Stock Screens Can Help You to Beat the Market

Among the challenges faced by investors who want to actively pick stocks is finding those with desirable traits. There are often companies with good stories and/or receiving lots of attention with risky or lousy stocks (aka good company/bad stock). There are also many good stocks sitting off the radar of most professional and individual investors.

A highly effective solution to this problem is to use a stock screen. Stock screens are database filters designed to identify stocks with specific quantitative criteria. Unlike humans—whose decisions are frequently influenced by irrelevant factors—stock screens are objective. A stock either has the required characteristics or it doesn’t. There are no shades of gray.

This objectivity is what makes stock screens an effective tool. They reduce the entire universe of stocks down to a manageable list from which further research can be done. Some of the stocks passing a given screen may be familiar names, others will be ones you have either limited or no familiarity with. All will have the basic traits used in the screen to identify potentially appealing investments. It is this process of giving you a systematically created and regularly updated list of stocks possessing desired traits that makes stock screens an effective tool.

I’m a proponent of stock screening because I have used stock screeners for 20 years (even prior to joining AAII and using our Stock Investor Pro screening and database program), because I believe in systematic approaches to investing and, most importantly, because well-thought-out stock screens work. Over approximately the last 20 years, 51 of the 59 screening strategies maintained on AAII.com have beaten the S&P 500 index. Two of the eight screens with lousy returns are ones that investors should rationally expect to perform poorly: (Earnings) Estimates Revisions Down 5% and Estimate Revisions Lowest 30 Down.

The stock screening approach results we show in the Stock Ideas section of our website assume that an investor buys every stock passing a given strategy with equal dollar amounts, holds the portfolio for a month and then replaces it with a new portfolio based on the stocks passing the methodology a month later. The performance figures do not consider the commission or other transaction costs (e.g., bid/ask spreads, etc.) an investor using a real-money portfolio would incur. The results do, however, shed light on what works and what doesn’t work.

Those preferring results for actual portfolios can look at the performance of our Model Shadow Stock Portfolio and Stock Superstars Report portfolios. All stocks added to these real-money portfolios are those identified directly from stock screening strategies. Since its inception in 1993, the Model Shadow Stock Portfolio has returned 14.6% annually versus 9.2% for the Vanguard 500 Index fund (VFINX) as of January 31, 2019. The Stock Superstars Report, which was started in 2002, has an annualized return of 8.0% versus 7.3% for the Vanguard 500 Index fund. The performance figures for these two portfolios include all of the commission and transaction costs encountered while managing them through actual real-money brokerage accounts.

The screen chosen, the ability to stick with it and having disciplined sell rules all matter. Good screens will incur periods of both out- and underperformance—as is the case with both actively managed and passively managed (“index”) approaches. If value is out of favor, a value-oriented screen will underperform. If growth is in favor, a growth-oriented screen is likely to do better. If small-cap stocks are outperforming, the stock screens that are targeting them are more likely to outperform market-cap-weighted approaches like S&P 500 index funds.

Due diligence is also required when using a stock screen. There can always be factors outside of the screen’s criteria that could influence your decision about whether to buy a passing stock (e.g., a recent profit warning that is not yet factored into the data).

Yet, even with these caveats, the good screens do outperform over time and reward those investors who have the discipline to stick with them. Good screens are those based on research that has been shown to lead to long-term outperformance. Such screens have criteria that make economic sense; in other words, there is a logical reason as to why they should work.