portfolio management - chapter 11
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Chapter 11
Security Screening
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Never tell people how to do things. Tell them what
to do and they will surprise you with theiringenuity.
- General George S. Patton
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Outline
Introduction
Why screening is necessary
What constitutes a good screen? Sources of information
Screening processes
Examples of commercial screens
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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
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Why Screening Is Necessary
Time constraints
Everyday examples of screens
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Time Constraints
The NYSE and AMEX, and Nasdaq listthousands 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
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Everyday Examples of Screens
University admission test
The football team
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University Admission Test
More people apply for admission than are
ultimately admitted
Universities use two steps:
An initial screen
Closer individual scrutiny for those passing thefirst round
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The Football Team
More players try to join the football team than
the rosters can carry
Coaches may use screens:
40-yard dashes for running backs
Bench presses for offensive linemen
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What Constitutes
A Good Sc
reen? Ease of administration
Relevance and appropriateness
Acceptance by the user
Ordinal ranking of screening criteria
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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
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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
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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
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Ordinal Ranking of
Sc
reening 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.
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Sources ofInformation
Value Line
Standard & Poors
Mergent
Brokerage information
Internet
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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 theirforecasts about the firm
Is followed closely by many market analysts
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Value Line Timeliness &
SafetyR
anking Sys
tem
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Ranking
Number of Stocks
with This Ranking Meaning 1 100 Best
2 300 Above average
3 900 Average
4 300 Below average
5 100 Worst
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Sample
V
alue LineR
eport
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Standard & Poors
Stock Report
Stock Guide
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Stock Report
The S&P Stock Reportis a one-page documentthat:
Is updated quarterly
Contains a description of a company
Contains an estimate of what the future holds fora company
Contains financial statement information,dividend payment dates, beta, and other riskmeasures
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Sample
S&P Stock Report
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Stock Guide
The S&P 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
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Sample
S&P Stock Guide
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Mergent
Mergents manuals
Mergent Dividend Record
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MergentsManuals
Mergents Manuals:
Were formerlyMoodys 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
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Mergent Dividend Record
The Mergent Dividend Record:
Contains information on the recent dividend
history of a company, including:
Payment dates
Ex-dividend dates
Etc.
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Brokerage Information
Brokers can be a good source of information
All full-service brokers have the ability toprovide their customers with stock research
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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
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Quote.Yahoo.Com
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Screening Processes
Multiple-stage screening
Subjective screening
Screening with the popular press only A quick risk assessment screen with the Stock
Report
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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
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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.
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Screening With the
Popular PressOnly
Price/earnings ratio
Dividend yield
Stock price Exchange listing
Familiarity
52-week trading range Options availability
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Price/EarningsRatio
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
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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
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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
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Exchange Listing
Some clients may want to restrict their
investments to a particular exchange:
AMEX
NYSE
Nasdaq
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Familiarity
Invest in companies that you know something
about
Familiarity is a subjective criterion
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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
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Options Availability
Some people invest in equity issues that have
options available because they are versatile
Options information is contained in the
financial press
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A Simple
Financial Pages Screen
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A Quick Risk Assessment Screen
With the Stock Report
ROA and ROE
Evaluating ROA and ROE
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ROA and ROE
The Stock Reportcontains ten-year histories ofROA 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
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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)
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Examples of
Commercial Screens
Value Line publications
Computerized data
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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 Surveycan be used for
sector screening Contains industry rankings
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Computerized Data
Value Line Investment Survey for Windows
Compustat
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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
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Compustat
Used by academic researchers
Available for mainframes and microcomputers
Variables include: Current ratio
Retained earnings
Unfunded pension liabilities, etc.
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