The Industry Focus team offers investors their final take on stock screening, including best practices that can maximize the value of research and due diligence.
They also point out the pitfalls likely to be encountered when using screens. To learn more, just check out the conversation below.
A transcript follows the video. For the full episode, click here.
This video was recorded on April 24, 2018.
Vincent Shen: Now that we've established the tools and metrics that you have at your disposal, I want to end the discussion on what to do with the results, and some of those best practices and cautionary notes. Asit, you've run a screen, you're looking to whittle down the list of results. How do you generally approach that?
Asit Sharma: The first thing that I look at is, are my first couple of results red herrings or outliers? To give you a quick example, many of the screen services give you minimum and maximum ranges, and some just give you an option to have a number or beyond that number.
Let's talk about dividend yield, for longer-term investors who like dividends. Some of the screening services allow you to say, "I want a dividend yield above 3%." So when you put in your other parameters and then hit submit, and you see the very first stock has a 12% yield, that may be a red herring. Maybe the stock had a 3% yield, but the price has fallen by 50%, shooting the yield up. Maybe there's an issue there that the company needs to offer a super high dividend yield to attract investors. There are special cases, as we know, in real estate and in the oil industry, where higher dividend yields are expected. But in general, be careful, stock screeners can sometimes return sort of funky results. So just as you would if you get back a circular review from fellow employees at your job, you're advised to discount that very best recommendation about you and discount the really worst things that people said -- it's the same with the stock screeners. Be skeptical of the very first couple of results.
The second best practice is to work from the stock out. When you uncover a new stock, don't just research that stock. Understand the industry that it plays in, understand what's going on in that industry. That search result is your jumping off point for as much research as you want. As Vince said, if you're buying that new car and you take five minutes to figure out what's good about the car, you go to the lot and buy it, and then you complain about the gas mileage nine months later, that's on you. And that's often been on me in the past. I take a little bit more time researching now. It's worth the effort.
And then, I would suggest one more thing. If you do run a screen and come up with a stock that you love and you buy, run that screen once a quarter. The reason for that is, financials are issued on a quarterly basis for every stock that is publicly traded. And all the information that gets crunched in these databases changes every three months. You will see what has changed for better or worse with your stock, and also, it will give you a cue about the industry that that stock is playing in. It's a great way to learn about companies. Don't run a screen, find a stock, and then forget about it. Do it again and see where your stock lands. It may be moving up and getting even better, or there may be a warning flag that gosh, something has changed, I need to go back and maybe read the annual report, quarterly report, see what's going on with this stock that I've chosen.
Shen: Alright. We have a couple of more minutes here. I'm just going to add a few more notes and give you a chance, Asit, to share any final takeaways. Something that I noticed myself when I first started running these, and I used to run tons of screens in my last job when I was in investment banking. We used to look at a lot of comparable deals when trying to price equity offerings. Something that you can fall victim to is, you can lose sight of what your original goal or objective was when running a lot of screens, because you try to game the criteria that you use for your results. And if you end up with dozens, if not hundreds, of results, you might have started with those handful of essential criteria at first, then you want to start adding more nice-to-have attributes to filter that list down further.
Keep in mind, this is just one step in the stock-picking process. So even if your results return just three companies, you should be digging into, for example, the financial filings, their earnings call transcripts, and the shareholder presentations before you make any decisions, because the metrics in the screens themselves can only take you so far. So if you value things like the intangibles -- like capable management, competitive moats, product innovation -- the filters don't always tell you that whole story, so you can't let a slick set of screen criteria trick you into thinking you've done the necessary research and due diligence for an investment.
On that note, in addition to the screen links I mentioned earlier, I'll also provide the stock-picking process that Financials host Michael Douglass wrote up last year. It largely matches my own approach to evaluating a company. I think it offers a great overview of what a more robust due diligence process looks like. So again, email firstname.lastname@example.org if you'd like to get your hands on any of those resources.
We have a few more minutes here, Asit. I'm sure I've forgotten some stuff. What else do you think Fools need to know before they start diving in?
Sharma: Just to give one last thing to be aware of, and this is a caveat or caution: Be prepared for the pain of learning. Stock screening is a really wonderful way to become more knowledgeable about the market and to find stocks that you're going to be comfortable with and that promote the values, both in the real world and financially, that you espouse, that you're into. The problem with stock screens, like anything else, they will turn up great results, they'll also turn up, like I said, red herrings, or maybe even ideas that you thought were great, you invest in a company, and later on you find it was a mistake.
But you know what? You're going to learn from that mistake. Really experienced investors know what to discount when they churn these stock screens, but they've had the benefit of time and study and having painful losses themselves. So if you're at the beginning of this learning curve, don't be afraid and don't get discouraged if you buy a stock based off a stock screen and it doesn't pan out. If you've done what Vince says, if you have put in the research beforehand and learned the narrative of that company and understood it, then you're OK, because you will take away some really valuable stuff for the next screens you run. So overall, it's a really wonderful tool, as we've said. But don't walk away from it if you have a few stumbles along that path.
Shen: Thanks, Asit! I'll just add, and this is kind of related to my comments on performing proper research on any results from your screens, I think this echoes a cardinal rule because I love screens in that it's a very quantitative approach to the whole stock-picking and stock discovery process, but just remember that past results from a company are no guarantee of their future performance. A lot of the metrics that get employed in a screen are backwards-looking. That means you're going to have to dig into the qualitative aspects of that company as well to understand what will continue to, for example, drive strong revenue growth, how the company is using debt.
And then, the last thing I'll end on, and this is slightly beyond the scope of our discussion, but I think with screens, this is where the benefits of keeping an investing journal really make themselves apparent. Besides, in your journal, tracking your investing thesis for a particular stock purchase -- so, for example, why company XYZ, why at that point in time -- which is a great way to hold yourself accountable and to test your assumptions and theories over time, you can also update your journal with the goals and priorities in your portfolio and how you set them as they change over time in relation to the kind of screens that you perform.