth doing a Stock Selection Guide (SSG) on.

Next Step: Review the Stock Screen Results

For this, I use the techniques outlined in an article I co-wrote in the February 2001 issue of Better Investing. NAIC members can read this online at http://new.better-investing.org/articles/bi/127/1029. These techniques as outlined require access to Value Line, so you will have to go to the library to do this, or you could try to get enough information from the Internet to do your "quick scan." It would be nice to be sure that you have at least one company worth doing an SSG on before making that trip to the library. I suggest http://www.marketguide.com as a good place to start.

Another is to go to the company Web site and see if you can download an annual report. I started out by clicking on the 'TBL' ticker link from the stock screen results. This actually gave me quite a lot of information, including Timberland's Web site at http://www.timberland.com.

Some will find value in Money Central's "research wizard" which you can access at the far left of the screen. I find this to ask a mix of good questions and some not-so-good questions from an NAIC perspective.

Timberland looked like it was worth some investigation. It's currently in a slump, but it looks like the reasons for this might be acceptable, and the company has the financial strength to weather the downturn.

Scientific-Atlanta doesn't have a steady history of growing EPS. This is easy to see by just scanning the EPS line on the Value Line page. Ditto with profit margins and return on equity. I decided to pass on this company.

Noble Drilling also has an inconsistent EPS growth history, but I recognized that the oil services sector has cyclical characteristics, so I didn't immediately toss this one out. I do find myself uncomfortable, however, about Value Line's Financial Strength rating of just a 'B.' That's fairly low.

Of the three, I liked Timberland best. Because it's one I've never studied before, I decided to dig into this stock and see where my screening adventure had taken me.

Final Screening Thoughts

Some final screening thoughts before going on to that, however. First, if you want to improve your screening technique, look at the stocks you ended up rejecting from the last screen you ran (Scientific-Atlanta and Noble Drilling in my example). Can you modify the screen so it would reject those for you? One thing I wish I could do would be to screen for Value Line's Earnings Predictability and Financial Strength ratings. In fact, you might be able to do this at your local library.

Ask the librarian if you can be set up on a computer at your library with online Value Line access. With the librarian there to supply a password, you should be able to access Value Line's stock screening tool at http://valueline.stockpoint.com/valueline/stockfinderpro.asp?Survey=Standard

Screening is part art and part science. Play with one or more of the free stock screeners available on the Internet, try things out. See what you get. Each is a little unique, so maybe you want to try out a couple. For example, marketguide.com has a screener that clearly shows how many stocks are left after each separate criterion. This can give you an idea of the impact of a specific criterion and thus help you tune your process.

Even if you were to use "wrong" techniques, sometimes you can still get "right" results, i.e., interesting stocks worthy of further study. Of course we should never buy a stock strictly based on a screen -- always follow through with analysis, including a Stock Selection Guide.

On to Study Timberland Company

Okay, now let's dig into Timberland Company (NYSE: TBL). One thing I might like to do is get a good list of competitors to compare it to. This can be a little tricky. It's not too hard to find a list of all stocks in that industry, but a list of closest competitors usually takes some work. Nancy Crays provided an interesting idea in a reply to this very question on the I-Club-List recently. She suggested trying http://www.hoovers.com, so I'll do that. First I enter the ticker (TBL) and select "search by ticker" and hit "go." Then I look a little lower on the page and see a list of three "Top Competitors," which Hoovers says are L.L. Bean, Lost Arrow and Wolverine World Wide.

In the same I-Club-List discussion, Cecelia Munzenmaier suggested using Quicken.com to compare competing companies, so I navigate to http://www.quicken.com/investments/comparison/, enter the TBL ticker, and hit the enter key. The result is a list of competitors, but it doesn't include L.L. Bean or Lost Arrow. Digging around a bit further on the Hoovers site, I find out why: these are private companies; I can't buy their shares on the stock market. So I'll go back to the Quicken site, and at least now I know that of the companies listed there, Wolverine might be one of the closer competitors. I can click to select a few of those companies (I chose Nike, Reebok and Wolverine), change to display fundamentals (rather than a price chart) and click the "compare" button.

Why Competitors?

Why am I doing this? Because if I do buy a company in this industry, I'd rather buy the "best of breed" or at least include the top companies in my analysis. Of the four companies, I see that TBL is the only one with a positive five-year income growth, and it also has the best five- and 10-year revenue growth. Debt isn't out of control for any of the four, but TBL alone has no debt.

From what I read in the ratio analysis workshop, I find both the current ratio and the quick ratio acceptable for all of these companies. I can see that TBL is tops in return on equity and return on assets, and that these have both been increasing for the company.

Okay, I'm sold. Let's go to the library, get the Value Line page and do the SSG.

Stock Selection Guide for Timberland Company

I usually use Investor's Toolkit, but I've been looking over Stock Analyst lately, so I'll use that tool just for the experience. Toolkit and Stock Analyst each have some unique features, but either tool makes the SSG process faster and easier.

Entering the data is pretty straightforward, though Stock Analyst allows me to enter some additional balance sheet data that I'm not used to from Toolkit. The help system gets me through this pretty easily, taking just a little extra thought the first time through.

