Messages: What Members Are Asking On-Line

Tailoring Stock Screens

I have been trying to find a program that screens for value in a truly useful manner. I am a veteran investor—43 years! When you screen for low price-earnings, price-to-book and price-to-cash-flow ratios you get nothing, most of the time, but cheap stocks that are as often as not going to stay cheap.

The most helpful way to screen for value is to look for stocks that are cheap using these metrics within a historical framework. I want to know which stocks are now in the lowest 10% of their 15-year range of price-to-book ratio and price-to-cash-flow ratio. Thus, Alcoa may be cheap at 0.9 times book and Patterson Dental at five times book. I don’t include the price-earnings ratio since it doesn’t work for cyclical stocks and cash flow is better anyway.

Long ago, I developed a chart program that does this (and a lot more), but maintaining the chart library is time-consuming and expensive. The charts are great, but being able to screen several hundred stocks every month by computer would let me focus my attention more consistently on potential candidates for purchase. I consider buying correctly to be 75% of the manager’s task.

—P.R.
via E-Mail

CI Editors Respond:

Stock screening services allow investors to quickly filter a large universe of stocks to locate a few that merit further analysis. If you are a value investor, you may use absolute levels or relative levels to filter your stocks. An absolute level may specify that you only want to examine stocks with a price-earnings ratio below 15. Absolute filters can lead to passive market timing—cash levels tend to build up when investors cannot find suitable investments that meet the minimum requirements during times of market extremes. Also, screens that only look at absolute levels can be weak because they may turn up securities from a single industry.

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Screens based on relative levels compare a variable against a benchmark that may fluctuate, such as the current price-earnings ratio for the S&P 500. In this case, the investor does not require that the price-earnings ratio meet some minimum level, but instead that it maintain its historical relationship with the benchmark figure. Common relative screens include comparisons against some overall market level, industry level, and historical average.

Our top stock screening systems presented in this issue allow investors to screen for companies comparing current multiples against historical norms. Unfortunately, none of them presents a comparison value that goes back 15 years. For example, with AAII’s Stock Investor Pro you can screen for companies with multiples below their three-, five-, or seven-year average for ratios such as price-earnings, price-to-book-value or price-to-cash-flow. Morningstar.com provides access to year-by-year and five-year figures, while the CNBC on MSN Money Web site provides for screening comparisons out to five years.

The figure below highlights a screen developed through CNBC on MSN Money that looks for stocks trading with a current price-earnings ratio that is within 10% of the lowest price-earnings ratio observed over the company’s last five fiscal years. The 10% range against the five-year low was specified by multiplying the five-year low by 1.1. If you run this screen, you might be surprised to see passing companies with current price-earnings ratios well below their five-year lows. Historical lows are typically determined using complete fiscal or calendar years, so the current ratio is not yet part of the historical timeframe and does yet factor into the calculation of the historical low or average.