In a previous post, I recommend using a stock screener to find high quality stocks to buy. In this post, I’ll review one of my favorite screens to find high quality growth stocks. This is a good starting point for your first stock screen. There are numerous other criteria and options available in most stock screeners beyond what I cover here, so be sure to make it your own.
My favorite stock screener
Nearly all reputable brokerages (TD Ameritrade, Fidelity, E*Trade, etc…) offer a stock screener. You can also find a number of free stock screeners online. A couple examples include Yahoo Finance and finviz. I’ve tried each of these stock screeners and my favorite to find high quality growth stocks is Fidelity’s.
Fidelity’s stock screener is my favorite because it provides greater options with respect to business fundamentals. In investing, there are fundamentalists (those focused on business valuation), technicians (those focused on statistics and how a stock trades – think charts, momentum indicators, moving averages, etc…), and techno-fundamentalists (a blend of each).
Personally, I’m more of a fundamentalist which is why I prefer Fidelity’s stock screener. Fidelity provides loads of statistics on a company’s financials and many of these data points are available within the screener.
For you technicians out there, Fidelity does provide some options, but you’re probably better off using TD Ameritrade’s thinkorswim or finviz to find stocks based on technical criteria.
Foundation of all my stock screens
There are a few criteria I add to nearly all my stock screens whether I’m screening for value, growth, or growth at a reasonable price (GARP). These are:
- Market capitalization – because it’s a lot easier for a $1 billion company to double in value than it is for a $100 billion company.
- Sector/Industry – because there are some sectors and industries I don’t understand and am not interested in.
- Debt-to-Equity ratio less than 1 – because I don’t want to invest in a heavily indebted company which could go bankrupt if the going gets tough.
- P/E ratio less than 30 – because great businesses make for great investments only if you pay the right price.
With these criteria, I’ve narrowed my focus from 9,752 stocks to 1,465. Note – I didn’t even screen out stocks based on sector/industry for this example.
Screen for strong business fundamentals
The foundational criteria above have enabled me to screen out expensive, heavily indebted companies outside my circle of competence. With the stocks remaining, I now like to screen for the following business fundamentals:
- Gross profit margin of 20% or greater – because pricing power matters.
- Operating margin of 5% or greater – because I don’t want R&D and SG&A to eat up all the gross profit.
- Return on invested capital of 15% or greater – because ROIC may be the greatest indicator of earnings potential.
With these additions, I’ve further narrowed down the list from 1,465 stocks to 369.
Look at past financial performance
One of my favorite investing hacks is to look to the past to inform the future. While past performance is not indicative of future results, it can certainly help establish expectations. Lastly, I like to include the following criteria to understand a stock’s past financial performance.
- 5YR revenue growth of 10% or greater – because I love sales.
- 5YR cashflow growth of 12% or greater – because cash is king and I want cashflow to outpace revenue.
- 5YR EPS growth of 12% or greater – because stock price typically follows EPS.
- Free cashflow greater than $0 – because FCF can be used for dividends and share repurchases and negative FCF means there’s no cash left over for me.
With these criteria added, I’m now left with what appear to be 95 high quality growth stocks from a starting point of 9,753. Not bad.
Now it’s time for homework
The 95 stocks passing this screen aren’t necessarily great companies representing great investments, so I don’t recommend blindly investing in any of them. Instead, I recommend using a stock screener to narrow down your homework. I’d much rather perform research on 95 stocks versus 9,753.
Fidelity’s stock screener gives you loads of options. For instance, if I only wanted to look at Mid Cap companies, the list narrows to 29 stocks. If I’m bargain-hunting for low P/E stocks (<15) within those Mid Caps, I’m now only left with 18. This is the power of the stock screener, so use it to your advantage.
