The Screener’s Proper Role in the Investment Process

Author: Lenny Grover

Estimated read time: 3 minutes

Publication date: 20th Dec 2019 11:40 GMT+1

As the founder of and author of Risk/Upside Analysis, I have given a lot of thought to how stock screeners can be best utilized as part of the investment process. While there are many proponents of quantitative investment strategies that rely almost entirely on screener-like rules to select securities (i.e. Joel Greenblatt’s The Little Book That Beats the Market), I do not advocate that approach. Instead, I rely on screens to narrow the universe of available securities to those that can be studied in greater detail—to exclude clearly unsuitable companies rather than select those that are suitable.

My distaste for using screener-like rules for automatic security selection stems from the simple fact that even highly complex rules-based ranking systems are likely to have both false positives and false negatives that could be easily detected by human intelligence. Even modern e-mail SPAM filters, Google PageRank, and other filtering or ranking algorithms that cost many millions of dollars of R&D to develop are not immune from this problem. Companies in secular decline are cheap for a reason, yet these firms often come up on value screens. For a period of time, many value screens were flooded with Chinese reverse merger companies whose reported performance was suspect. However, while I do not see screeners as the end-all-be-all, they can be very valuable tools as part of a disciplined investment process.

The need for tools to narrow the scope of investment inquiry is clear. While the universe of companies with a primary listing on a US exchange is large to begin with (~5,492 in the coverage universe on 12/19/2019), even retail investors are gaining the ability to trade across global markets through their brokerage accounts. That expands the universe of available symbols substantially (to ~30,895, in my screener universe). Even funds with large investment teams, aided by proprietary tools, cannot thoroughly analyze and remain up-to-date on over 30,000 companies. As evidence of this, only ~11,533 of these symbols have consensus revenue estimates for the current year in our data set in other words, the entire universe of research analysts (at all firms) tracked by our data provider cannot cover 1/2 of the company universe I am screening.

Core to my belief in the importance of powerful screening tools is a relief belief that if you prospect in the same narrow company universe as everybody else, it will be harder to consistently differentiate yourself with superior returns. Casting a wider net, and looking off the beaten path for investment opportunities, is especially important for value investors as there tends to be a positive correlation between the level of analyst coverage and the company’s valuation (specifically, the extent to which the company’s valuation incorporates future earnings). Screeners allow you to cast a wider net, while studying only the result set of companies that is likely to be a match for your specific investment strategy. Furthermore, advanced screeners like allow you create complex composite variables and screener conditions unique to your screens, increasing the odds that you will encounter overlooked investment opportunities.

While I am obviously biased, I believe robust screeners have an important role to play at the “top of the funnel” of the investment process, allowing investment professionals to cast a wider net and focus their efforts on the stocks most likely to fit their specific investment strategies. I welcome your feedback and look forward to your comments.

Disclaimer: The writer is an experienced financial consultant who writes for The observations he makes are his own and are not intended as investment or trading advice.