Stock Screeners: How To Use Important Financial Metrics

Stock screeners are powerful tools that allow investors to filter stocks based on specific criteria, including financial metrics that provide insights into a company’s past performance and future potential. The importance of these numbers cannot be overstated: they often serve as the foundation for informed decision-making when it comes to stock-picking. 

Here are some of the benefits they provide:

1. Objective Analysis: Stock-screener metrics serve as objective criteria to filter stocks, helping investors avoid emotional bias within their decision-making process.
2. Comprehensive Data: There is an enormous variety of financial metrics and ratios that stock screeners can filter for, enabling a thorough analysis of potential investments.
3. Consistency: You can use these metrics to maintain consistency in your stock selection process, leading to more reliable investment decisions.
4. Comparative Analysis: These metrics allow for easy comparison between different stocks, sectors, and industries, helping you to identify the best-performing stocks within a given category.
5. Risk Assessment: The metrics also help assess the risk associated with a particular stock by analyzing aspects like volatility, debt levels, and profitability.
6. Valuation Insights: They provide insights into whether a stock is overvalued or undervalued, assisting investors in making buy or sell decisions.
7. Performance Tracking: Investors can use metrics to track the performance of their investments over time and make appropriate adjustments as needed.

Understanding these metrics and how to interpret them is essential for anyone looking to build a robust and growing investment portfolio.

Let’s explore some of the key metrics used in stock screening:

Earnings per share, or EPS, is an important measure of a company’s profitability, and is closely followed by investors. We calculate it by dividing a given company’s net income available to shareholders (that is, net income minus preferred dividends) by the total number of shares outstanding:

Incorporating EPS into your decision-making:

• Trend analysis – growing EPS: This indicates consistently strengthening profitability or at least prioritization of shareholder interests (by way of share buybacks, for instance), and is generally looked upon favorably by investors.
• Trend analysis – declining EPS: This can point to issues with the company, or potentially neglect of shareholder interests
• Earnings quality analysis: Assess the quality of a given company’s EPS by examining factors like non-recurring items, which might artificially inflate or only temporarily dent the number.

The P/E ratio is one of the most widely used metrics in stock valuation. It is calculated by dividing the current market value of the stock – that is, the share price – by its EPS:

Incorporating P/E into your decision-making:

• Industry Comparison: Comparing a company’s P/E ratio with its industry peers is the standard method of assessing where it stands.
• High P/E Ratio: If a company’s P/E is significantly higher than the industry average, the stock is often considered expensive. This could indicate that a stock is overvalued, although it can also mean investors simply expect high earnings growth in the future – in other words, that earnings will eventually catch up with the lofty share price.
• Low P/E Ratio: A lower-than-average P/E tends to indicate a cheap stock, and may suggest that the company is experiencing difficulties. However, it could also mean the stock is unfairly underpriced, and that the shares may ultimately normalize with future earnings growth.

The P/B ratio compares a company’s market value – or share price – with its book value, which is the total value of the company’s assets minus liabilities, or debts. The metric is particularly popular among deep-value investors.

Incorporating P/B into your decision-making:

• Low P/B ratio: For value investors seeking a diamond in the rough, a company with a low P/B – often seen as that below 1.0 – can look enticing, as it can suggest the stock is undervalued. However, it could also indicate an unhealthy balance sheet.
• High P/B ratio: Conversely, a P/B above 1.0 may indicate that the stock is overvalued – although, similar to high P/E, it can also simply point to investor expectations for a higher total asset value or lower debt (or both) going forward.

• Where P/B is most useful: As might be expected, P/B is a particularly straightforward indicator for tangible-asset-heavy industries like manufacturing or utilities.
• Where P/B may fall flat: For companies with significant intangible assets, like tech firms, the P/B ratio might be a tougher way to assess an investment.

Dividend yield measures the annual dividend payment to shareholders (usually paid out on a quarterly basis) as a percentage of the stock’s current price.

Incorporating dividend yield into your decision-making:

• High dividend yield: Generally defined as a dividend that exceeds the current 10-year U.S. Treasury yield, this is attractive for income-focused investors and can indicate a stable, income-generating investment. However, it’s crucial to assess the dividend quality in this case, as the payout may be unsustainable for a struggling company.
• Low dividend yield: Not ideal for income strategies, but common in growth companies that reinvest profits into the business rather than paying dividends.
• Growth vs. Income: Consider your investment goals. If you seek growth, a lower dividend yield might be acceptable, while income-focused investors should look for higher yields.

