How I Find Lower Risk/Higher Reward Stocks

by Charles Rotblut, CFA

How I Find Lower Risk/Higher Reward Stocks Splash image

There are four key attributes I look for in a stock: an attractive valuation, good financials, a strong business model and the ability to add diversification to my portfolio.

These traits are based on some of the great investment literature that has been written over the past 100 years. For example, Benjamin Graham and David Dodd emphasized the importance of book value in “Security Analysis” (1934). Philip Fisher stressed the importance of a good business model in “Common Stocks and Uncommon Profits” (1958). And Harry Markowitz revolutionized portfolio management by showing that diversification can increase returns and lower risk at the same time.

When you combine attractive valuations, strong financials, a good business model and the ability to add diversification, the result is a good risk-reward ratio for a stock.

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Charles Rotblut, CFA is a vice president at AAII and editor of the AAII Journal. Follow him on Twitter at twitter.com/charlesrotblut.


Discussion

RD Walker from Alabama posted over 3 years ago:

In Table 1, for the current ratio, the best score is given to a current ratio above 1.0 and below 2.0. Why isn't the best score for a current ratio above 2.0? Is this a typo, or am I missing something?


Charles Rotblut from Illinois posted over 3 years ago:

R,

A current ratio above 2.0 requires additional investigation.

For example, a high current ratio can be a warning flag that a company has slowed payment of receivables (meaning its bills) or that inventory levels are rising. The current ratio can also be elevated by a high level of cash, which is a double-edged sword. A large amount of cash does provide flexibility, but if management uses the cash balance to engage in projects or mergers that adversely impact profitability, then shareholders will be harmed.

-Charles


CSarahan from District of Columbia posted over 3 years ago:

I wonder what the author's return has been using this approach?


James from New Jersey posted over 3 years ago:

This screen is interesting and I look forward to analyzing it further. However, it is good only in a context of top-down analysis of the market, it's sectors and it's industries. In order to reduce risk it is very important to know where investment money is flowing. A financially sound company is going down with the rest of the ships if investment money is moving out of company's industry or sector. It will just sink more slowly. Conversely, if money is flowing into it's industry it will rise more quickly than less sound compan ies.


Rein from Massachusetts posted over 3 years ago:

Can you make available the code for the stock investor professional?


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