It takes time to find great investment ideas.
I know I have to pass on at least eight ideas before two become research worthy, but it still doesn't guarantee that those two ideas are investment worthy.
Unless you are a full-time investor, it's difficult to dedicate the hours you need into searching, analyzing and learning at the speed that you'd like.
The whole investing process is a funnel. You start with the search, casting a net wide and far. Then let it trickle down the spout.
A lot of time is also spent at the top of the funnel where it's filled with low quality stocks, companies that simply doesn't fit within your investment objective and noise.
Here's my methodology to cut through the fat quickly.
Use a quality, value and growth filter
As a fundamentalist, I've spent more than five years backtesting, testing and challenging ideas to see which numbers really affect stock prices.
That's why I share results of 15 predefined stock screens where I tested things to see whether Joel Greenblatt (Trades, Portfolio)'s Magic Formula really works and how cash ROIC (CROIC) performs as an indicator.
My latest work involves scoring a stock based on three simple categories.
- Quality.
- Value.
- Growth.
I then combine all three to come up with a final score which I call my "Action Score."
Basically, the stocks that I should be acting on instead of wasting my time on other stocks that I will end up passing up on anyway.
A score and name to keep me focused on researching and looking for the best stocks that are worth my time.
Now here's the methodology for how I do it and how you can, too.
1. Quality criteria method
Quality stocks are ranked and scored based on
- CROICÂ –Â signals competitive advantage, management effectiveness. CROIC between 23% and 40% is the best range.
- FCF/Sales – signals cash generation ability, how efficient a company is. FCF/Sales has to be positive.
- Piotroski score –Â signals fundamental strength. Highest is best.
2. Value criteria method
The Value score is based on
- P/FCFÂ –Â has the biggest impact on the results and receives the highest weighting.
- EV/EBITÂ –Â does a great job of identifying cheap stocks and receives the second-highest weighting.
- P/BÂ –Â acts as a "cleaning" filter to remove stocks you overpay for assets. Also a way to remove bad stocks you wouldn't want to own no matter how cheap it looks.
- Piotroski score – assigned a fairly high weighting so the list removes "lotto" stocks.
3. Growth criteria method
Although this says growth, I look for fundamental business growth and not simply earnings or revenue growth.
Growth stocks are created using
- TTM sales percentage change – to find growing companies but also limited to a certain upper percentage to eliminate high flyers.
- Five-year sales CAGRÂ –Â to find growing companies that are not perennial losers.
- Gross Profit to Asset Ratio (GPA)Â –Â a wonderful measure of profitability to find stocks that are making the best use of their assets to generate sales.
- Piotroski F Score – assigned a fairly high weighting so that the list removes "lotto" stocks.
With the help of a math Ph.D., I then created a weighted ranking formula for quality, value and growth.
Instead of having to go through each of the numbers by hand, I've now got a powerful single number that I use to quickly pinpoint what I want to look at instead of swimming around at the top of the funnel.
The final "Action Score" is the best average of the three scores.
Three action score stocks
Here are three stocks scoring high marks that are worth looking into.
Another look at the three stocks in more detail.
No. 1: Westwood Holdings Group (NYSE:WHG) Grade A / 92.8 score
Operates in the financial sector. Company manages investment assets and provides investment advisory services related to retirement plans, endowments, foundations and more.
Basic stats
- Price: $58.78 per share.
- Market cap: $513 million.
- Enterprise value: $372.8 million.
- Forward div. yield: 4.02%.
Action score: Grade A (score of 92.8)
- Quality score: 93.5.
- Value score: 90.9.
- Growth score: 93.9.
Key highlights
- Piotroski score of 7 shows fundamental strength.
- Excellent FCF generation ability and achieves a high return on the cash it invests.
- Cheap valuation with EV/EBIT of 9 and P/FCF of 8.8.
- Solid revenue growth in TTM and 5 year CAGR.
- No debt.
No. 2: Hawaiian Holdings (NASDAQ:HA) Grade A / 88.3 score
Operates Hawaiian Airlines and one of the best performers in the Action Score list year to date.
Basic stats
- Price: $47.64 per share.
- Market cap: $2.5 billion.
- Enterprise value: $2.7 billion.
Action score: Grade A (score of 88.3)
- Quality score: 93.8.
- Value score: 86.1.
- Growth score: 84.9.
Key highlights
- Airline that is growing the top and bottom line.
- Able to generate 27 cents in cash for every $1 the company invests.
- Making better use of its assets with a Gross Profit to Asset (GPA) of 0.5 and room to improve.
No. 3: Gilead Sciences (NASDAQ:GILD) Grade A / 87.7 score
Wrote about Gilead before (Is GILD worth $100 or not?).
Gilead is just too high quality of a company with good valuations to pass by. Lots of noise related to Gilead with all the political headlines, but headlines often make for a great reason to buy.
Basic stats
- Price: $92.35 per share.
- Market cap: $125.6 billion.
- Enterprise value: $133.6 billion.
- Forward div. yield: 1.88%.
Action score: Grade A (score of 88.5)
- Quality score: 90.2.
- Value score: 85.9.
- Growth score: 87.0.
Key highlights
- Piotroski score of 7 shows fundamental strength.
- Fundamentals are excellent with a strong balance sheet.
- Cheap valuation with EV/EBIT of 6.7. Mostly all valuation numbers are on the low end.
- No risk of default or financial difficulties even if it were to lose additional battles in court.
Key lowlights
- Lost patent case to Merck (MERCK, Financial) and will pay $200 million in damages.
- Competition building up in the HBV space.
What's your action criteria?
These are just three stocks that have a lot of promise that came up very quickly.
More importantly, what's an important criteria that you look at to quickly filter stocks?
