Even before an investor decides to invest in stocks, the first question that pops into his/her mind is- What stocks to select for investigation? There are multiple ways to select stocks. The investor could approach a broker, subscribe to stock advisory firms, ask fellow investors, or personally screen stocks based on certain parameters.
About Stock Screening:
Stock screening is a technique in which an investor can filter the most relevant stocks from the extensive database of stocks based on certain parameters in which he/she can invest and earn profit. Thanks to the omnipresence of the internet and smart phones, many investors take the help of stock screeners available on various websites or apps to filter stocks. These screeners are available for free, or on a subscription charge basis.
Investors using a stock screener tool can screen stocks as per their requirements. It could be based on the stock price, certain ratios, market cap, 52 weeks high/low price, technical indicators etc.
Some of the advantages of screeners include:
- Saves a lot of time
- Eliminates bias and emotion
- It reduces the mechanical process of deriving stocks
- Good screens help in increasing returns
Ways to Screen stocks:
Screening of stocks mostly involves quantitative methods; however, an overlay of qualitative analysis would further enhance the screening quality.
Stock screening through qualitative analysis involves shortlisting of stocks by looking at the business itself and deciding based on below-mentioned parameters.
- Talking to the company’s management.
- Studying the product and services offerings, to gauge the scope in the future.
- Management strength and potential.
- Competitive advantage of the company.
- Company’s brand and its potential.
- It also involves Scuttlebutt approach, which entails interviewing the company’s customers, current and ex-employees, competitors, vendors and distributors to get legally available information which is more closer to the actual business ecosystem and also at times one gets information much quicker than relying only on quarterly or annual results.
In a layman language, the term Scuttlebutt refers to gossip or rumours. In the world of investment, Scuttlebutt was initially popularised by Phil Fischer, a famous money manager and the author of the wonderful book Common Stocks and Uncommon Profits. In the Scuttlebutt process, information gathering is based on the research about the company, generally through primary research.
The data from the open sources, such as the company’s annual report gives an idea about the company, its related product and services, the management, the results etc. But you get a clearer picture when talking to the employees within the organisation, the users who are using the product and services and its competitive advantage.
Through this, an investor can make a more informed judgement.
It depends on the personality as well as the skillset of the investor when it comes to screening the stocks via the above methods. Those investors who love to play with numbers are generally seen screening stocks via the quantitative method, while those investors who love talking to people, reading journals related to trading prefer qualitative analysis or the Scuttlebutt approach.
Stock Screening using quantitative analysis is done via the process of data crunching. The data could be from the financial statements such as the balance sheet figures, P&L statement, etc or from industry-specific journals, for example, monthly automobile sales data, or Department of Industry, Innovation and Science (DIIS) figures. It also involves looking at data in multiple time frames such as analysing data on a quarter on quarter basis, or on year on year basis.
Screening stocks via this method, an investor typically looks at:
- The financial statements of the company. They use actual figures or derived ratios from the profit and loss statement, balance sheet and cash flow statement.
- Comparing current data, valuations with the historical data.
- Comparing the company with its peer group and the industry in which the company is operating.
- Stock Price action, such as YTD returns, 5 years returns, 52-week highs and lows etc.
In this article, we would look a way in which an investor can select the stocks with an emphasis towards technology stocks.
Financial Ratios to look while Screening Stocks:
Know About Technology Stocks:
Technology stocks or tech stocks are stocks of those companies that are into the business of selling technology-based product and services.
These stocks are related to technology such as personal computers, social networking, telecom, software-based internet services and many more.
Companies under the tech sector:
- Software Companies
- Hardware Companies
- Internet information companies
- Telecommunication companies
- Cloud Computing
- Financial Technology
- Social Networking
- Artificial Intelligence
- Digital Advertising
- Connected TV
- Chip technology
Screening Technology Stocks; Key Features of Technology stocks:
Investors while screening stocks generally use the ratios discussed above. But while screening tech stocks, an investor also looks at whether the stock selected by him/her has a competitive advantage. Competitive advantage is a unique advantage which it has over its rivals.
Like the analysis of most businesses, IT business also entail a detailed study of the company’s balance sheet, P&L statement and the Cash flow statement.
In the IT business investors take into consideration gross profit margin, operational leverage, order book analysis to forecast revenue growth, since IT business is more human resource intensive attrition rate is also closely monitored.
Key Terms Explained:
- Gross profit margin: Gross profit margin is calculated by subtracting the cost of goods sold from the net sales and then dividing it by net sales. It tells how much profit the company has made before deducting selling, general and administration cost. It also gives an idea about how good a company is at developing a product or offering a service from its competitors. As the business models in the technology sector differ from one another, the gross profit also varies from company to company. This number also gives a good indication of the company’s pricing power.
- Operational leverage: It measures the extent to which an organisation can increase its operating income by increasing revenue.
It investigates the relationship between the fixed and the variable cost. Software companies generally have fixed operating cost in the form of salaries given to the developers as compared to the variable cost, which is related to the sale of software.
- Revenue growth: Revenue growth in a technology company is most commonly watched by investors to get an idea about the growing trend.
- Customer base: Investors also look into the customer base of the company as it gives an idea about the uniqueness of the products and services offered, which distinguishes from its competitors in the industry.
A good screen aimed at zeroing in on goof IT stocks should consider the above-discussed points. In today’s AI age, it has become even more easy for investors, as many brokers provide built-in screeners as part of their customer offering. However, an astute investor clearly understands that tools are not the edge, but sensible use of the tools is.
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