Systematic Stock Selection Criteria and Tools

Key Insight

Enterprising investors seeking superior results can employ systematic methods for stock selection, moving beyond generally accepted Wall Street practices that often fail to produce desired outcomes. A practical approach involves 'winnowing' a large universe of stocks, such as the 4500+ companies listed in Standard & Poor's Stock Guide, by applying specific criteria. A preliminary screen might identify stocks with a low price-to-earnings ratio, for example, nine or less, generating a list of hundreds of candidates.

Further selectivity is achieved by applying additional criteria, similar to those for defensive investors but less stringent. These include a strong financial condition (current assets at least 1.5 times current liabilities, debt not more than 110% of net current assets), earnings stability (no deficit in the last five years), a current dividend record, earnings growth (last year's earnings exceeding those of five years prior), and a price less than 120% of net tangible assets. Applying these six requirements to a list of 450 initial candidates could narrow it down to about 150 companies, allowing for further subjective selection.

Modern stock screeners available on websites and apps allow investors to set filters for criteria like low debt, low price-to-earnings (P/E) and price-to-book (P/B) ratios, and high dividend yields. For identifying 'superstocks,' filters can target rising net operating cash flow, return on assets, and return on invested capital, averaged over three to five years. It's crucial to view screener results as a 'watchlist' for further study, not a 'buy list,' recognizing that professional investors with advanced tools are constantly scrutinizing the market. Simple prediction models with fewer criteria tend to be more robust and effective than complex ones.