The Problem With Filtering Stocks For What You Want

by: Richard Shaw

Filtering is necessary, but over-filtering is a problem.

If you invest in individual stocks and you don't filter, then you have to study all stocks, which is impossible -- or take the alternative.

The alternative is to rely on comments or reports from others, in which case you often don't know how they did their research, how suitable their criteria are for you, what their conflicts may be, and what they did not research that might be of interest to you.

So, we conclude that at least some degree of filtering is a good idea, no matter who you are, to create a broad list of potentially suitable companies. Then, if you don't want to or can't research further, when you hear or read about a company recommendation, you can check it against your broad universe of potentially acceptable stocks.

You could skip the filtering step and just research each company you hear about when you hear about it, but that would probably put you in a more subjective mode that is unlikely to be as consistent or as cool-headed as a list of pre-approved stocks prospect list.

Back to the Problem of Over-Filtering

The more specific you are about what you want, the smaller the universe of prospects becomes. Too many criteria, or too tight criteria, makes for very short lists. In the end some compromises are necessary.

Logical Wants

Here is an example of what we think is a rational set of five "wants" that eliminates most stocks:

  • I want above average financial strength and quality
  • I want above average income
  • I want better than average valuation
  • I want the analyst community to be bullish about it
  • I want the stock to be in good technical condition.

It is pretty hard for us to find arguments against wanting that set of features, but what that does to the universe of many thousands of stocks available can be disappointing in practice if you are rigorous about each separate want. To get more than a handful of prospects, each want must be defined in a somewhat forgiving way.

Specific Filter Criteria:

Once you decide the nature of your "wants", you have to make them executable with specific parameters. Here is one set that shows how what might seem reasonable, effectively eliminates the market:

Quality -- If you require that either Standard & Poor's or ValueLine give the stock an above average strength and quality rating (B+ or better from S&P or B++ or better from Value Line), the universe drops to 1,331 stocks.

Income -- If you also require that the dividend yield be at or above the median level of the overall U.S. stock market (2.76%) and the 5-year dividend growth rate be at or above the median for the market (3.71%), then the stock universe drops down to 200 stocks.
Valuation -- Now, if you add very desirable valuation to quality and income requirements, the universe gets tiny. If you required that the trailing P/E be in the lower 40% of its industry, and the 5-year historical EPS growth rate to be in the upper 40% of its industry, and the forward PEG to be 2 or less, the universe slips to 26 stocks.

Opinions -- Adding the Buy, Sell and Hold opinions of analysts takes the list down further. If you require that at least one of Standard and Poor's, or Value Line or Thompson Reuters Star Mine have a Buy rating (4 or 5 Stars from S&P, 1 or 2 Timeliness from ValueLine or 9.1 or greater out of 10 from StarMine), then the list drops to 14.

Technicals -- If you want some simple positive chart indications, a few more stocks fall away. Let's say you deal only with moving averages and want these two conditions:

  1. The price is greater than the 50-day average
  2. the 50-day average is greater than the 200-day average.

In combination with the quality, income, valuation and opinions criteria above, there are only 6 stocks that survive -- and they may or may not be interesting to you for any number of reasons.

The Survivors

This article is about the old saying, "You can have anything you want, but you can't have everything you want." It's not about the specific survivor of this hypothetical exercise, but we know our readers would feel cheated if we went through all this and did not say which companies survived. This article is not about them, but here are the stocks that passed the filters as of March 3, 2012 (presented in alphabetical order by symbol):

  • CVX -- Chevron
  • INTC -- Intel
  • NOC -- Northrop Grumman
  • RSG -- Republic Services
  • RTN -- Raytheon
  • SRE -- Sempra Energy

Disclosure: QVM has positions in CVX, INTC, NOC, and RTN in some accounts as of the creation date of this article (March 4, 2012).

Disclaimer: This article provides opinions and information, but does not contain recommendations or personal investment advice to any specific person for any particular purpose. Do your own research or obtain suitable personal advice. You are responsible for your own investment decisions. This article is presented subject to our full disclaimer found on the QVM site available here.