Chapter 11
Security Screening
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Never tell people how to do things. Tell them what to
do and they will surprise you with their ingenuity.
- General George S. Patton
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Outline
 Introduction
 Why
screening is necessary
 What constitutes a good screen?
 Sources of information
 Screening processes
 Examples of commercial screens
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Introduction
 Security
screening involves reducing the
security universe down to a manageable
size
 Picking
stocks is an art rather than a science
• There is no single best way to choose individual
investments
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Why Screening Is Necessary
 Time
constraints
 Everyday examples of screens
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Time Constraints
 The
NYSE and AMEX, and Nasdaq list
thousands of potential investments
• There is no time to analyze every security and
process the associated information
 Many
people never develop a wellconceived way to deal with the information
overload
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Everyday Examples of Screens
 University
admission test
 The football team
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University Admission Test
 More
people apply for admission than are
ultimately admitted
 Universities
use two steps:
• An initial screen
• Closer individual scrutiny for those passing the
first round
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The Football Team
 More
players try to join the football team
than the rosters can carry
 Coaches
may use screens:
• 40-yard dashes for running backs
• Bench presses for offensive linemen
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What Constitutes
A Good Screen?
 Ease
of administration
 Relevance and appropriateness
 Acceptance by the user
 Ordinal ranking of screening criteria
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Ease of Administration
 The
screen should be easy to administer and
implement
 E.g.,
narrow stocks down to thinly traded
stocks by using the Wall Street Journal
• Thin trading refers to a security with a
relatively small number of shareholders and a
lack of trading volume
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Relevance and Appropriateness
 Screens
should logically have something to
do with the ultimate objective
 For
example, start at the top of the NYSE
listings with your screen
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Acceptance By the User
 Screens
lose value if people fundamentally
disagree with it
 For
example, people may not believe in
SAT scores as a screen for admission
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Ordinal Ranking of
Screening Criteria
 Use
a screen pecking order for multiplestage screening:
• The first screen is the one that eliminates the
most alternatives
• The second screen eliminates the second-most
alternatives, etc.
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Sources of Information
 Value
Line
 Standard & Poor’s
 Mergent
 Brokerage information
 Internet
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Value Line
 The
Value Line Investment Survey:
• Follows 1,700 common stocks
• Rates each stock in two categories:
– Timeliness: the advisability of buying a stock now
– Safety: the confidence Value Line analysts have in
their forecasts about the firm
• Is followed closely by many market analysts
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Value Line Timeliness &
Safety Ranking System
Ranking
1
2
3
4
5
Number of Stocks
with This Ranking
100
300
900
300
100
Meaning
Best
Above average
Average
Below average
Worst
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Sample
Value Line Report
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Standard & Poor’s
 Stock
Report
 Stock Guide
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Stock Report
 The
S&P Stock Report is a one-page
document that:
• Is updated quarterly
• Contains a description of a company
• Contains an estimate of what the future holds
for a company
• Contains financial statement information,
dividend payment dates, beta, and other risk
measures
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Sample
S&P Stock Report
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Stock Guide
 The
S&P Stock Guide:
• Is a monthly publication
• Contains summary statistics on common stocks,
convertible preferred stocks, warrants, and
mutual funds
• Is a companion to the Bond Guide
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Sample
S&P Stock Guide
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Mergent
 Mergent’s
manuals
 Mergent Dividend Record
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Mergent’s Manuals
 Mergent’s
Manuals:
• Were formerly Moody’s Manuals
• Contain seven sets of volumes covering
industrial firms, public utilities, over-thecounter industrials, transportation issues, and
bank/finance issues
• Include the Company Archives Manual, which
provides data on defunct companies since 1996
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Mergent Dividend Record
 The
Mergent Dividend Record:
• Contains information on the recent dividend
history of a company, including:
– Payment dates
– Ex-dividend dates
– Etc.
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Brokerage Information
 Brokers
can be a good source of
information
 All
full-service brokers have the ability to
provide their customers with stock research
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Internet
 Examples
of good sources:
• www.thomsoninvest.net: contains consensus
earnings estimates and a stock screener
• quote.yahoo.com
• www.smartmoney.com
• www.morningstar.com
• www.fool.com
• www.quicken.com
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Quote.Yahoo.Com
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Screening Processes
 Multiple-stage
screening
 Subjective screening
 Screening with the popular press only
 A quick risk assessment screen with the
Stock Report
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Multiple-State Screening
 Most
investment applications require
several screening stages
• E.g., EPS by itself is not very useful
• E.g., dividend yield should not be the only
screen for growth stocks
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Subjective Screening
 Not
all screens need to be quantitative
 For
example, socially responsible investing:
• Tobacco stocks, nuclear power, animal testing,
the environment, human rights, etc.
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Screening With the
Popular Press Only
 Price/earnings
ratio
 Dividend yield
 Stock price
 Exchange listing
 Familiarity
 52-week trading range
 Options availability
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Price/Earnings Ratio
 Low
PEs are good:
• Investors pay little to get a lot
 High
PEs are good:
• The efficient marketplace anticipates that future
earnings will be higher than those of the past
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Dividend Yield
 Dividends
do not materially alter a
recipient’s wealth
 People
like to receive dividends:
• Strokes the ego
• Important for income or growth of income
objectives
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Stock Price
 Some
people believe in an optimum trading
range for stock prices
 The cost of a share should be merely a
market
 People prefer to avoid odd lots
• E.g., investing $2,000 means the stock price
cannot be higher than $20
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Exchange Listing
 Some
clients may want to restrict their
investments to a particular exchange:
• AMEX
• NYSE
• Nasdaq
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Familiarity
 Invest
in companies that you know
something about
 Familiarity
is a subjective criterion
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52-Week Trading Range
 “The
stock is trading at the low end of its
annual high and low”
 If
the market is efficient, annual highs and
lows are of no value in predicting future
prices
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Options Availability
 Some
people invest in equity issues that
have options available because they are
versatile
 Options
information is contained in the
financial press
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A Simple
Financial Pages Screen
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A Quick Risk Assessment
Screen With the Stock Report
 ROA and
ROE
 Evaluating ROA and ROE
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ROA and ROE
 The
Stock Report contains ten-year histories
of ROA and ROE:
• Useful for a quick comparison of companies:
– ROA is net income after taxes divided by total assets
– ROE is net income after taxes divided by equity
– If the firm has debt, ROE will exceed ROA
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Evaluating ROA and ROE
 A “good,
safe investment” has a history of
stable ROA and ROE figures, with ROE
somewhat higher than ROA
 If
ROE is substantially higher than ROA,
the firm is heavily leveraged (risky)
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Examples of
Commercial Screens
 Value
Line publications
 Computerized data
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Value Line Publications
 Timeliness
and safety rankings are one of
the most widely used screens
• E.g., limit stock picks rated either 1 or 2 for
timeliness
 Value
Line Investment Survey can be used
for sector screening
• Contains industry rankings
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Computerized Data
 Value
Line Investment Survey for Windows
 Compustat
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Value Line Investment
Survey for Windows
 A 7,500
 Can
security database
be screened by more than 200 variables
 Can
be used to prepare statistical summaries
and detailed tabular reports
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Compustat
 Used
by academic researchers
 Available for mainframes and
microcomputers
 Variables include:
• Current ratio
• Retained earnings
• Unfunded pension liabilities, etc.
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