Skip Table of Contents

Introduction

Welcome to our blog post on stock screening criteria for value investors. As a value investor, you understand the importance of finding undervalued stocks that have the potential to provide long-term returns.

But with so many stocks on the market, how do you know which ones to invest in? This is where stock screening comes in.

By using a set of criteria to filter out stocks, you can narrow down your options and increase your chances of finding a hidden gem.

In this blog post, we will be discussing the key financial and operating metrics that value investors should consider when screening stocks.

We will also be taking a look at additional criteria such as industry analysis and management analysis that can give you a more well-rounded view of a company.

To make it more relatable, we will also be providing a case study of a stock that meets the screening criteria and analyzing its performance.

As an investor, it's important to remember that there is no one-size-fits-all approach to stock screening and that it's always important to conduct your own research and due diligence.

But we hope that this blog post will give you a solid starting point and some useful insights as you navigate the stock market.

Financial Metrics

Financial metrics are some of the most important factors to consider when screening stocks as value investors. These metrics can provide insight into a company's financial health and give you an idea of whether or not it's undervalued.

In this section, we'll be discussing five financial metrics that value investors should keep an eye on:

1. Price to Earnings ratio (P/E)
2. Price to Book ratio (P/B)
3. Dividend Yield
4. Return on Equity (ROE)
5. Debt to Equity ratio (D/E)

Let's start with the Price to Earnings ratio (P/E). This metric compares a company's stock price to its earnings per share (EPS) and can give you an idea of how expensive a stock is.

A lower P/E ratio typically indicates that a stock is undervalued, while a higher P/E ratio suggests that it's overvalued. However, it's important to keep in mind that P/E ratios can vary by industry, so it's always a good idea to compare a stock's P/E ratio to that of its peers.

Next up is the Price to Book ratio (P/B). This metric compares a stock's price to its book value, which is the total value of a company's assets minus its liabilities.

A lower P/B ratio suggests that a stock is undervalued, while a higher P/B ratio suggests that it's overvalued. It's important to note that some industries such as technology tend to have higher P/B ratios than others, so it's always a good idea to compare a stock's P/B ratio to that of its peers.

There is also a variation of the Price to Book ratio (P/B) called the Price to Tangible Book ratio (P/B-tang) that uses only the tangible book value. This is because the book value can include items that don't have a true value and are essentially just guesses by accountants.

A high Dividend Yield is another indication of undervaluation. Dividend yield is the annual dividend per share divided by the stock price, it's a way to measure the return on your investment.

A higher dividend yield means a higher return on your investment, and if it's above industry average, it's a sign of possible undervaluation.

The Dividend Payout Ratio may be a good metric to look at after the Dividend Yield, since it tells us how much of their earnings they are paying out as dividends.

Return on Equity (ROE) is another metric that can indicate a company's financial health. ROE is calculated by dividing a company's net income by its shareholder equity and it measures how well a company is using its shareholders' investments to generate profits.

A higher ROE suggests that a company is using its shareholders' investments more effectively and could be a sign of an undervalued stock.

Finally, the Debt to Equity ratio (D/E) compares a company's total liabilities to its total shareholder equity and it gives an idea of how leveraged a company is.

A lower D/E ratio suggests that a company has less debt and is in a better financial position, while a higher D/E ratio suggests that a company is more leveraged and may be at a higher risk of financial distress.

It's important to note that each metric should be looked at in context and not in isolation and that these are just a few of the many financial metrics that value investors should consider when screening stocks.

But hopefully, this gives you a good starting point and a better understanding of how to use financial metrics to identify undervalued stocks.

Operating Metrics

Operating metrics are another important factor to consider when screening stocks as a value investor. These metrics provide insight into a company's operations and give you an idea of its growth potential.

In this section, we'll be discussing four operating metrics that value investors should keep an eye on:

Revenue growth

Earnings growth

Operating margin

Return on assets (ROA)

Let's start with Revenue growth, it measures the increase or decrease in a company's revenue over a specific period of time.

A company that consistently shows revenue growth is likely to be expanding its business and may have more room for future growth.

As a value investor, you want to look for companies that are growing their revenue over time, because it indicates sustainable growth.

Next up is Earnings growth, it measures the increase or decrease in a company's earnings per share (EPS) over a specific period of time.

Like revenue growth, a company that consistently shows earnings growth is likely to be expanding its business and may have more room for future growth.

It's also important to note that a company with high revenue growth but low earnings growth could be a red flag, as it suggests that the company may not be managing its expenses effectively.

Or, it can mean that they are making investments with their earnings that will affect future earnings. This is why it's never good to judge a company solely based on one metric.

Operating margin is another metric that can give you an idea of a company's profitability. Operating margin is calculated by dividing a company's operating income by its revenue and it measures how much of its revenue is left over after operating expenses are subtracted.

A higher operating margin suggests that a company is more profitable and may have more room for future growth.

Finally, Return on assets (ROA) is a measure of how well a company is using its assets to generate profits. ROA is calculated by dividing a company's net income by its total assets.

A higher ROA suggests that a company is using its assets more effectively and may be a sign of an undervalued stock.

It's important to note that each metric should be looked at in context and not in isolation, and that these are just a few of the many operating metrics that value investors should consider when screening stocks.

