November 18, 2005

My problem with stock screens

Most of us know the problem with simple stock screens such as one’s based on low P/E ratio, low P/B ratio etc. A lot of stocks which get filtered through the screens are typically companies with poor economics. I have tried to overcome this problem by building a screen which has the following additional screening criteria
  • An ROCE/ROE of atleast 13% or more

  • No loss during the past 5 years

  • Above average growth over 5 years in NP

  • D/E < 2
Adding the above stock screens has filtered out companies in the following industries (partial list below)
  • auto components

  • bank

  • cement

  • Chemical

  • Shipping

  • Fertiliser

  • Shipping

  • Paper

  • Textile
I have started analysing one company at a time under each of the classification. Unfortunately the reason these companies have filtered out is either due to a cyclical uptick in the industry (cement, shipping, paper etc) or it is tier II company in the industry with high operating leverage and has seen a reduction in interest cost. Due these reasons , the recent PE, ROE etc of these companies is good, debt is down and these stocks look good.
My concern is how these companies would fare once the cycle turns downwards. Let me explain using the example of shipping industry which I am analysing currently.
The main companies in the shipping industry which have filtered out through the screen are
  • mercator lines : High asset addition recently through debt which has resulted in high earnings and high ROE. The risk to the business is high if the business cycle reverses as the company may be unable to service its debt

  • Varun shipping / Shreyas shipping: high operating leverage, high debt and high growth in earnings in recent times due to high shipping rates. Earnings risk is high due to operating leverage

  • Essar shipping : High earnings due high shipping rates. Also ROE is high to asset revaluations. This stock looks interesting and worth investigating further.
I guess the stock screen is throwing up a lot of companies which may be statistically cheap but not really a value stock. So essentially I am not be able to come up with a list of companies which are great value. I guess it is to a certain extent an indication of the kind valuation levels existing in the current market (The same filter in 2003 gave much better companies). So I guess I will have go through the entire list and maybe at the end (the list has 100+ companies) come up with a few good stocks. It defintely not a waste of time because it helps me to understand more companies/ industries which could be helpful in the future

any suggestions on improving the above screens ?


Abhi said...

I understadn your problem as I go through the same thing. What I try to add to my screener is year to date return or annula return negative 15 % or more.
This way I try to determine why the company has gone down given that fundamentals are good. Typically you will find a temporary set back or a bad news that can be corrected. This can be a buying opportunity. This way you can ensure your paying good price for good company. It is really difficult to find value with general screens liek you mentioned.

Rohit said...

thanks abhi , good input to add to my stock screen. i assume the YTD return you are referring to is the stock price.

abhi said...

yes, stock price.. as percentage. I typically use -15% or more negative return

Pradeep said...

i think the best way is to ignore screens...look at companies as stand alone businesses...understand the business (up/down cycle, management, industry etc) and then make decisions.

screens of 52 week lows works in the US.In the current Indian market, any screen might only throw expensive stocks now.

Pradeep said...

Two of your shipping 'hits' had problems with higher debt.
Shouldn't a 'debt to equity' check guard against that debt?

Rohit said...

yes ...i have kept the filter at 2 which is fairly high for a cyclical industry. tightening it to <1 would filter out these stocks

Kotekoppa said...

How do I create a stock screen consisting of the multiple criterion as you have talked about? In ICICIdirect site I got only a few preset criterions.

sandy said...

which screener to use?
i have been using icici direct screener but couldnt filter out industries with poor economics