Screens for Great Stocks

Some folks, myself included, are addicted to stock screens. So when the market was down in the wake of September 11, I did some quick screens to come up with a list of buy candidates. I searched for stocks using the following criteria:

1. Sector: Technology 
2. Market Cap: Greater than $2 billion 
3. Revenues TTM: Greater than $2 billion
4. Financial-Leverage Ratio: Less than 3.0
5. Morningstar Rating: 5 stars
6. Price/Cash Flow: Less than 20
7. Percent Below 52-Week High: 50%

In other words, I wanted to pick up some beaten-down stocks in the tech sector--an area of the market I shunned during the go-go days of 1999 and 2000 because it was too expensive for my taste. I figured if I’m ever going to get technology exposure, now’s the time to do it. To find some acceptable stocks, I focused on established companies (those with market caps and annual revenues of at least $2 billion), good balance sheets (shown by the low financial-leverage ratios), and beaten-up share prices (high star rating, low price/cash flow, and a stock price well below its 52-week high).

Among the stocks that passed the screen, I ended up buying Intel (INTC), Dell Computer , Tellabs , and AOL Time Warner . After reading our Analyst Reports on those companies I felt comfortable with their businesses, and because they sported high star ratings, I also felt comfortable with their valuations.

Now that we’ve added our star ratings to our  Premium Stock Selector, you can run such screens faster than I was able to back in September. (For a primer on using the selector, check out Peter Di Teresa’s recentAsk the Professor column on the topic.) Here are three basic screens I’ve used at one time or another to winnow the 8,000-odd stocks out there to a shortlist worthy of more research.

Good Dividends
I search for high-yielding stocks for several reasons. First of all, because dividends get taxed at ordinary income-tax rates, high-yielding stocks make perfect additions to an IRA or other tax-deferred account. By tucking them away in such an account, I sidestep paying taxes on my dividend checks. Dividend-paying stocks are also good for these type of long-term accounts because I can instruct my broker to reinvest those dividends, thus creating an automatic dollar-cost averaging plan. When the stock price is low, I buy more shares. And when it’s high, I buy fewer shares. This strategy forces me to be contrarian.

Second, high dividend yields signal that a stock is cheap. Granted, it may be deservedly cheap. I’m especially skeptical of high-yielding cyclical stocks. Unless they have excess cash on their balance sheets, cyclical companies may slash the dividend when times get tough. But by limiting my screen to stocks with Morningstar Ratings of 4 or 5 stars, at least I know our analysts think the future results of the company will support today’s stock price. And by focusing on above-average financial-health grades, I toss out highly leveraged companies. As for the yield cutoff, with 10-year Treasuries yielding 4.4%, I figure any stock yielding more than 3% qualifies as high-yield these days. Thus, my screening criteria look like this:

1. Morningstar Rating: 4 or 5 Stars
2. Dividend Yield: Greater than 3%
3. Financial Health Grade: A or B

The stocks currently showing up on this screen include General Motors (GM)--one of those high-yielding cyclicals I’m wary of--Winn-Dixie Stores , Royal Caribbean Cruises (RCL), and FleetBoston Financial . If you want to get more selective, add a screen requiring that a company must show positive five-year growth in dividends (growth of more than 5%, for example). That assures you that the company has at least a five-year history of paying dividends, and that management has been willing to pay out more of its profits over time to shareholders.

"Safe" Stocks
No stock is ever a sure thing, but I can sleep easier at night by owning stocks that meet some basic safety screens. I can use the Morningstar Risk Measure, which our analysts calculate based on their assessment of a company’s competitive position, financial health, and stock valuation. It’s a kind of all-encompassing measure of risk. As for specifics, I look for low debt--exemplified in this screen by the good financial-health grade--and positive cash flows. And by including a star rating hurdle of at least 4 stars, I’m looking for stocks that are safe and cheap (to use a Marty Whitman phrase).

1. Morningstar Rating: 4 or 5 stars
2. Morningstar Risk Measure: Low
3. Financial Health Grade: A or B
4. Operating Cash Flow: Greater than 0
5. Free Cash Flow: Greater than 0

Right now 16 stocks make the cut, among which are New York Times (NYT), Paychex (PAYX), Safeway , and Estee Lauder (EL).

Cheap-By-Any-Measure Stocks
I like to regularly check the bargain bin--stocks that are cheap by just about any measure. This is essentially what I did when looking for technology stocks after September 11. When I see that a sector or the market as a whole is down, I like to examine what’s been beaten up the most.

1. Morningstar Rating: 4 or 5 stars
2. Price/Sales: Less than 1
3. Forward Price/Earnings: Less than 20
4. Dividend Yield: Greater than or equal to S&P 500
5. Percentage Below 52-Week High: 30%

Some of the stocks passing these criteria are Black & Decker , Boeing (BA), Loews (LTR), and El Paso (EPG). If you run this kind of screen, remember that the results will change regularly. When the market’s volatile, you’ll see lots of new names each week.

Add ‘Em to Your Watch List
Even if you decide not to buy anything that pops up on one of these screens, save those names that look interesting. Within Premium Stock Selector, put a check next to those stocks that caught your eye. If you have a watch list already saved within our Portfolio Manager, you can just add the selected stocks to the list by clicking the Add to Portfolio link. Over time, you’ll build up a nice stable of possible buys.

Happy hunting.