Although my strategy calls for allocating between a fixed portfolio of stocks, the portfolio isn’t completely balanced to my satisfaction, and from time to time I have to add new stocks as the portfolio broadens, or replace them if they get taken away (fun when it happens).
I could just buy the stocks I want right now, but the problem is that some of them are more expensive than I want to pay for. So for the ones I eventually want, I’ve created placeholder positions with other “value” stocks. For example I hold Intel now, but eventually want to replace it with another solid, but zippier semiconductor stock – Nvidia and Broadcom being prime candidates.
So being the cheap SOB that I am, how do I find my stocks? I use the MSN Money website Deluxe stock screener, and here are the 3 main things I screen for.
#1 PRICE-TO-CASHFLOW RATIO
Some might consider this heresy, but I pay only passing interest to the Price/Earnings ratio. Why? Because earnings are very easy to manipulate, and I’m wary of them except in the case of well-established companies that would do themselves more harm than good by playing around with earnings. Instead of earnings I look for a price-to-cashflow ratio of less than 15, meaning the stock price is less than 15 times the cash flow per share.
To me positive and increasing cash flow, particularly free cash flow, is a better indication of day-to-day management ability than earnings, and the lower this ratio, the better the value you are getting. (Cash flow can be negative (bleeding money), so you clearly want to screen that out).
#2 DEBT-TO-EQUITY RATIO
Cash is fine, but not if the company just went to the ATM to get it. I like to see a company with low or no long-term debt. I cut off the debt-to-equity ratio at 30% for screening purposes.
Leverage in and of itself is not necessarily bad, but a company that is highly leveraged, or increasingly relying on debt to fund its operations, has far less flexibility to deal with being economically blind-sided. Look at the mess the North American auto industry is in.
#3 RETURN-ON-EQUITY (5-YEAR AVERAGE)
OK, that is earnings, but a company that has grown on average over the past five years at the rate of 15% annually or more, demonstrates to me that management at least knows how to make money, since recently they’ve done it successfully and consistently.
So basically then I look for companies with money in the bank, a management that knows how to make more, and very manageable liabilities that leave the company with all sorts of options such as being able to buy back stock, increase dividends (if they pay them), make intelligent acquisitions, and hold their own during economic downturns. There’s a bit more to it, but all the stocks I’ve bought, even if temporarily down, haven’t been down by all the much, and except for two recent purchases (Omnivision and Hi-Tech Pharmacal), bounced back and are all positive right now.
I must admit to having a bit of a cash fetish. I get very interested when I see cash and marketable securities covering over 20% of the stock’s price, and over 100% of all current and long-term liabilities. This is an extra analysis I do beyond the basic initial MSN stock screen.
Stocks I currently own or recently held that have passed through the basic screen are:
CURRENT
Frontier Oil FTO
Credo Petroleum CRED
Drew Industries DW
Western Digital WDC
Encana ECA
Intel INTC
Omnivision OVTI
Hi-Tech Pharmacal HITK
Cree Inc CREE
Cryptologic CRYP
Mine Safety Appliances MSA
Polaris Inc PII
RECENT
KOS Pharmaceuticals KOSP (taken over by Abbott Labs ABT)
Florida Rock Industries FRK (taken over by Vulcan Materials VMC)
Nokia (replaced) NOK
Merck (replaced) MRK
Ashland Inc (replaced) ASH
Cheers,
Allocator
Copyright 2007 – all rights reserved
1 Comment
March 11, 2007 at 8:02 pm
[...] to create your own customized screens, and is the one I use for my primary stock screening (see The stock screen that picked two take-overs). To get the deluxe version, just follow the instructions [...]