Parts A and B of my Scorecard exist to determine the “quality” of the balance sheet. Parts C and D of the Scorecard use the balance sheet numbers to define a low price “if” quality has been assured in Parts A and B. Taken as a whole, the Scorecard recognizes that a low-risk situation is one where I buy into a healthy company when a share of company ownership is available at a bargain price. The absence of quality or a low price means I’m taking more risk.
As discussed in my book, I use the finviz website to screen for stocks, selecting filters in a manner that would turn up companies that could possibly meet both my quality and low-price standards. The standards are then implemented on a particular stock through the parts of my Scorecard.
The seven filters I use, covered in my book, typically produce ample stocks to analyze with the Scorecard. However, the stock market is flying high these days. As a result, my normal set of screening filters is presently identifying too few stocks to analyze further with the Scorecard. Of course, this can change quickly with a correction in the stock market.
Until stock prices come down enough to allow my normal screening practice to once again produce more stocks to analyze with the Scorecard, I want to revisit something I mentioned in a previous post about relaxing some of my filters. My strict screening practice, the one revealed in the book, normally produces a good number of companies to analyze, often more than 30. So, following my very strict screen has kept me from having “too” many stocks to look at. However, tonight that screen has produced only two stocks. Clearly, more stocks are needed, if we can find them without compromising low-risk standards.
So, let me revisit some simple screen filter changes that can be made to produce more stocks to analyze with the Scorecard that still have a chance of meeting the Scorecard standards:
a P/E of “Under 30”
an insider transactions of “Positive (>0%)”
a current ratio of “Over 1.5.”
Changing these three filters and leaving the other four unchanged produces 14 stocks, as of tonight, for further analysis with the Scorecard.
Now, let’s do one more thing. Leave the P/E at “Under 30,” the current ratio at “Over 1.5,” but we’ll change the insider transactions to “Any,” which, in effect removes the insider transactions as a filter. Tonight, this leaves 37 stocks to analyze with the Scorecard.
Note, that I “prefer” the insiders to be buying with me. Changing the insider transactions to greater than zero from greater than +5 percent still means there has been net buying by insiders over the prior six months…..and we still have 14 stocks to check out. However, while removing the filter altogether yields 23 additional stocks (37 – 14 = 23), we can observe that the extra stocks come at the expense of giving up the affirmation of insider buying.
Again, my “un-relaxed” filter set, the one in the book, usually gives enough stocks to analyze. I hope this information proves helpful to those reading this post.
Dr. Allen,
Based on my analysis of several value investors, 3 strategies come to mind in such situations:
1. Get out of the market completely: Walter Schloss shut down his partnership (early 2000), as did Warren Buffett (late 60’s) when they were unable to find stocks to purchase based on their valuation criteria. They remained faithful to their core philosophy and protected capital when the bull market inevitably turned into a bear.
2. Reduce exposure: Graham suggests only a 25% exposure to stocks when they get overvalued; 50% for most times; 75% at the depth of a bear market.
3. Maintain full exposure to the market: there are always pockets of value; finding 10-15 value stocks is possible at all times.
Dr. Allen, what do you recommend during times such as these? After all, we are 5 years into a bull market and there must be a correction in the offing. Do you follow any market-timing / market-valuation systems e.g. Shiller CAPE etc.?
You have mentioned more than once in your book that relaxing the 7 criteria will likely decrease returns and increase the chance of losses.
I’d appreciate your advice Dr. Allen since I feel quite lost.
Thanks so much.
Al
Al,thanks for the great comment.
I don’t believe anyone can consistently time market directions, Al. I’ve done well in the market but have never done well at timing it. So, you won’t find me prognosticating more than a mere personal opinion when it comes to timing. Some of my stocks took real hits during 2008 and 2009 but they also recovered faster than the overall market afterwards since their balance sheets were strong enough to weather the storm and the value soon got recognized when things turned.
I usually try to remember that if the stock market crashes completely and never recovers again, it’s not going to make much difference what I’ve done with investing. I try to trust in the Lord as my security on a daily basis and go about my business, being extremely frugal with regard to investing.
Hypothetically speaking, if I feel too uncomfortable with being in the market, for whatever reason, it’s not worth the angst of working through that day after day. I’d rather be on the sidelines. So, taking a more conservative approach with regard to how much to have in stocks when the individual believes the market is overpriced is certainly a hard position with which to find disagreement.
As to my 7 criteria, allow me to clarify a bit. The screening criteria enable me to “fish” for low-priced stocks that possess quality. However, the criteria don’t “determine” quality or a low price under my method. That’s the job of my Scorecard. Using my normal 7 criteria usually provides ample stocks to score. That’s not true at the moment. Could that mean that value is harder to find here? That’s a reasonable conclusion.
Now, when I speak of relaxing my criteria, am I changing the depth of value I’m seeking? No. Remember, I’m not relaxing parts of my Scorecard. I’m just having to look harder in my “fishing hole.” Again, it’s my Scorecard that’s examining a company for quality and a low price…not my screening criteria. Finally, note that the relaxing of 3 of my 7 criteria, as discussed in my recent post, don’t compromise the stringency of my balance sheet emphasis, with exception of relaxing the current ratio to “Over 1.5.” Yet, again, the Scorecard still requires the company scored by it to pass my adjusted current ratio standard of liquidity. So, I’m not actually compromising the current ratio criterion when is screen because I have my own current ratio criterion on the Scorecard that must be surpassed by any company I actually buy.
So, understand what the screen does vs. what the Scorecard does. One is simply fishing while the other is scoring quality and low price. That is, by relaxing the screen, I’m not raising the price I’m willing to pay on a company even a single penny per share as there is no modification to the Scorecard. If the screen gets too liberal, the company won’t make it on the Scorecard.