Extending on from the Generating Investment Ideas blog let’s take a closer look at the filtering and screening process. Filtering is the process of using a set of fundamentals or criteria to narrow down an investment universe using a screener. There are several screeners available that are free of use. However, I am currently using Tikr (This is not an endorsement of the product at all). I like to try a range of products to see how they all work.

Sorting through the abundance of available data is required while searching for investment ideas.

The filtering and screening process is usually done quantitatively by filtering out ideas that don’t meet your criteria. This then highlights the qualities you do want to see. What remains is a selection of ideas that meet the requirements you are looking for in a company. Stock screeners can be fantastic tools to help generate ideas from the tens of thousands of securities around the world. By applying your “filter” you can immediately identify ideas to form a watchlist of companies to conduct further analysis on.

The parameters of Filtering and Screening.

When using a screener the inputs you use will all depend on the criteria that meet your investment strategy. The more your specific requirements the greater the filtering process becomes. The more details create a smaller pool of potential investment ideas. The inputs are endless, so a clear idea of what you are looking for is important. Using the screener incorrectly can filter out strong candidates in the process.

Common filtering criteria:

• Country or Stock exchange.
• Market-Cap size.
• Industry and sector break down.
• Momentum such as 52w high or lows or daily volume.
• Risk levels such as Beta.
• Investment ratios such as ROE, P/E, ROC, P/S.
• Financial Health like Net debt and Debt-to-Equity.
• Operating health such as Gross Margins and FCF.
• Dividend yields and income focused.
• Earnings Growth or CAGR of EPS.
• Insider ownership.

The list can be exhaustive. These are just examples of the types of criteria that can be used.

An example of filtering for ideas.

Let’s run an example of a filtering idea in Tikr to show what it can look like.

The criteria and inputs will be: Small-cap companies under USD 1bil market cap, searching on the London Stock Exchange for companies that have a Gross Margin greater than 40%, and a ROIC above 15%.

Out of the 67,518 available companies publicly listed the screener presented 35 ideas filtering a vast universe down to 0.05%.

This is the power of using a screener with very specific criteria you are after. Conducting further research on 35 companies is a lot better than sifting through 65,000.

What are the cons of running a screener?

There are some concerns I have with using screeners exclusively. The first is it is mostly focused on TTM (Trailing Twelve Months). It is rear looking. Sure, there are analysis and forward looking estimates but most of the time if you are looking to hold companies long-term the future is the important aspect to evaluate to.

Spending too much time looking at past data and what has already happened can filter out potential candidates.

The second concern I have is that filters can also filter out great ideas because they were a fraction away from making the cut. The data and inputs you enter will determine what it spits out at the other end. Maybe valuable investment ideas are being missed because you have an ROE of 15% expectation but this great long-term compounder was 14.5%. So once again that data is important to interpret correctly.

It does not encourage second-level thinking and further quantitative or qualitative analysis. A lot of investors will screen for UNDERVALUED companies for example by inputting low P/E and P/B and take a list of results as undervalued ideas. It is not as simple as substituting your thinking and fundamental research to a screener.

Using a screener to narrow down a list of ideas based on common stock metrics or ratios is a good start but should be no more than idea generation. Once a list of potential candidates is found the real work begins.

Once you create a list it must be treated as an “idea generation” tool on ideas for further analysis. Not immediate investable ideas.

How do I use filtering and screening?

Using stock screeners does save time when researching for ideas. It is fast, convenient and a great way to either “Kill an idea” or add one to a watchlist. I do not use screeners to filter ideas in the typical way. I use them for research and on companies to scan to see if it has the qualities I look for and how the company has been performing. Most of my analysis begins with individual security research on a screener.

SCREEN	PURPOSE
Financial Statements	An instant look at the income statement, the balance sheet and the cash flow statement. Rather than scanning multiple Annual Reports.
Margins	Easy way to look at the margins, how they have evolved over time GM + OM.
Ratios	Look at the TTM and forward estimates. Are they consistent? How have they evolved?
Free Cash Flow	Instant look at Working Capital, CapEx, FCF and how the companies income statement is converting into cash.
Insider Activity	Instant view on insider ownership, buying and selling and skin in the game.
Analysts & Competitors	Easy way to see if a company is being tracked, what the analyst calls are and whether there are competitors
Valuations	Can see the type of valuation others are placing on the business.
News and Coverage	A consolidated list of all the articles, news, earnings calls, and reports in one place.

Know the meaning behind the inputs first.

The issue in using a screener properly is the investor needs to have an idea of what the ratios and metrics mean. If you don’t understand what makes a stock cheap, or overvalued what Free Cash Flow is or what ratios mean for a stock then what good is it to screen based on them?

A hyper-growth stock for example may not necessarily be profitable as it reinvests to scale. So, if you are a growth-focused investor screening for profitable companies you will leave out potentially great ideas. How do you use certain inputs to find what you are looking for if you don’t understand the cycles of business and the nature behind them?

To effectively use filtering and screening, investors need to be able to explain why they are using these inputs. What are you looking for? Certain companies, industries, and business cycles have different qualities around them. Learning about these can help the screening process become more powerful and direct.

In Summary…

Filtering and screening is best used with a detailed investment strategy and guiding philosophy. I believe they work far more efficiently if you know what you are looking for as per your criteria.

If you are not entering specific criteria down to a few input items, then there are still hundreds of companies to select from. The issue is the more fine-tuned the criteria the narrower the universe becomes. This may sound great in theory but finding multi-baggers and long-term compounders can be filtered out based on what a company looks like today. A screener is a snapshot of TODAY’s fundamentals.

Most of the stock screeners are quantitatively focused i.e. numbers, ratios and returns. However, the qualitative approach and thinking much deeper about companies is still needed.

I have other ways to generate ideas that I find a lot more useful for me. Once I get ideas I run them through the screen, check out what is under the hood, look at the engine and then determine whether I want to add it to a watchlist, research further or pass it by.

A lot of investors use filtering and screening to find all their ideas. It can be very useful to run a screen regularly based on your criteria to see what companies “make the cut”. I think stock screeners are a good way to prevent or at least combat Behavioural Biases. The screeners sift through ideas that meet an investor’s criteria according to their strategy and not emotional decision making.