Stock selection process. Don't use popular stock screeners.

In this article, I want to discuss the danger of using stock screeners, how not to use them, and the solutions for retail investors in finding great stocks. 

First, a stock screener is a tool that lets you find the stocks based on different measurements that you set. There are a lot of popular stock screeners such as Finviz or Morningstar screener, or Yahoo finance stock screener. These are good tools for finding great stocks. But the problem with those tools is that they are mainly for professional analysts and investors who know what they are looking for and how to apply different financial rations. These investors and analysts usually have solid experience in equity valuation and company analysis. If you are only starting your investment journey and don’t have solid valuation experience, using popular stock screeners can be a dangerous idea for you. Let us consider why. 

If you open any popular stock screener such as Finviz or yahoo finance screener, you will notice that you are offered many filtering options. The classical stock screeners usually consist of plenty of financial ratios you must choose from to find great stocks. But the problem is that those financial ratios can be contradictory and confusing. Moreover, it is generally a bad idea to use many ratios as you may end up with 0 stocks, or you can significantly shorten your search results. Even experienced investors have difficulties applying the right filters to reflect their investment goals. For example, suppose you choose a PEG ratio that is lower than 1. In that case, you are searching for companies where analysts expect good net income per share growth dynamics. Still, from the other side, the company’s P/E and P/FCF ratios can be the highest among its peers, meaning that the company’s stock is trading higher than its closest peers. Would you choose that stock? Or another example is if you choose a larger market cap, which could mean that you are choosing a larger, more stable company, its stock can have a very high Beta coefficient which would mean that the company’s stock is very volatile. Would you choose that stock?

Another problem you can face is what financial ratios you should pay attention to. All the popular stock screeners give you only the standard set of financial ratios and data you should choose from, such as (P/E, P/B, PEG, Volatility, market capitalization, and many other standard data). Still, the problem is that often you need your custom ratios to differentiate between overbought or oversold companies. For example, if the company is in the oil industry, you should take into consideration the oil reserves and explorational goals (but not only limited by that), if you are dealing with telecommunication companies, you can take custom ratios that will best reflect the telecommunication sector. I am not against applying a standard set of ratios in the filters, but you should also use custom, industry-specific ratios. If you don’t do so, you risk making wrong conclusions or missing interesting stocks. Another pitfall is that you should not use too many parameters in the screener. If you apply more than four filters, you risk missing interesting stocks, or your search result could become 0 because you are tightening your search results.  

And there are a lot of such examples; I can continue describing those contradictions and dangers for a long time. To make a long story short, you should know precisely what the most important features for you are and what you are looking for to use popular stock screeners.  And you should also have experience in company analysis and equity valuation to apply the best filters for you. 

When I made it clear that popular stock screeners are great, but for more experienced investors, you may ask, “what should an inexperienced investor do?” If you don’t have the good market expertise and have no equity valuation experience, you can try using Diversset. This stock screener and portfolio building tool is designed for retail investors with little market experience or knowledge. To use Diversset, you don’t have to apply complicated financial ratios, choose among many unfamiliar filtering options, or analyze the stock graph. All you do is answer four simple questions, like your age, investment horizon, available funds, and required rate of return. And based on your answers Diversset will find you great stocks and construct your first efficient portfolio. Let’s consider in more detail how Diversset works. When you finish answering four questions, the app assigns you to a particular group, depending on your answers: risk-averse, risk-seeking, or moderate investor. And the app will apply complicated filters for you based on the group you belong to. Diversset analyses many things, including but not limited to asset trading volume, market capitalization, standard deviation, momentum, asset type (stocks, ETFs), company’s operational stability, and free cash flow growth dynamics. 

All this analysis is done to help you find stocks and ETFs that will best reflect your investment goals. The last step is a portfolio construction process. When Diversset finishes the stock selection process for you, it will construct your efficient portfolio. Press the “construct the portfolio” button when you finish answering questions, and the app will create your first well-diversified, efficient portfolio. In simple words, Diversset picks 10 of the most liquid, most stable stocks from the list it made based on your answers. And then will distribute those ten assets in your portfolio so that your portfolio’s expected loss will be the lowest possible, given your required return. Diversset uses the Markowitz portfolio model to make all those calculations. 

As you can see, if you use Diversset, you don’t need to apply manual filters or manually apply portfolio management models to construct an efficient portfolio. All you do is answer four simple questions, and Diversset will provide you with a fast and simple solution. It is entirely up to you what stock screener you will be using. You can get additional knowledge on equity valuation, financial instruments, and analysis by taking my Udemy course and then use popular stock screeners. Or you can try using Diversset and find stocks tailored for your investment goals and construct your first efficient portfolio. No financial knowledge is required in this case. Make your choice. Thanks for reading the article.