Black Friday, Cyber Monday, Boxing day… It’s another wonderful shopping season! As a lazy bum, I especially appreciate the modern shopping experience: just sit and search good deals on internet. Rather than walking into each store, I can just browse Amazon, Groupon, etc. to find steep discounts (69% off iRobot vacuum is quite tempting…).
Just like online shopping, you can now also search and browse to find good value stocks nowadays. The purpose of this article is show how to use stock screeners to find potentially undervalued stocks. Before proceeding further, you may want to read my previous article (click here) to fully understand what I’m going to discuss.
Step 1: Pick a stock screener.
Personally, I use tne Bloomberg equity screener (Function: EQS), but this is not available for anyone. If I remember correctly, 1 Bloomberg terminal costs over $100,000 annually. I have access to it only because I work in a financial sector. For people who do not have access to Bloomberg, I believe Finviz will serve you pretty well (click here for the link). You can use the majority of the screening functions for free.
Step 2: Pick your screening criteria
After a series of backtesting, I came to a conclusion that criteria of Price/Free Cash Flow < 10 and Return on Equity > 15% are good starter for stock screening. If I remember correctly, this simple screen beat the market (S&P500) about 10% on average per year when I backtested for 20 years. If you are a beginner and worry about your stock value going to 0, you may also want to add Debt to Equity < 0.5, just to make sure that the company does not have too much debt to handle.
It does not capture special investment opportunities including spin-off, distressed investing and companies with negative enterprise value; however, the criteria above should help you find high quality stocks in general.
Step 3: Sort them out as you like
Depending on what you are looking for, you could sort the list by certain characteristics. I like sorting by the % of change from 52-weeks low, just to see if the stock price is currently near the 1 year low. For beginners, you could sort the list out by the market cap (from large to small), this way, you can find the companies you may recognize faster.
Step 4: Pick your favorite and do some research
Once you pick your favorite out of the list that was generated after the screen, you need to do some research on the stock. The key questions you should be asking are as follows:
(1) Has the level of free cash flows been stable over the past several years?
(2) Will the current level of free cash flows most likely be sustainable for the next several years or decades?
(3) Does the company have any growth prospects? (E.g. Having a good track record on M&A, developing new products, effective spending on R&D, growing industry, etc.)
Step 5: Buy the stock!!
If the company is picked by the previous screener and passes the qualitative tests in step 4, the stock of the company is most likely undervalued and a good investment. If you are confident enough in your analysis, you should go ahead and purchase the stock, hold it for at least a decade and see if your investment thesis turns out to be correct.
Now you know how and where to find fantastic stocks! You should start looking for great investment opportunities and beat the market! Still not sure how? Subscribe to my blog and stay tuned for new updates!