Decided to invest in stocks and exchange-traded funds (ETFs), but unsure where to start? You’re not alone – it’s a position in which many would-be investors find themselves. With tens of thousands of stocks and ETFs available worldwide, how can you possibly hope to sift through them all to find appropriate and attractive investments? Well, one solution is investment screening.
Screening is the process of filtering investments based on certain self-set criteria. The goal is to arrive at a much shorter and more manageable list of stocks and/or ETFs as candidates for further analysis. Investment screening’s a very useful activity – and one commonly undertaken by individual and professional investors alike.
How you approach screening depends on how you approach investing in the first place. “Top-down” investors start by looking at big-picture economic or thematic trends; they tend to invest in ETFs tracking entire sectors or markets rather than individual stocks. A top-down screening process therefore focuses on finding ETFs that offer exposure to these areas. “Bottom-up” investors, on the other hand, principally pick individual stocks based on companies’ “fundamentals”. They usually screen for shares whose basic financial characteristics look attractive – and may therefore merit more in-depth scrutiny…
There’s no right or wrong approach – and those outlined above aren’t mutually exclusive. Many investors have a healthy mix of stocks and ETFs in their portfolios. But these different types of investment demand different screening processes. Lucky for you, however, we’ve got both covered in this Pack.
We recommend using ETFdb.com when searching for and scrutinizing ETFs. Not only does it offer a free database with detailed information on over 2,000 ETFs around the world, but there’s an easy-to-use screening tool tool.
The first filter to apply in the ETF screening process is asset class. Are you looking for ETFs that track equities (a.k.a. stocks)? Bonds? Commodities? You can get even more granular by filtering by sub-asset class – focusing, for example, only on ETFs that track agricultural commodities, or those which invest in emerging-market bonds.
With equities ETFs, you can apply further filters based on company size (large-cap, small-cap, etc), investment strategy or style (e.g. value, growth, low volatility), region, and sector. By way of example, here’s what a screen for ETFs tracking small-cap US growth stocks throws up:
Once you’ve got such a shortlist of ETFs, the next question is obvious: which do you pick? A good place to start is the ETFs’ liquidity: how easy it is to buy in or sell out without causing big shifts in price (or paying too much in trading costs). If you’re presented with multiple ETFs tracking the same thing, it’s a good idea to narrow things down to the most liquid.
You can compare liquidity using the “total assets” and “average daily volume” columns in the screener. Looking at the screen above, we can see two ETFs – VBK and IWO – each have around $10 billion in total assets, while the rest are all below $1 billion. On an average day, 250,000 shares of VBK change hands, most recently at a price of $210 per share. With $50 million worth traded every day, that’s one liquid ETF…
Another important factor is the ETF’s cost, as measured by its “expense ratio”. To see this in the screener, tap the Expenses tab:
We’ve already narrowed our screen down to VBK and IWO based on liquidity, so let’s compare these two on cost. At 0.24%, IWO’s expense ratio is more than three times higher than VBK’s – so it’s a bit of a no-brainer. If looking to get exposure to small-cap US growth stocks, we’d probably pick VBK. Not only is it very liquid, but it’s also the cheapest ETF out of the bunch.
What else should you look at when screening for ETFs? If you’re looking to track overseas stocks or bonds, you might find that some ETFs – like this European fund – promise to hedge (i.e. remove) foreign currency risk. There’s no right or wrong answer, but more conservative investors generally lean towards currency-hedged ETFs.
GLD tracks the price of gold by physically buying gold bars – which is probably preferable to DGL’s purchases of gold futures. Because futures contracts have expiry dates, the ETF has to constantly reinvest its funds into newer contracts – and that process can cause the performance of the ETF to deviate from the performance of actual gold.️
Last but not least, when it comes to equity ETFs in particular it’s worth looking at the ETF’s holdings to make sure it’s not overly concentrated on just a few investments. On ETFdb, you can do this by clicking on the Holdings tab. A quick glance at, say, VGT – which purports to track the US information technology sector – reveals that almost 40% of the ETF is invested in just two stocks! By owning VGT you’re making a bigger bet on Apple and Microsoft than on the wider tech sector.
