Since the dot-com bubble burst, you know enough to avoid hot tips at Internet message boards. But where do you get investment ideas? The pros often start by screening thousands of stocks for selected traits. Armed with a list of potential winners, they then investigate the results of their screen more thoroughly.
You, too, can pan for stocks with golden prospects with the screening tool at BusinessWeek Online. Go to www.businessweek.com/investor/stocks.html, look for "Investing Tools," and under it, click on "Stock Screeners." Here you'll find a "Quick Stock Search," which allows you to construct screens using any one of 17 criteria, including such basics as price, market capitalization, and price-to-earnings ratio. "Advanced Stock Search" works the same way except you have 70 criteria on which to base your search. (A third screen focuses just on the BusinessWeek 50 and Standard & Poor's 500-stock index with 14 variables.)
To do some serious stock sifting, you'll want to employ the advanced model. Not that you screen with 70 variables or even 10 at a time. Every measurement doesn't work on every kind of company. Price-to-book value ratios, for instance, work well for financial firms, but they're meaningless when looking at biotech or software companies. Still, the vast selection of criteria make for richer, more targeted searches.
SCENARIOS. Here's how you put the screener to work. Suppose you think that lower interest rates make it an opportune time to invest in stocks of the smaller community banks and thrifts that escape Wall Street's notice. For instance, portfolio manager Anton Schutz of Burnham Financial Services Fund, up 76.2% over the last 12 months, looks for bank investments by searching for those with the lowest p-b ratio ("Price/Book" in the valuation section on the BusinessWeek screener). Book value is the value of a company's assets if they were liquidated. Since bank assets are easily valued--mostly loans and securities--a bank with a stock price below its per-share book value can be a takeover prospect, Schutz says.
But what if the takeover doesn't happen? You still want to own stock in a healthy company that's a viable, ongoing business. That's why Schutz also screens for companies by the "Company Growth Ratio," which is the estimated earnings growth rate (as projected by Wall Street analysts) divided by the estimated price-earnings ratio for the next fiscal year. In short, you want to buy the shares of companies whose ratios are no less than one: the higher, the better. That way, you know the earnings growth rate is higher than the p-e.
Try to run a screen like Schutz'. Go to the Advanced Screener, and under "Select an Industry," enter "Banks." Then set the p-b ratio at a maximum of 0.9 and company growth ratio at "High as Possible." At the bottom of the screener, it asks for number of stocks. Set it at 25, which keeps the list manageable.
Still too many stocks? Try setting "Market Capitalization" at a minimum of five, which equals $50 million, to eliminate the tiniest banks that are difficult to research. You can also tap in a minimum of 15% for earnings-per-share under "EPS Growth 1 Yr" so you pick up the fastest growers. Hit the search again, and you get 13 companies, two of which are favorites of Schutz': Berkshire Hills Bancorp (BHL ) and MutualFirst Financial (MFSF ). Other top picks are EverTrust Financial Group (EVRT ) and Credicorp (BAP ).
Want to invest in a pharmaceutical company? What matters most are the earnings expectations for drugmakers and how Wall Street values them. Under Select an Industry, choose "Drugs." First, look for "Proj EPS Next FY" or projected earnings per share for the next fiscal year. That's a consensus of what analysts expect the company to earn in the near term. Right below is "Proj EPS Annualized 5 Yr," or what those same analysts estimate for the longer period. For both, set a minimum value of 15%, not unreasonable for a drug company. Both values identify the fastest-growing firms.
You want to pay a reasonable price for that growth. So you need to set Company Growth Ratio to High as Possible, as we did in the bank-stock screen. But here, we're also going to add the "Company/S&P Growth Ratio," which compares the company growth ratio with the growth ratio of the broader market. Set it at a minimum of 0.9, which is to help select stocks whose p-e ratios are no more than 10% higher than that of the Standard & Poor's 500-stock index. Frank Sustersic, portfolio manager of the Turner Healthcare & Biotechnology Fund, suggests a few more criteria--setting them to High as Possible. They are "EPS Stability Current," which measures the consistency of a company's earnings; "EPS Surprise Breakout," in which a positive number indicates better-than-expected earnings; and "Return on Equity," a profitability measure.
The screen nets 25 stocks. Of them, Sustersic owns Pfizer (PFE ), a big global player, but also several lesser-known companies: Taro Pharmaceutical Industries (TARO ), Andrx (ADRX ), and Noven Pharmaceuticals (NOVN ).
CLEARING THE SMOKE. Technology is the trickiest sector to screen. You can start with some growth variables: "Company Growth Ratio," minimum of 1; "EPS Surprise Breakout," 1 minimum; "Proj EPS Annualized next FY, 15% and 5 Yr," 15% minimum. But tech earnings projections are often high, and reported earnings may be exaggerated. Cash flow offers a better picture of a company's finances. Some companies record sales that sometimes fail to produce any cash. So, after selecting either "Computers" or "Electronics" as the industry to search, set "Cash Flow Growth 1 Yr" to High as Possible and "Price/Cash Flow Ratio" to Low as Possible. Those look for companies with the highest possible cash profits selling at the lowest possible valuation.
Next, take a look at the debt, which takes on special importance during an industry downturn. Go to the "Debt/Equity Ratio" and set it to a maximum of 100, which means the company's long-term debt cannot exceed the value of the shareholder equity. Then set "Current Ratio" to a minimum of 1.5. That means the company has current assets well in excess of its current liabilities and can pay its bills.
Ratios such as "Turnover-Inventory" and "Turnover-Receivable" can detect problems. Inventory turnover measures how many times a company sells and replaces inventory each quarter. If it's low, the company is having trouble selling its products. So set that to High as Possible. Turnover in Receivables--goods the company has sold but not received payment for--should be Low as Possible. If not, the company may be lending customers money to boost sales. If borrowers default, as some dot-coms have, revenues and earnings evaporate.
The results? You know how to screen for stocks, so go to BusinessWeek Online and try it yourself.
By Lewis Braham