How To Use A Stock Screener To Find Hidden Gems

So you’ve decided to invest in stocks, but you’re not really sure where to start. You’re not alone there: a lot of would-be investors find themselves in the very same position. And that shouldn’t come as a surprise. With tens of thousands of stocks available worldwide, the idea of sifting through them all to find appropriate and attractive investments can seem pretty daunting. But one solution to that is stock screening.

OK, so what is stock screening?

Just like it sounds, it’s the process of filtering stocks based on certain criteria that you set. The goal is to arrive at a much shorter and more manageable list of stocks to analyze further. Screening is a very useful activity – and one commonly undertaken by individual investors and pros alike.

To get started, you first want to decide what kind of stocks you’re after. That’ll help you decide what criteria to screen for. But if you just want to search for some attractive-looking gems that are 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 how.

Step 1: Pick a screening tool.

When it comes to searching for individual stocks, I like Finviz’s online screening tool. It’s free and powerful, and allows you to filter for stocks based on lots of different criteria. Another noteworthy mention is Yahoo Finance’s online screener, which is also free.

Step 2: Set any exclusion criteria.

The first thing you want to do with your screen is to set any exclusion criteria – that is, the kind of stocks you don’t want in the results. For example, if you want to exclude microcap stocks (sometimes called “penny stocks”), which are inherently risky due to their higher volatility, then you can set Finviz’s market cap filter to “+ Small (over $300 million)”.

Another way to avoid very volatile stocks is to exclude stocks with a high beta. Beta measures how much a stock moves when the market moves. So, say the stock market falls 10%: a stock with a beta of 1.5 would be expected to fall 10 x 1.5 = 15%. The higher the beta, the riskier the stock – and so to avoid the riskiest ones, you could set the beta filter to “Under 1.5”.

Finally, let’s say you’re interested only in tech stocks and want to exclude ones from all other sectors. To do that, you can simply set the sector filter to “Technology”. (Note that I don’t include a sector filter in the example shown at the end of this piece.)

Step 3: Define and screen for “quality”.

Different investors define quality in different ways, but most would probably agree that – at a bare minimum – a quality stock belongs to a business with high profitability, good financial health, and strong growth. The good news is, you can easily incorporate all three of these key elements into a stock screen.

For high profitability, consider focusing on two metrics: net profit margin (how much profit a company makes relative to sales) and return on equity (how much profit a firm generates from its use of shareholders’ money). Both metrics are available on Finviz: you can set the net profit margin filter to “High (>20%)” and the return on equity filter to “Very Positive (>30%)”.

Regarding good financial health, a simple way to assess that is by looking at the firm’s financial leverage – that is, how much debt a company has relative to the amount of money its shareholders have invested in it. Although a bit arbitrary, a good rule of thumb is to only include firms that have less debt than equity. To do that, set the debt/equity filter in Finviz to “Under 1”.

Finally, for strong growth, you can use one of the many growth filters found on Finviz. I prefer looking at growth in earnings per share (EPS) instead of sales because the former represents actual profit available to investors. What’s more, by looking at profit on a per-share basis, EPS captures the positive effect of stock buybacks and the negative, dilutive impact of issuing new shares.

Finviz allows you to filter by EPS growth this year, next year, over the past five years, and over the next five years. For the sake of screening for companies that have managed to grow their earnings at a healthy rate over a long time horizon, it’s better to stick to EPS growth over the past five years, which you can set to, for example, “Over 20%”. I don’t recommend using the EPS growth over the next five years filter for a simple reason: earnings forecasts that far out tend to be extremely inaccurate.

Step 4: Define and screen for “cheap”.

After entering all of the filters above, you’re left with a promising list of high-quality companies. But as an investor, it’s important not to overpay for quality. To avoid doing that, you can further narrow down the list to only include cheap stocks. Once again, different investors define cheap in different ways, but a good starting point is to include only the stocks that are trading at a valuation multiple below the market’s average. One of the most popular valuation multiples that investors look at is the forward price-to-earnings (P/E) ratio, which measures how much a stock costs relative to every dollar of forecasted profit.

You can use the WSJ Markets page to see the latest forward P/E ratio of the S&P 500 Index. Make sure you use the “estimate” figure, as shown below.

The latest forward price-to-earnings (P/E) ratio for the S&P 500. Source: WSJ.

As of the time of writing, the S&P 500’s forward P/E ratio is around 18x. Unfortunately, Finviz’s filter only lets you enter values in increments of five. So if you want to be a bit more relaxed about valuation, you can set it to “Under 20”. Or to be more strict, set it to “Under 15”.

Step 5: Further narrow down the list of results (optional).

With all the filters you’ve used so far, Finviz has filtered down to a list of 30 stocks. Recall, these are non-microcap stocks, with betas below 1.5, belonging to high-quality companies, and with relatively cheap stock prices. Now, you can stop here and start looking at the 30 stocks, but if you want an even smaller and more manageable list, then you can enter a couple more screening criteria.

For example, you can decide to include only stocks that professional investment analysts are positive about. To do this, set the Finviz analyst recommendation filter to “Buy or better”. As another example, you can screen for stocks that are currently experiencing an uptrend in price. One way to do that is by examining the stock’s simple moving averages (SMAs) – a simple arithmetic average of prices over some timespan. And if a stock’s shorter-term moving average is above a longer-term moving average, then that usually indicates a general uptrend in price. To screen for that on Finviz, set the 50-day simple moving average filter to “SMA50 above SMA200”.

After including the above two criteria, our initial list of 30 stocks shrinks to 17 (shown below).

Seventeen stocks that meet the above screening criteria. Source: Finviz.

Step 6: Finally, evaluate the results.

Once you’re done with the screen, you’ll be left with a manageable list of stocks that seem like promising investment candidates. But it’s very important that you treat the list as a starting point of ideas for further analysis, and not as a menu of investments to blindly pour your money into.

Quantitative metrics, like those used in stock screens, can tell you only so much and should be accompanied by proper qualitative analysis before arriving at investment decisions. And if, after further analysis, you don’t like any of the stocks, so be it. The neat thing about a Finviz screen is that it’s constantly updated. That is, you can bookmark the link after entering all your filters, and check back on it in the future. Your bookmarked link will automatically contain all the filters that you’ve originally entered, and show you the latest crop of criteria-meeting stocks.