Monday, August 29, 2011

Stock Screens (1)


The computer has changed the landscape of stock analysis.  Instead of the drudgery of searching through reams of printed information to find stocks with desired financial strengths and ratios,  an investor can access and create computerized stock screens to identify companies which meet his or her requirements.  Most, if not all, brokerage companies with an on-line presence provide their customers with this time saving tool at no charge.  Individual investors can create their own screen, setting it up with his or her desired financial characteristics and save it for future reference.

If, for example, the investor wants a list of companies traded on the New York Stock Exchange (NYSE)  with market capitalization of two billion dollars or more; annual earnings growth of not less than 15%;  paying a dividend of not less than 2% per annum, and trading at a price earnings ratio of not more than 15, then he or she enters these requirements and the screen will find those publicly traded companies which meet them.  Value, growth and contrarian investors can adjust the screening requirements to fit their particular investment strategies and press the "enter" button for the results.  In seconds, a list of investment candidates appears on the screen.

In setting up the screen, the investor can establish the stock exchanges to be searched: the New York Stock Exchange (NYSE), the American Stock Exchange (AMEX), the NASDAQ, and the over the counter market (OTC) or all of them.  If the investor were to choose all of them, the universe of stocks to be screened would include over 7,000 companies.  The level of market capitalization (stock price multiplied by number of traded shares) can be established.  The investor can limit the screen to companies in a particular industry.  The screen can search for companies paying a dividend with a specific yield or trading at a certain price limit.

A screen can be programmed to search for companies with preset analysts' ratings.  The investor can set the screen to look for companies with histories (up to five years) of desired revenue and earnings growth rates or with analysts' revenue and earnings estimates going forward.  If the investor wants to focus on price, various standards can be established, including the price performance of a company when compared to its industry or to the S&P 500 index.

Valuation ratios can be established, such as price/earnings, price/book or price/sales.  Of particular importance to investors looking for dividends would be the dividend payout ratio.  This ratio measures what percentage of a company's earnings are paid out annually to shareholders in dividends.  The lower the ratio, the better the chances that the company should not have to reduce or suspend its dividend payments in the future.The screen can be set for various tests of financial strength such as ratios for debt to equity, return on equity, quick and current ratios and cash flow per share, to name just a few.

There are also various settings for technical measures of a company, but these would, typically, be of little interest to a fundamental investment strategist.  In the next blog, we will run a test screen with some metrics and see what happens.

Comments are always welcome.

Monday, August 22, 2011

So Many Stocks; So Little Time


If an individual investor decides to put together a portfolio based on value investing, the books reviewed in the last few blogs can provide the strategy and rules for analyzing stocks that meet the investor's requirements.  To continue the "gold miner" analogy, the value investor will have the necessary information to separate real nuggets from fool's gold.  The remaining question is how to find them.

In the bad "good old days", the individual investor had to almost take on a second job, i.e., the job of a securities analyst, poring over thousands of company communications, balance sheets, income statements and the like.  Since this is a full time job for the analysts on Wall Street, the individual investor would be faced with the almost impossible task of finding the time in his or her busy life to devote to identifying companies which could prove to be a good investment.   

In several of the biographies about Warren Buffett, it is reported that, for many years, he devoted substantially all of his waking moments to stock analysis.  Apparently, his family understood or, at least, put up with his single minded devotion to finding good stocks.  Given his financial success, it obviously paid off.  Not many individual investors will be able to convince their spouses and families that they can give up the day job because they will be able to do the same. If faced with such a proposal, most spouses would probably suggest their partner take up psychological analysis, not financial.

There are almost 5,300 companies traded on the NYSE (New York Stock Exchange) and the NASDAQ (the exchange formerly known as the National Association of Securities Dealers Automated Quotations).  The total universe of stocks increases significantly if you include the stocks traded on exchanges affiliated with the NYSE and all other exchanges around the world.  Reviewing all of the available information on all of these companies would be a daunting task, even for a full time Wall Street analyst.  Many analysts specialize in one or two industries, which greatly reduces the number of companies they must follow.

Before computers became ubiquitous, analysts and individual investors had to plod through volumes of material to find attractive candidates for purchase.  One method was to review the monthly Standard & Poors (S&P) Stock Guide, a small, thick pamphlet with financial information printed in very small type for all traded stocks.  An analyst or an individual investor could spend hours combing through the lists of statistics for each company looking for a stock which met some or all of his or her financial metrics.  As the computer took over Wall Street, this arduous task was taken over by computerized stock screens which quickly identified stocks with the analyst's desired financial ratios.  The computer accomplished in seconds what had previously taken many hours.

The home computer now allows individuals to also screen for investments.  The screening of thousands of stocks is the first step for an individual investor putting together his or her portfolio.  In the next blog, we will examine this investment tool in greater detail.

Comments are always welcome.

