Stock screening is a tool that investors can use to filter a large database of stocks into a more manageable list of stocks that qualify for further analysis. Stock screening tools can be web-based tools or downloadable software. There are some free screeners out there, as well as more advanced programs that can be quite costly.
Selecting stocks can be a difficult and tedious process, and stock screening programs can help you by:
- Saving time.
- Removing emotion and behavioral biases from the investment decision-making process.
- Uncovering investments you may not have known about.
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Let's go into more detail into each of these benefits.
How stock screeners save you time
There are thousands of stocks on the market, and stock screening databases usually include a subset of them. Depending on the database, the data set could include hundreds to thousands of stocks, and thoroughly analyzing all of them would be impossible for most investors. Delving into each company's financial statements, ratios, multiples, and historical and future growth prospects would take entirely too long.
Once you determine which metrics will go into your stock screen, the screener filters out stocks that don't meet your criteria and produces a list of stocks that do. The stricter the screening criteria, the fewer stocks will pass the screen. For example, if you're looking for undervalued stocks, you may search for stocks with a price-to-earnings (P/E) ratio below a specific level. If you're less concerned with valuation and more concerned with growth, you may look for stocks with a high level of year-over-year earnings growth.
How stock screeners remove behavioral biases
Investors have natural tendencies that can lead them to make unwise investing decisions. These are generally called "behavioral biases," and they can be difficult to detect and avoid. These biases can lead investors to make illogical investment decisions which ultimately hurt returns over time. For example, investors will often change their strategy so that certain stocks will fit into it. Say I really liked the company Target Corporation (NYSE: TGT) because I shopped there often. I might convince myself that I should buy the stock even if, according to my investing strategy, it had too high of a price-to-earnings (P/E) ratio or too little revenue growth. Stock screening helps to remove these types of biases and helps investors to remain objective.
That said, a stock screener won't save you from behavioral biases entirely. For example, if I wanted Target to pass my screen, I could change my screening criteria until it passed.
How stock screeners reveal new investment options
Another major benefit of stock screening is that it can unearth potential investments you would not have considered otherwise. If a screening database has 7,000 stocks, then it likely includes some stocks that you're unfamiliar with. Often, the less familiar stocks are overlooked and thus undervalued in the market. This issue presents an opportunity for a savvy investor using a stock screening program.
How to get started with stock screening
The first step in stock screening is determining which service you want to use. The key considerations are the screener's database, the screening criteria it includes, the functionality of the tool, the cost, and your personal preferences. A good starting place is a free online screening tool. Some companies that have free screeners include Finviz, Zacks Investment Research, Morningstar (you have to create a free account), Yahoo Finance, and Fidelity. Some more complex (and comprehensive) online screening tools include Stock Rover, Portfolio123, GuruFocus, and Morningstar's Premium Screener. Some downloadable stock screening programs include Equities Lab and AAII's Stock Investor Pro.
The next step is to determine which metrics you want to include in your stock screen. Typically, you'll start by narrowing your universe of potential investments with criteria such as market capitalization, P/E (for a value-oriented approach, perhaps), or earnings growth (a growth-oriented approach).
Once you have a collection of stocks that have passed your screen, you have to determine which stocks qualify for further analysis. This may be based on fundamental analysis, additional market research, or your current portfolio's allocation to specific sectors or industries (perhaps you want to avoid specific sectors).
Screening is only the beginning
Stock screeners are just one of the many tools in the Foolish investor's toolbox, and though they can help you narrow down your potential investments, it's important to do your own research into companies' businesses and decide whether or not you believe in their long-term prospects. Just because a stock passes your screen doesn't mean it's a good investment.
Happy screening!