Looking at the Visual Analysis graph of the SSG (below), I see that the sales growth history is a lot more consistent than earnings. Profits and earnings dipped and then climbed back in 1994--1996. Aside from those years, the other thing that strikes me immediately is how the historic EPS growth rate has been so much higher than sales growth.

Timberland did that using both of the primary means of growing EPS faster than sales: increasing profit margins and reducing the number of shares outstanding by buying back shares. The other thing I notice from the front side of the SSG is something I had to grapple with a little in entering the data: percent insider ownership. I'll come back to this matter later.

Sales growth has been pretty consistent, and Value Line's estimate of a future sales value lines up pretty well with historic growth rates.

I end up deciding not to remove any outliers, because I'll use the preferred procedure to calculate a future EPS value, and I'd rather the SSG show the actual history.

I like the fact that Stock Analyst allows me to adjust the historic trend lines. Doing this with the sales growth history plus looking at Value Line's estimated future sales figure helps me arrive at an 11.5 percent sales growth estimate for the next five years.

Preferred Procedure Calculation

Instead of "Preferred Procedure," Stock Analyst uses the more logical term "Revenue Based EPS." For this calculation I used Value Line's estimate of the future tax rate. For % Pretax Profit on Sales, I chose a figure very close to the most recent year. This is a key judgment, and I almost always find my choice is lower than what Value Line forecasts.

My logic here is that Timberland has been raising profit margins every year for five years in a row, and then it dropped off this year. Picking the current value gives me a number that's historically high, yet conservative relative to the analyst estimates and to what was achieved last year. Finally, I chose 38 million shares outstanding, somewhat less than the nearly 40 million outstanding today, to reflect a history of stock buybacks, but less optimistic than Value Line's estimate.

The result is an 11.5 percent estimate for EPS growth, same percentage I chose for sales growth. As a cross-check, I'm comfortable that my 2006 EPS estimate of $4.74 is well below Value Line's '04-'06 estimate of $5.20. Note: I'm using the November 16, 2001 issue of the Value Line report on Timberland. By the time this feature appears in BITS Online, an update report will be available.

Note also that even though the 4th quarter of FY 2001 hasn't been reported yet (in late January), I elected to use Value Line's estimate numbers for FY 2001. The year is complete and the company will report those results soon, so I decided I would err less by using the estimates for the final quarter of 2001 and for FY 2001 in general.

All of the Section 2 (Evaluating Management) numbers look great (below). Stock Analyst optionally adds a third line to this section to let me see the historic trend of the debt-to-equity ratio, and it's hard to find fault when the ratio has declined to zero.

In Section 3 I don't feel the need to remove any outliers. The previous down years were longer than five years ago, so there are no issues there. Similarly, in Section 4 I used the default values for average high and low P/E ratios and for the low price calculation.

SSG Analysis Results

The stock price was $38.65 when I did my analysis. Even with the more conservative 25/50/25 zoning in Section 4, the stock is (barely) in the Buy zone, with an upside/downside ratio of 3.3 to 1 and potential compound total return of almost 21 percent. Looks great. Should I consider buying shares in this company?

Here's where I want to do a little extra reading and thinking. One thing that bothers me is listed in the Capital Structure section on the left of the Value Line page: there are two classes of stock. Class 'B' shares get 10 times the voting power than the class 'A' shares. Reading in the "Business" box in the middle of the page, I see that someone named S. Swartz owns 98 percent of these class 'B' shares, and that the Sidney W. Swartz 1982 Family Trust owns a further 31.4 percent of the class 'A' shares. Doing a hasty calculation, it looks to me like the Swartz family has almost 80 percent of the voting power. Furthermore, the Chairman is S.W. Swartz, and the CEO is J.B. Swartz. Looks to me like a family owned business that went public (in 1987) but has maintained effective and virtually complete control of the company nevertheless.

This isn't automatically bad. It's certainly nice to think that the chief officers probably have most of their fortunes tied up in the enterprise. At the same time, before I bought shares I would want to be sure that senior management is chosen based on merit (rather than family connection), and that the Swartz family goals and plans line up well enough with my goals as a shareholder. When, for example, might they choose to pay a dividend?

Another factor is my feeling about the economy in general, plus I might want to investigate further to see how well Timberland has been doing in the current economic conditions relative to its competitors.

And a question I like to ask about any growth company: Where will future growth come from? For example, will future growth come more from international sales or more from domestic? From adding stores, or broadening its product offerings? If the company is able to keep reducing expenses, exactly how will it do this? Are there any concerns about how its overseas workers are treated (in the Caribbean, China and Taiwan)?

If you're interested in this company, these are the kinds of questions you might want to read and research to answer to your own satisfaction. My gut feeling at this point is that a long-term investor would do okay with this company, though the stock could remain "on sale" at a reasonable price for some time.

The neat thing for me, however, is that my foray into stock screening yielded a reasonable stock study candidate without a tremendous amount of work. I encourage you to play with some of these screening tools and see what kind of interesting results you can turn up!

A member since 1994, Brian Lewis is the President of the Puget Sound Chapter. He's a founding member of BetterInvesting's Online Investor's School and has presented a number of classes online. Brian has taught a variety of classes in the Seattle area since 1999 as well as at the BetterInvesting National Convention, and has published several articles in BITS and BetterInvesting Magazine. He can be contacted at brianle@nwlink.com.