The P/S ratio compares a company’s stock price to its revenues, calculated as the share price divided by sales per share.

Incorporating P/S into your decision-making:

• High P/S Ratio: If a company’s P/S is high vs. industry peers – and compared with other companies that have similar debt loads – this could suggest overvaluation or high expected growth.
• Low P/S Ratio: This might indicate a bargain-priced company or, potentially, issues with the company’s revenue generation.
• Where the P/S is particularly useful: This can be a great metric for companies with volatile or negative earnings. 
• Margin Analysis: Pair the P/S ratio with profit margin analysis to get a complete picture of profitability.

Market capitalization, or market cap, is the total market value of a company’s outstanding shares. Multiply that figure with the current stock price in order to calculate market cap.

Incorporating market cap into your decision-making:

• Large-Cap: Typically defined as companies with a market cap over $10 billion. These companies tend to be more stable and less risky, but may also afford fewer growth opportunities for investors.
• Mid-Cap: Seen as companies with a market cap between $2 billion and $10 billion. These can offer a balance of stability and growth potential.
• Small-Cap: Companies with a market cap below $2 billion. These sport higher growth potential than their bigger counterparts, but also constitute higher-risk investments.
• Risk Tolerance and Portfolio Diversification: Your risk tolerance should guide your focus on market cap. Aim to populate your portfolio with a mix that reflects this and, ideally, one that contains a range of market caps to incorporate both stable companies and high-risk, high-reward investments.

The PEG ratio augments the P/E ratio, incorporating a company’s expected earnings growth rate over any specified time frame (e.g., one year, three years, five years):

• PEG < 1.0: Suggests the stock may be undervalued relative to its growth rate.
• PEG > 1.0: Suggests the stock may be overvalued relative to its growth rate.

• Where the PEG is particularly useful: If you’re a growth investor, you would do well to pay attention to this metric in your growth stocks.
• Where the PEG may fall flat: Make sure there are solid and, ideally, numerous analyst forecasts underlying the PEG denominator, so as to produce a reliable figure

While each metric provides valuable insights, combining them offers a more comprehensive analysis. Here are some combinations to consider:

• P/E and PEG Ratios: A low P/E ratio combined with a low PEG ratio suggests that the stock is undervalued and has good growth prospects.
• P/B and Dividend Yield: A low P/B ratio with a high dividend yield might indicate a stable company with a good return on investment.
• EPS and Market Cap: High EPS growth in a mid- or small-cap company could signal a strong growth opportunity.

Customizing your stock screening process with these key metrics can significantly enhance your investment strategy. Understanding and interpreting the P/E ratio, EPS, P/B ratio, dividend yield, P/S ratio, market capitalization, and PEG ratio allows for a more informed and objective analysis of potential investments.

By combining these metrics and considering them within the broader context of industry and market conditions, you can build a robust and diversified portfolio that aligns with your financial goals and risk tolerance.

Combining multiple metrics offers a more comprehensive analysis of a company’s financial health, performance, and potential risks. Relying on a single metric can be misleading, while a combination can reveal a fuller picture and help mitigate the risks of making poor investment choices.

Combining qualitative metrics (such as management quality, industry position, and competitive advantages) with quantitative metrics (like P/E ratio, ROE, and EPS) enhances stock selection by providing a holistic view of a company’s potential. It helps investors evaluate not just the numbers but also the strategic factors that might influence future performance.

Yes, using a combination of financial metrics such as P/E ratio, P/B ratio, and EPS growth rate can help distinguish between growth stocks (which have higher growth potential but might be more expensive) and value stocks (which are often undervalued but may offer steady returns). This enables investors to align their selections with their investment goals.

Risk assessment metrics like the D/E ratio, Beta (measure of volatility), and the interest coverage ratio help investors understand the financial risk and volatility associated with a stock. By integrating these metrics, investors can gauge the risk level and decide if it aligns with their risk tolerance, leading to more balanced and stable portfolios.

Considering market-specific metrics (such as market capitalization, sector performance) alongside company-specific metrics (like ROE, EPS, and FCF) can provide insights into how a company performs within its market context. This dual approach helps investors understand broader market trends and how a particular stock might perform relative to its peers.