But hopefully, this gives you a good starting point and a better understanding of how to use operating metrics to identify undervalued stocks with a good potential for growth.

Visualize the data

Now you know what kind of ratios you can use, but they can all be useless if used in the wrong way.

For example, Company A has a P/E ratio of 9. As we know, a lower ratio is considered to be a better value.

But the year before, it was only 3. This can suggest that the company is very unstable and could possibly be a bad investment.

Even a sudden, extreme jump in earnings can be a bad sign, as it may be unsustainable in the long run. Peter Lynch talks about this in his formula for GARP investing.

Or, they may have done something unethical to increase their earnings, such as selling important money-generating assets, which would negatively impact future earnings.

I recommend using a tool as simple as a Google spreadsheet to input the ratios, and then generate a chart displaying the metrics for each year.

There is, however, a good solution to this, which is to look at the company's past performance. I like to use 10 years of data, but there is no rule on how far back you can look.

Additional Criteria

As a value investor, it's not enough to just look at financial and operating metrics when screening stocks. You also want to consider additional criteria such as industry analysis, management analysis, and competitive analysis to get a more well-rounded view of a company.

In this section, we'll be discussing these additional criteria and how they can be used to identify undervalued stocks.

First up is industry analysis. As a value investor, you want to look for companies that operate in industries with strong growth potential.

For example, if you're looking at a company that operates in the technology industry, you want to look for one that is at the forefront of emerging technologies, rather than one that is lagging behind.

It's also a good idea to keep an eye on the overall trends in an industry, such as regulatory changes or the introduction of new technologies, as these can have a significant impact on a company's future growth potential.

Next is management analysis. As a value investor, you want to invest in companies that have strong management teams.

This means looking for management teams that have a track record of success and are committed to creating shareholder value.

One way to do this is by looking at the company's insider ownership and the history of the management team. If the management team has a significant ownership stake in the company, it's more likely that they will act in the best interests of shareholders.

Finally, competitive analysis. A company's competitive position can have a significant impact on its future growth potential.

As a value investor, you want to look for companies that have a strong competitive position in their industry, whether it's through a strong brand, a dominant market share, or a unique product or service offering.

You can also look at the company's competitors and see how they compare in terms of financial metrics and growth potential.

It's important to note that these additional criteria should be looked at in conjunction with the financial and operating metrics that we discussed earlier.

By considering all of these factors together, you'll be able to get a more well-rounded view of a company and increase your chances of identifying an undervalued stock with strong growth potential.

It's also important to remember that no single criteria or metric can guarantee success, it's always important to conduct your own research and due diligence, and to invest in a diversified portfolio.

But hopefully, this gives you a good starting point and a better understanding of how to use additional criteria to identify undervalued stocks.

Case Study

As a value investor, it's one thing to know what metrics and criteria to look for when screening stocks, but it's another thing to see how it all comes together in practice.

That's why in this section, we'll be providing a case study of a stock that meets the screening criteria we've discussed in this blog post, and analyzing its performance.

Let's take a look at XYZ Inc. as an example. This company operates in the technology industry and has consistently shown strong revenue and earnings growth over the past few years.

It also has a low P/E ratio, P/B ratio, and D/E ratio, indicating that it may be undervalued.

Additionally, XYZ Inc has a high operating margin, a high ROE, and a high ROA, all of which suggest that it is a profitable and efficient company.

In terms of additional criteria, XYZ Inc has a strong management team with a history of success and a significant ownership stake in the company.

The company also has a strong competitive position in its industry, with a well-established brand and a unique product offering.

Now let's take a look at the stock's performance. Over the past year, XYZ Inc's stock has performed well, with a total return of 25%.

This is well above the industry average and suggests that the company's strong financial and operating metrics, along with its additional criteria, are translating into strong returns for investors.

It's important to note that this is just one example and that past performance is not indicative of future results.

It's also important to conduct your own research and due diligence before making any investment decisions.

But this case study provides a concrete example of how the metrics and criteria we've discussed in this blog post can be used to identify an undervalued stock with strong growth potential.

It's also important to keep in mind that investing in the stock market always involves risks and it's important to have a well-diversified portfolio.

But by using the screening criteria and metrics we discussed in this blog post, you'll be better equipped to identify undervalued stocks with strong growth potential and make more informed investment decisions.

Conclusion

In conclusion, stock screening is an essential tool for value investors looking to identify undervalued stocks with strong growth potential.

By using a set of criteria to filter out stocks, you can narrow down your options and increase your chances of finding a hidden gem.

In this blog post, we've discussed the key financial and operating metrics that value investors should consider when screening stocks, as well as additional criteria such as industry analysis, management analysis, and competitive analysis.

We also provided a case study of a stock that meets the screening criteria and analyzed its performance.

It's important to remember that there is no one-size-fits-all approach to stock screening and that it's always important to conduct your own research and due diligence.

But we hope that this blog post has given you a solid starting point and some useful insights as you navigate the stock market.

Remember, stock screening is just one part of the investment process, it's also important to diversify your portfolio, have a long-term investment horizon, and have an investment plan.

We hope that you found this blog post informative and helpful. As always, it's important to do your own research and due diligence before making any investment decisions. Thank you for reading and happy investing!