Looking at an ETF’s holdings can also, of course, help you find individual stock ideas. Let’s say you’re interested in picking up a couple of renewables companies. On the ETFdb screener, filter for equity ETFs and under Sector, select Clean Energy. This throws up 8 ETFs; clicking on one of them and then exploring its Holdings should help you compile a nice little list of solar and wind energy stocks.
You can do the same thing with thematic ETFs to track down stocks exposed to certain trends. Top-down investors, naturally, may want to invest in the ETFs themselves to gain more diversified exposure. iShares and Global X are two of the biggest providers of such investments. Remember – if you spot an ETF that you like the look of, do check its holdings on ETFdb to ensure it’s not too narrowly focused
Another way to find stock ideas, of course, is – you guessed it – to use stock screening tools.
When it comes to searching for individual stocks, we’d recommend using Finviz’s online screening tool (no relation). It’s free and powerful, allowing you to filter things based on lots of different criteria.
And what criteria should you be screening for in the first place? Well, it depends on what kind of stocks you’re after. If you’re looking for, say, large-cap technology stocks, then you’d apply those criteria under the Market Cap and Sector filters as shown below.
The resulting screen contains 115 results, which you can winnow down based on other metrics. Here, for example, we’ve sorted those results according to dividend yield. We can thus see at a glance which large-cap technology stocks offer the greatest income potential – and we could then, perhaps, delve deeper into the top 10.
You can also use the screening tool to find specific kinds of stocks; “value” or “growth” stocks, for example (check out our Pack on Investment Styles for more on what this means). One way to find value stocks might be to select “low (<15)” under the “Forward P/E” filter. And if you were interested in growth stocks, you could select “over 20%” under the “EPS growth next 5 years” filter.
And if you’re not fussy about the style of stock, but just want to screen for some attractive-looking gems worthy of further investigation? Then it may be worthwhile filtering at the intersection of “quality” and value – in other words, robust companies with relatively cheap stock prices. Here’s an example of a screen we’ve run that attempts to do this. In order to exclude idiosyncratic smaller stocks, our first criteria is market cap >$2 billion. Then, to capture cheapness, we select “low (<15)” under “Forward P/E”. Finally, for quality, we select high (>20%) net profit margin, over 15% return on equity, and under 0.5 long-term debt/equity.
The result? A manageable list of around 20 stocks that are a decent size, relatively cheap, generate attractive returns, and have reasonable debt loads.
This isn’t an exact science – it’s just one interpretation of what constitutes high-quality and cheap. Another, made famous by legendary investor Joel Greenblatt in The Little Book that Beats the Market, is “Magic Formula Investing”.
Magic Formula Investing is an investment strategy that begins by screening for inexpensive, dependable companies with a high earnings yield (operating profit divided by enterprise value) and a high return on invested capital (operating profit divided by (net fixed assets + working capital)). (More on these in our Analyzing Financial Statements Pack.) You then invest equal amounts in the top 30 stocks based on these criteria, rescreening and rebalancing once a year. This strategy, which starts off with a simple stock screen, has – according to Greenblatt – consistently beaten the market.
As well as searching for value and quality, you can also add some technical analysis criteria to a screen. Some examples (shown below on Finviz) include seeing whether a stock’s price is above its 50-day simple moving average (SMA), whether its 20-day SMA is above its 50-day SMA, or quite simply whether the stock price is up over the past year. These criteria are more or less trying to capture the same thing: stocks with prices on an upward trend.
Regardless of how you conduct your screen and what criteria you use, it’s important to always do more in-depth fundamental research into the investments they throw up. Think of stock screening as a search engine you use to draw up a preliminary shortlist of shopping ideas; you’re always going to do your homework on the individual products before you buy.
And that’s it. You now have a pretty good grounding in how to go about screening for ETFs and stocks based on your preferred investment criteria, as well as a few initial ideas. Get out there and put what you’ve just learned into practice – you might just find your next best investment idea through running some screens!
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