Monday, August 15, 2011

Dr. Burton Malkiel's Random Walk Riposte to Fundamental Analysis


We have now spent the last dozen or so blogs exploring fundamental analysis with Philip Carret, Benjamin Graham, Al Frank, Warren Buffett, Philip Fisher and David Dreman.  You may remember the excerpt from Al Frank's 1995 book, Al Frank's New Prudent Speculator in which he comments on the various forms of investing:

Given the multitude of information, possibilities, published "successful" methods, and strategies for speculating with stocks, how is one to choose?  The problem is especially vexing as apparently successful strategists dismiss their competitors' methods as seriously flawed or completely missing the point.

I pointed out in an earlier blog that proponents of the efficient market hypothesis, also called the random walk theory, reject, more or less, the fundamental and technical forms of analysis.  I say "more or less" because there are three subsets of random walk theory, the "weak", "semi- strong" and "strong" forms.  The essence of the theory is that the price of a stock, at any given moment, represents its true value, which varies in a random fashion as the stock is constantly repriced by the market.

One of the most famous of these random walkers is Professor Burton G. Malkiel, the Chemical Bank Chairman's professor of economics at Princeton University.  His famous book, A Random Walk Down Wall Street, is the classic text on the efficient market hypothesis, first published in 1973.  It is now in its 10th edition.  We will explore the book in depth in a later blog, but I wanted to share with you Professor Malkiel's analysis of fundamental investing.  He called it the "firm-foundation theory" of investing and described it as follows:

The firm-foundation theory argues that each investment instrument, be it a common stock or a piece of real estate, has a firm anchor of something called intrinsic value, which can be determined by careful analysis of present conditions and future prospects.  When market prices fall below (rise above) this firm foundation of intrinsic value, a buying (selling) opportunity arises, because this fluctuation will eventually be corrected - or so the theory goes.  Investing then becomes a dull but straightforward matter of comparing something's actual price with its firm foundation of value. (author's emphasis in bold)

Given all we have read about the fundamental form of investing, this is a very succinct and accurate summary of fundamental analysis.  Professor Malkiel goes on to point out what he feels are its weaknesses as follows: 

Despite its plausibility and scientific appearance, there are three potential flaws in this type of analysis.  First, the information and analysis may be incorrect.  Second, the security analyst's estimate of value may be faulty.  Third, the market may not correct its "mistake" and the stock price might not converge to its value estimate.

Professor Malkiel's observations should be kept in mind by any investor drawn to fundamental analysis.  In essence, he is reminding investors that nothing is perfect in this world, including Wall Street.  There is no one fool proof method for an investor to always use in managing his or her portfolio through constantly changing markets.  As Al Frank advised, the individual investor can only find the investment strategy that he or she feels most comfortable with and stick to it through up and down markets, enjoying the market rises and enduring the market declines.

You may have noticed that I have now added links in the blog to help you move around the site more conveniently.  Credit for this must go to my IT department, my daughter Susan.  If the links work, she gets the credit.  If they fail to connect you, it's my fault.  Comments are always welcome.

The material from Al Frank's New Prudent Speculator by Al Frank, copyright 1995 by Al Frank, is used with permission of the copyright holders, the heirs of Al Frank.
The material from A Random Walk Down Wall Street by Burton G. Malkiel, copyright 1999, 1996, 1990, 1985, 1981, 1975, 1973 by W.W. Norton & Company, Inc is used with permission of W.W. Norton & Company, Inc.

Monday, August 8, 2011

Contrarian Investing - David Dreman


My blog of January 17,2011 was titled A Long Wolf Does Not Call Home.  In that blog I discussed the life of a wolf driven from the pack and forced to hunt on its own.  I suggested that an individual investor might pattern his or her investment strategy along the same lines; avoiding the investment crowd to the extent possible and going it alone.

As I said in the last blog, some investors take this idea even further and intentionally invest in a manner opposite to that of the general investment community.  They are referred to as "contrarians."  One of the hallmarks of a contrarian is his or her search for stocks with a low price to earnings ratio (P/E).  A low P/E relative to the overall market is an indication that either the investing public is unaware of the company or is intentionally ignoring it.  The crowd may be ignoring the company because of a general lack of interest in the company (it's not seen as a "hot" stock) or because of a perceived economic weakness in the company or its industry.

Put simply, a low P/E stock is not popular; it is "out of favor" with the Wall Street community.  Contrarians look for these stocks, relying on the fact that sooner or later Wall Street will recognize the financial value of the stock and start to bid up its price as the company or its industry garner investors' attention.  Ben Graham characterized the market in this famous quote, "In the short run, the market is a voting machine but in the long run it is a weighing machine."

David Dreman is considered by many as one of the foremost contrarian investors.  His book, The New Contrarian Investment Strategy, was published in 1982 and remains, to this day, one of the best expositions of this investment strategy.  He was also one of the first authors to explore the psychological underpinnings of investment decisions.  He rejected the efficient market theory that investors always acted rationally.  Today there is an entire field of study called behavioral economics which researches how an individual's psychological makeup can affect and control his or her investment decisions.  Mr. Dreman recounts the results of several psychological experiments which revealed the way people actually approach risk and potential loss.  Some of the research also dealt with the effects "group think" can have on an investor's decisions.

