Portfolio Management - Chapter 11

8/3/2019 Portfolio Management - Chapter 11

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Chapter 11

Security Screening

Prof. Rushen Chahal 1

Prof. Rushen Chahal


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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


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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Portfolio Management - Chapter 11