Screening for stock market equity investments is a tricky task but crucial to maximizing returns.
Three Methods Of Basic Stock Screening
Market Multiples And Valuation are an important concept to understand when comparing stock to each other or the broader market in general. A multiple is typically a comparison of one financial metric with another, such as price to earnings, or P/E. P/E is the most common market multiple tracked by stock investors and shows how much a stock is worth relative to its earnings potential. P/E can be either past or forward looking and is used to determine if the stock is under or over-valued relative to its peers and the broad market. Companies with lower P/E have lower value in the eyes of the market. If two companies with comparable business have significantly different P/E one is under-valued and the other is over-valued relative to each other. If a stock has a lower P/E than a broad market benchmark like the S&P 500 it is considered under-valued relative to the market.
* Tip – When screening look for companies within an index or sector that are undervalued relative to its peers and/or the broad market. High quality undervalued stocks tend to outperform in upswings. Also, screening by multiple will not limit the listing, any stock that matches will be listed.
Another way to value an business is with its market capitalization or market cap. This is the total value of the business in the eyes of the market and measured by multiplying the total number of shares by their last know price. This comparison helps to put the prices of different stock into perspective. For example, one stock may trade at $15 while another trades at $115. Because there are more shares of the $15 stock the market caps are nearly the same, making them similarly sized and valued in the eyes of the market. There is no set guidelines but market caps are grouped into nano, micro, small, mid, big and mega cap. Nano-caps tend to be valued under $50 million, micro-caps are usually $50 to $300 million, mid caps are $300 million to $2 billion, big caps are $2 to $10 billion and mega caps are over $10 billion in total market value.
* Tip – Screen by market cap. This will provide a list of companies that are the same size. Generally speaking, companies of a size tend to share some risk factors. Mega cap blue chip stocks tend to be stable with a history of performance and returns to shareholder. Micro-caps stocks tend to be volatile and risky with a higher chance for rapid growth.
Dividends are yet another way to value a stock investment, dividends are payments of profits to shareholders of a stock. These payments are usually made quarterly but can be as often as monthly or as infrequent as annually. The payments are most commonly made using the profits from operation but can also come from cash reserves held by the company as well as with leveraged funds. The health of the dividend is directly related to the health of the company, the amount of profits it makes and how reliant it is on leverage to produce those payments. Companies that earn more than their dividend payments are considered to be the healthiest while those relying on previously earned money or leverage are less healthy. Sometimes dividends can be in the form of stock where current shareholders receive additional shares.
* Tip – Once your list of possible investments is narrowed look to the dividend. Companies with higher yield are the obvious choice but not always the best. Companies with strong cash flow, healthy dividend coverage and prospect for increasing yield are best because they offer the chance for increased returns.
Dividends are measured in terms of yield. This is the amount of distributions, annually, compared to the current price of the stock. A stock worth $10 that pays a dividend of $1 has a yield of 10%. At face value the higher the yield the better the investment but this is not always the case. Higher yielding stocks are often seen as more risky for a number of reasons including dividend health; the higher the yield the harder it will be for the company to pay it consistently. A high yield can also be a warning sign that the company is in trouble, not performing as expected and/or in danger of lowering the dividend distribution amount. If a company issues a bad report or other negative news share prices can fall rapidly and artificially inflate yield.