How to use ratio screeners to shortlist stocks to buy - Motilal Oswal
How to use ratio screeners to shortlist stocks to buy - Motilal Oswal

How to use ratio screeners to shortlist stocks to buy?

The best way to short list stocks from a universe of over 3500 stocks is to use screeners. What exactly are screeners? These screeners allow you to short list your choice of stocks based on financial criteria. Screeners are useful not only because they can be used in isolation but also because they can be used in combination. So how to use stock screener and what is the best stock screener in India. Let us also understand some of the best stock screeners for day trading in India..

 

Profitability screeners
This screener allows you to screen and short list stocks based on their profitability. You can apply a variety of profitability parameters for this screening. For example, you can screen based on operating profits or even on the basis of net profits. If you want to look at the stock in terms of return on capital, then you can use screeners like Return on Equity and Return on capital employed. In fact, you can also use combinations of profitability screeners as under:
Screen for =>=> NPM > 10% .and. OPM > 20%

Screen for =>=> ROCE > ROE .and. OPM > 25%

 

Efficiency screeners

Apart from profitability screeners, the other important set of screeners pertain to efficiency or asset turnover as it is better known. Efficiency screeners measure how efficiently the assets are turned over for the level of sales. For example if the sales are 3 times the size of the assets then the asset turnover ratio is 3 (which shows a healthy level of asset efficiency). You can also have screeners based on fixed assets efficiency, core capital efficiency, working capital efficiency etc. These screeners can be customised based on the unique requirements of the investor.

 

Solvency screeners

The inclusion of debt in the capital structure is a double-edged sword. On the one hand it reduces the cost of capital but on the other hand it adds to your financial risk. That is because, unlike equity, debt has to be serviced in terms of the interest and the principal repayments. Hence solvency screeners are very critical as a sounding board on whether to invest in the stock or not. Solvency screeners can be created on the debt equity ratio, the total leverage ratio, interest coverage ratio, debt service coverage ratio etc. Solvency cut-off parameters can be set in advance and one can combine this with the results of the profitability screeners to get the best output.

 

Working capital screeners

Most manufacturing companies have a big challenge in terms of managing working capital. Managing short term assets like debtors, inventories, cash balances and short term liabilities like creditors, WC loans etc poses a huge challenge. The whole idea of working capital screeners is two-fold. First, it measures whether the company in question has a comfortable working capital position. That means; the company should have liquid assets that are sufficient to service the short term liabilities. This can be measured by screeners like the current ratio, quick ratio and the net working capital. The second purpose of this screener is to gauge whether the working capital is being used efficiently. Very low working capital ratios can be dangerous while very high working capital ratios reek of inefficiency.

 

Valuation screeners

This is normally the last level ratio screener after the fundamental screeners are completed and done with. Once you have short listed stocks based on your profitability, turnover, solvency and working capital screeners, the last step is to ratify your findings based on the valuation screeners. There are various approaches to valuation screeners. There are screeners based on P/E ratio, past price performance, P/BV for select industries, dividend yield etc. These ratios help you to shortlist companies that have a valuation comfort for the investor. You don’t just need a stock that is available at a price lower than the intrinsic value. You also need the stock to provide a reasonable margin of safety.

 

Combining the various screeners..

The real value addition for the investor comes from combining the various screeners. You can do that by setting multiple conditions at the same time. Typically, you do not screen these ratios as discrete variables. You always screen them as combinations. Look at some such examples:

 

Screen for =>=> NPM > 20% .or. ROE > 15% and P/E Ratio < 15X

 

Screen for =>=> Asset Turnover > 2 .or. Fixed asset turnover > 3 .and. Interest coverage > 1.5

 

Screen for =>=> Current Ratio >2 .and. Interest coverage > 1.25 .and. PBV < 2

 

The above are examples on how you can combine various ratio screeners to short list companies. The advantage of a fully loaded corporate data base is that the ratio screener can make your job much easier. This can be your first step before zeroing in on stocks.
 

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