How to Use Stock Screens and My Stock Screener Criteria

I like to use stock screeners to identify potential dividend stocks to invest in. I know there are many people who actually use stock screeners to mechanically invest in stocks, but that I not my forte. I find that I do not have the conviction to blindly follow a mechanical strategy. However, my purposes for running stock screens is to weed out from 1000’s of available stocks to a very few that warrant further investigation.

There are a number of stock screening services available on the web for investors to use. Some cost money and some do not. The most widely known of the free services is the MSN Money Deluxe Stock Screener. However, as a Mac user I have not been using it as much since my switch from Windows. I can run it using Parallels but that can be a pain. I have recently been using the Premium Stock Screener at Morningstar.com and have found it to be a pretty good substitute. Keep in mind that I pay a monthly subscription fee to the site for access to this and other services, but it has been working for me.

How to Use Stock Screens

It is import to mention again that I do not use this screen as a buy tool – in other words I do not run the screen and then turn around and blindly purchase the stock. It that was motivation then an index fund would be a much better avenue to go down. Instead, I run stock screens using stringent financial requirements to weed out the companies that do not posses the fundamentals that I deem to be important. The effect is that 99% of the companies fail to meet the test.

The flip side is that because my criteria is so stringent there are typically very few stocks that make the screen and therefore I may miss some companies for further analysis. That is why I do not use stock screens as my sole idea generation tool. However, the obvious question is that if they don’t show up on the screen are they worth looking at as investments. That is a judgement call and is really the fundamental problem with individual stock selection – your idea of what is good may not be the same as mine!

My Dividend Screen Criteria

Keep in mind that not all stock screening software includes exactly the same parameters. The result is that depending on the stock screen you use you may not be able to exactly replicate the criteria I use. However, I think that is an important point as stock screens are intended to be an evolving mechanism that can constantly be improved upon depending on what factors are extremely important to you. Here is my current criteria:

1. Morningstar Rating >= Four Stars

Morningstar assigns star ratings based on our analysts’ estimates of a stock’s fair value. A 5-star stock is a good value at its current price; a 1-star stock isn’t. Although I typically do not put too much stock in these types of ratings, I have found that the Morningstar system does a good job of initially screening the crap from the rest by looking at things such as fair value, economic moat, and margin of safety.

2. Dividend Growth % Past 5 Years >= 8.82

Five-year dividend growth measures the annualized growth of a company’s dividends over the indicated time period. Note that the calculation uses dividends paid out during the most recent trailing 12 months as compared with those paid out during the trailing 12 months six years ago. Increasing dividends are usually a signal that management has confidence in the company’s continued earnings power.

3. Dividend $ – Year 1 ($ / share) >= Dividend $ – Year 2 ($ / share)

Identifies companies that have raised the dividend in the most recent year.

4. Op Income % Growth Year 1 / Year 2 >= 0.01

The annual percentage change in a company’s operating income. The calculation is a given year’s operating income minus the prior year’s operating income, divided by the prior year’s operating income. The resulting figure is then multiplied by 100. If this figure is positive, the company’s operating income is growing; if it’s negative, operating income is generally declining.

5. EPS % Growth Year 1 / Year 2 >= 5

EPS growth represents the percentage growth in a company’s earnings per share over a certain period, usually a quarter or a year, compared to the same period a year earlier. I screen for at least 5% EPS growth in the most recent year. This shows strong growth but does not weed out the big companies such as JNJ and KO.

6. EPS % Growth Year 2 / Year 3 >= 5

Same as #5 above but looks at EPS growth in years 2 and 3. This additional criteria ensures that the company has more than just one year of EPS growth.

7. Long-Term Liabilities / Total Capital % < 2.46

This is the value of a company’s long-term liabilities divided by its total market capitalization. The result is expressed as a percentage and is used as a measure of how leveraged a company is. The lower the number the better and indicates all the liabilities, or debt, of the organization.

8. Equity per Share % Growth Year 1 / Year 2 >= 0.01

This figure represents the compounded or annualized growth rate per share in a company’s shareholders’ equity, or book value. Equity per share represents the net-asset value backing up each share of the company’s stock. Growth in equity per share is therefore one of the key variables in determining if a company is increasing shareholder wealth over time. I look for at least some growth in equity per share.

9. Payout Ratio – Year 1 < = Payout Ratio - Year 2

Payout ratio is calculated by dividing dividends declared for the indicated 12 month period by net income for the same period of time. I want to see the payout ratio decreasing as it shows that there is good potential for the company to further increase dividends in the future.

10. Return on Equity % – Trailing 12 Months >= 15.17

Return on equity is the percentage a company earns on its total equity. The calculation is net income divided by end-of-period total equity. The resulting figure is multiplied by 100 to put it in percentage form. Return on equity shows how much profit a company generates on the equity shareholders have in the company. I want to see ROE at least 15.17 – companies in the top quartile of the market have at least a ROE of 15.17%.

The Results

On the day I ran the screen using Morningstar a whopping one company passed the screen – Stryker Corporation (SYK). My next steps is to complete further analysis on the company to see if it warrants further investigation and even possible investment.

What is Your Criteria

I would love to hear what your criteria for a stock screen might be if you use them. Or if you have not used screening software before, what criteria would you use? Let me and the other readers know using the comments below.