Stock Screening Methodology
I have devised certain stock screening strategies based on healthy annual sales growth [10 years, 7 years, 5 years, 3 years & 1 year] and net profit margins [NM] and return on equity [ROE]. In my view revenues are much better indicators and provide better significant statistics – revenues are real while EPS/earnings, if needed, can be manufactured.
Pay more attention to Sales Growth. The companies have a lot more leeway to make [or beat] bottom line results. As one would imagine, it’s hard to grow earnings without revenue growth. Corporate America has resorted to all sorts of “financial engineering” – stock buybacks, tax rate changes, one-time write-off of cost, and excessive stock based compensation.
We have divided the total stock universe into three groups: Small, Medium and Large. We have analyzed the data for one year, three years, five years, seven years and ten years.
- Annual Sales Growth [Revenue]
- Net Profit Margins [NM]I
- Return on Equity [ROE]
Our screening methodology is shown in the table below:
|Revenue TTM||Large Company||Medium Company||Small Company|
|Sales Growth 1 years||>=$5,000 M||>=$1,000 M||>=$100 M|
|Sales Growth 3 years||15%||<=$5,000 M||<=$5,000 M|
|Sales Growth 5 years||12%||20%||25%|
|Sales Growth 7/10 years||10%||15%||20%|
|Net Margin TTM||8%||12%||15%|
Please note that only handful of companies [10-15 stocks] among thousands of publically traded companies will successfully pass these rigorous selection criteria. You have to consider the quality of the process that led to the decision of stock selection. We want each decision we make to have a meaningful impact on our results and to be rewarded when we are righty. So our portfolio will be very concentrated. This is called ‘Focus Investing’. You should be willing to take action with conviction and comfortable diverging from the crowd.
“If you are a professional and have confidence, then I would advocate lots of concentration. For everyone else, if it’s not your game, participate in total diversification. If it’s your game, diversification doesn’t make sense. It’s crazy to put money in your twentieth choice rather than your first choice.”