A key trait successful investors share is a list of characteristics they want in a stock.
The criteria will vary, depending on the style of investing, but there specific traits a stock must have to qualify as a potential investment.
The advantage of knowing what you want in a stock not only helps you build wealth, but it also helps to reduce research time. If you know what traits you want, you can build a screen to find stocks possessing those characteristics.
For example, I’m a value investor who likes bargain stocks. A bargain stock has fundamental characteristics that should drive the price higher. To find such stocks, I created a personalized “Shopping List” stock screen. As the name implies, this screen identifies stocks with characteristics I want in a portfolio holding.
This is a restrictive screen designed to both find potential investment candidates and eliminate those companies I would likely pass on buying. It is based on my book, "Better Good than Lucky", and seeks out stocks with more potential reward than risk.
Before discussing the criteria, I want to emphasize that a screen is merely a database filter. Screens can only determine whether or not a stock meets specific criteria. A stock screen cannot tell you if a stock is an attractive investment. For example, the financial numbers of Hewlett-Packard tell you nothing about what will or won’t happen to the company’s PC business. So, treat any screen as merely a starting point for further research.
One driver of higher prices is rising sales and profit along with stable to rising earnings estimates. I combined these traits with a return on equity (ROE) ratio that is above the average of a company’s peers—a sign of good management.
Though profits receive a lot of attention, they are merely an accounting figure. This is why I want cash from operations (CFO), which is located on the cash flow statement, to routinely be positive. Furthermore, CFO should also routinely exceed capital expenditures (what the company spends on equipment and other fixed assets). I prefer dividends, and I want them to be either be stable or rising.
The balance sheet must be strong with a current ratio above 1.0 and a debt-to-equity ratio below 50%. Goodwill and intangibles should account for 50% or less of book value. (The reported values of goodwill and intangibles are subjective and can artificially reduce the price-to-book ratio.)
Finally, I set the valuation limits at a maximum price-to-book ratio of 4.0 and a maximum price-earnings ratio of 25.0. I have no intention of paying either multiple for a stock, but I want to set the valuation limits high enough to attract stocks I would be willing to watch while waiting to see if they go “on sale” in the future.
The table below lists the stocks currently passing my screen. Keep in mind that it is merely a starting point; not every stock may look attractive upon further research, as will be the case with any stock screen.
DISCLOSURE: Mr. Rotblut currently owns Intel (INTC) and may buy other stocks appearing in the screening results in the future.
Charles Rotblut, CFA is a Vice President with the American Association of Individual Investors and editor of the AAII Journal.