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Chapter 11 Security Screening

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The NYSE and AMEX, and Nasdaq list thousands of potential investments ... AMEX. NYSE. Nasdaq. 33. Familiarity. Invest in companies that you know something about ... – PowerPoint PPT presentation

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Title: Chapter 11 Security Screening


1
Chapter 11Security Screening
2
Outline
  • Introduction
  • Why screening is necessary
  • What constitutes a good screen?
  • Sources of information
  • Screening processes
  • Examples of commercial screens

3
Introduction
  • Security screening involves reducing the security
    universe down to a manageable size
  • Picking stocks is an art rather than a science
  • There is no single best way to choose individual
    investments

4
Why Screening Is Necessary
  • Time constraints
  • The NYSE and AMEX, and Nasdaq list thousands of
    potential investments
  • There is no time to analyze every security and
    process the associated information
  • Many people never develop a well-conceived way to
    deal with the information overload

5
What Constitutes A Good Screen?
  • Ease of administration
  • Relevance and appropriateness
  • Acceptance by the user
  • Ordinal ranking of screening criteria

6
Ease of Administration
  • The screen should be easy to administer and
    implement
  • E.g., narrow stocks down to thinly traded stocks
    by using the Wall Street Journal
  • Thin trading refers to a security with a
    relatively small number of shareholders and a
    lack of trading volume

7
Relevance and Appropriateness
  • Screens should logically have something to do
    with the ultimate objective
  • For example, start at the top of the NYSE
    listings with your screen

8
Acceptance By the User
  • Screens lose value if people fundamentally
    disagree with it
  • For example, people may not believe in SAT scores
    as a screen for admission

9
Ordinal Ranking of Screening Criteria
  • Use a screen pecking order for multiple-stage
    screening
  • The first screen is the one that eliminates the
    most alternatives
  • The second screen eliminates the second-most
    alternatives, etc.

10
Sources of Information
  • Value Line
  • Standard Poors
  • Mergent
  • Brokerage information
  • Internet

11
Value Line
  • The Value Line Investment Survey
  • Follows 1,700 common stocks
  • Rates each stock in two categories
  • Timeliness the advisability of buying a stock
    now
  • Safety the confidence Value Line analysts have
    in their forecasts about the firm
  • Is followed closely by many market analysts

12
Value Line Timeliness
Safety Ranking System
13
Sample Value Line Report
14
Standard Poors
  • Stock Report
  • Stock Guide

15
Stock Report
  • The SP Stock Report is a one-page document that
  • Is updated quarterly
  • Contains a description of a company
  • Contains an estimate of what the future holds for
    a company
  • Contains financial statement information,
    dividend payment dates, beta, and other risk
    measures

16
Sample SP Stock Report
17
Stock Guide
  • The SP Stock Guide
  • Is a monthly publication
  • Contains summary statistics on common stocks,
    convertible preferred stocks, warrants, and
    mutual funds
  • Is a companion to the Bond Guide

18
Sample SP Stock Guide
19
Mergent
  • Mergents manuals
  • Mergent Dividend Record

20
Mergents Manuals
  • Mergents Manuals
  • Were formerly Moodys Manuals
  • Contain seven sets of volumes covering industrial
    firms, public utilities, over-the-counter
    industrials, transportation issues, and
    bank/finance issues
  • Include the Company Archives Manual, which
    provides data on defunct companies since 1996

21
Mergent Dividend Record
  • The Mergent Dividend Record
  • Contains information on the recent dividend
    history of a company, including
  • Payment dates
  • Ex-dividend dates
  • Etc.

22
Brokerage Information
  • Brokers can be a good source of information
  • All full-service brokers have the ability to
    provide their customers with stock research

23
Internet
  • Examples of good sources
  • www.thomsoninvest.net contains consensus
    earnings estimates and a stock screener
  • quote.yahoo.com
  • www.smartmoney.com
  • www.morningstar.com
  • www.fool.com
  • www.quicken.com

24
Quote.Yahoo.Com
25
Screening Processes
  • Multiple-stage screening
  • Subjective screening
  • Screening with the popular press only
  • A quick risk assessment screen with the Stock
    Report

26
Multiple-State Screening
  • Most investment applications require several
    screening stages
  • E.g., EPS by itself is not very useful
  • E.g., dividend yield should not be the only
    screen for growth stocks

27
Subjective Screening
  • Not all screens need to be quantitative
  • For example, socially responsible investing
  • Tobacco stocks, nuclear power, animal testing,
    the environment, human rights, etc.

28
Screening With the Popular Press Only
  • Price/earnings ratio
  • Dividend yield
  • Stock price
  • Exchange listing
  • Familiarity
  • 52-week trading range
  • Options availability

29
Price/Earnings Ratio
  • Low PEs are good
  • Investors pay little to get a lot
  • High PEs are good
  • The efficient marketplace anticipates that future
    earnings will be higher than those of the past

30
Dividend Yield
  • Dividends do not materially alter a recipients
    wealth
  • People like to receive dividends
  • Strokes the ego
  • Important for income or growth of income
    objectives

31
Stock Price
  • Some people believe in an optimum trading range
    for stock prices
  • The cost of a share should be merely a market
  • People prefer to avoid odd lots
  • E.g., investing 2,000 means the stock price
    cannot be higher than 20

32
Exchange Listing
  • Some clients may want to restrict their
    investments to a particular exchange
  • AMEX
  • NYSE
  • Nasdaq

33
Familiarity
  • Invest in companies that you know something about
  • Familiarity is a subjective criterion

34
52-Week Trading Range
  • The stock is trading at the low end of its
    annual high and low
  • If the market is efficient, annual highs and lows
    are of no value in predicting future prices

35
Options Availability
  • Some people invest in equity issues that have
    options available because they are versatile
  • Options information is contained in the financial
    press

36
A Simple Financial Pages Screen
37
A Quick Risk Assessment Screen With the Stock
Report
  • ROA and ROE
  • Evaluating ROA and ROE

38
ROA and ROE
  • The Stock Report contains ten-year histories of
    ROA and ROE
  • Useful for a quick comparison of companies
  • ROA is net income after taxes divided by total
    assets
  • ROE is net income after taxes divided by equity
  • If the firm has debt, ROE will exceed ROA

39
Evaluating ROA and ROE
  • A good, safe investment has a history of stable
    ROA and ROE figures, with ROE somewhat higher
    than ROA
  • If ROE is substantially higher than ROA, the firm
    is heavily leveraged (risky)

40
Examples of Commercial Screens
  • Value Line publications
  • Computerized data

41
Value Line Publications
  • Timeliness and safety rankings are one of the
    most widely used screens
  • E.g., limit stock picks rated either 1 or 2 for
    timeliness
  • Value Line Investment Survey can be used for
    sector screening
  • Contains industry rankings

42
Computerized Data
  • Value Line Investment Survey for Windows
  • Compustat

43
Value Line Investment Survey for Windows
  • A 7,500 security database
  • Can be screened by more than 200 variables
  • Can be used to prepare statistical summaries and
    detailed tabular reports

44
Compustat
  • Used by academic researchers
  • Available for mainframes and microcomputers
  • Variables include
  • Current ratio
  • Retained earnings
  • Unfunded pension liabilities, etc.
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