One of my favorite stories from his book is about a mutual fund company, Bull and Bear, Inc. The fund managers wanted to cater to both types of investors in the market at that time.  So, they established two mutual funds: a bull fund for investors who thought the market was going to go up and a bear fund for those who thought the market was going into decline.  Mr. Dreman reported, "Both lost money!  That year, the bull fund declined 15 percent and the bear fund 9 percent."

Mr. Dreman also provided his rules for the contrarian investor.  He agreed with Messrs. Carret, Graham, Frank and Buffet that a company worth investing in had to have a strong economic position with acceptable financial ratios.  He also agreed with Mr. Fisher that a company should demonstrate a rate of earnings growth which exceeds the average earnings growth rate of the market.  He looked for companies with strong records of increasing dividends over time.  He also recommended diversification (equal investments in 15 to 20 different stocks ranging over 10 to 12 industries).

Although each of the previously mentioned authors recommended not overpaying for a stock, Mr. Dreman made a stock's P/E ratio the centerpiece of his investment philosophy.  His primary rule was to buy low P/E stocks listed on the New York Stock Exchange.  He told his readers, "In my own application of the low P/E approach, I have used the bottom 40 percent of stocks according to P/E's for stock selection."  Like Ben Graham, David Dreman was always looking for a cheap stock, as measured by its P/E ratio. By limiting his purchases to the NYSE, he was buying mid to large sized companies.

Mr. Dreman authored several books on contrarian investing, but, to my way of thinking, The New Contrarian Investment Strategy remains his best explanation of this branch of fundamental investing.  Unfortunately, the book is out of print.  You may be able to find copies at your local library or used copies at

Comments are always welcome.

Monday, August 1, 2011

You Gotta' Go Where They Ain't


You get in your car to go to work and turn on the radio.  The traffic reporter advises that the expressway you use everyday is totally bogged down and traffic is at a crawl because of a multi vehicle accident.  Do you follow your usual pattern and drive to the on ramp?  Obviously not.  You take an alternate route to avoid the traffic jam; you avoid the crowd.  Many of the authors we have discussed advise against joining investment crowds.  Some investors take an additional step.  They not only try to avoid being sucked into the emotions of the market crowd; they also take the affirmative step of heading in the opposite direction.

Most parents can remember their children's "terrible twos."  As a two year old takes those first steps towards independence, the little tyke will repeatedly resist parental commands.  "No" becomes his or her mantra.  Over the years, countless mothers have looked at their little rebel and said, "You are so contrary."

Humphrey B. Neill, known as The Vermont Ruminator, wrote The Art of Contrary Thinking in 1954.  It has undergone five editions and fourteen printings since then.  His opening line in the book is, "When everyone thinks alike, everyone is likely to be wrong."  He counseled his readers to avoid the crowd mentality that rules Wall Street, citing to our old friend, Gustave Le Bon and his book, The Crowd.  You may recall that we explored Le Bon's book in detail in earlier blogs.

Mr. Neill did not subscribe to the blanket idea that the crowd was always wrong.  He drew a finer distinction and felt that the crowd was most likely to be wrong at certain times in a market trend.  He had the following to say about the crowd:

Is the public always wrong?  This is probably the most frequently asked question about the Theory of Contrary Opinion.  For a correct answer we need to change the words in this question.  Let me put it this way:  Is the public wrong all the time?  The answer is decidedly, "No."  The public is perhaps right more of the time than not.  In stock market parlance, the public is right during the trends but wrong at both ends.  One can assert that the public is usually wrong at junctures of events and at terminals of trends.  So, to be cynical, you might say, "Yes, the public is always wrong when it pays to be right --but is far from wrong in the meantime."  (author's emphasis in bold)

Neill noted that no investor, including the contrarian, can accurately forecast such junctures of events or terminals of trends.  The contrarian, sensing the ongoing rush of crowd emotion, will usually find himself or herself leaving the market "party" early.  The departure may be weeks or even months ahead of the "game changing" event or "end of the trend", but it is better to be safe than sorry.  Like Cinderella, many investors stay at the ball way past midnight and rue that delay the morning after.  Neill believes this to be simply human nature, which he described as follows:

It has been my observation over a long period that it takes us average humans a considerable interval to shift our viewpoints, once we have established a given mental outlook.  That is, if we have (mentally) accepted a trend as moving in one direction, we are not inclined to change our outlook until well after the trend turns(author's emphasis in bold)

Humphrey B. Neill was the author of several books on investing, some of which we will look at in future blogs.

The excerpts from The Art of Contrary Opinion by Humphrey B. Neill, copyright 1954, 1956, 1960 and 1963 are used with the permission of the publisher, Caxton Press, Caldwell, Idaho;

Comments are always welcome and will be posted promptly.