From Intelligent Stock Picks to Capital Growth – Step by Step…

On the previous page, it was stated: “The challenge is in knowing how to bring together initially fragmentary metrics into cohesive, fully integrated formulae, which combine logic and reason into identifying successful businesses, which provide potential deep-value and growth trading ideas…”.

Here, we will go deeper into the precise stock screening and ranking methods we apply, every four weeks, towards capturing our Select10 stocks…

Starting from a clean slate, every four weeks, our first step is to run two independent stock-screens designed to capture two sets of stocks offering distinct characteristics. In order to screen stocks based on fundamental company data (extracted from the quarterly profit/loss, cash-flow, and balance-sheet statements released by every S&P 500 company), the quality of the backend data is of critical importance…

The Stock Screening Process…

Running a stock screen essentially narrows down the universe from 500 stocks, to ‘x’ number of stocks. Let us suppose for example, we are running the first stock screen. Assume the screen gives us 36 ‘qualifying’ companies from the original five hundred S&P stocks…

The thirty-six qualifying companies are placed in a ranking order, based on a ‘key’ fundamental ratio. So, continuing with the Screen One example, the rank order for this strategy is based on the ‘Free Cash Flow to Enterprise Value’ (FCF/EV) yield, from highest to lowest.

The top eight ranked stocks from Screen One are published in our four-weekly report. At the same time, the top 8 ranked stocks from Screen Two are also published. The Select10 strategy invests in the top 5 stocks from each screen (totalling 10), refreshed every four weeks.

Screen One – Screening Rules…

The first screen takes into account a number of key qualifying criteria, based on rational operating and management competence, combining gross profit margin growth, pure operating margin growth, minimum free cash flow to enterprise value yield, and minimum pure operating income to enterprise value yield. More precisely, the following four rules are applied, in order to initially narrow down the five hundred S&P stocks, to ‘qualifying’ companies…

(1) TBA.

(2) TBA.

(3) TBA.

(4) TBA.

The next step is to remove certain industries, which we exclude from the resulting list. From the above four-rule screen results, any companies within the following twenty industries are automatically removed: Automobiles, Auto Components, Household Durables, Leisure Equipment, Textiles/Apparel, Diversified Consumer Services, Media, Distributors, Multiline Retail, Specialty Retail, Biotechnology, Commercial Banks, Thrifts and Mortgage Finance, Diversified Financial Services, Consumer Finance, Capital Markets, REIT’s, Industrial Conglomerates, Insurance, and Real Estate.

Finally, from the remaining list of ‘qualifying’ companies, stocks are ranked (sort-ordered) by the key ratio ‘Free Cash Flow to Enterprise Value’ (FCF/EV) yield, from the highest reading to the lowest.

The top 8 stocks from the final ‘FCF/EV’ ranking are published. The Select10 strategy invests in the top 5 stocks from this list. So, for instance, assuming $20k of total capital, the first $10k is allocated to the 5 stocks from Screen One, with an equal dollar value of $2k each.

Screen Two – Screening Rules…

Screen Two focuses squarely on the free cash flow (FCF) metric, capturing companies/management which demonstrate strength in their cash flow generation relative to FCF margin growth, FCF to enterprise value yields, FCF to invested capital yields, and FCF to shareholders equity (book value) ratio. The following four rules are applied, in order to initially narrow down the five hundred S&P stocks, to ‘qualifying’ companies…

(1) TBA.

(2) TBA.

(3) TBA.

(4) TBA.

The next step is to remove certain industries, which we exclude from the resulting list. From the above four-rule screen results, any companies within the following nineteen industries are automatically removed: Automobiles, Auto Components, Leisure Equipment, Textiles/Apparel, Diversified Consumer Services, Media, Distributors, Multiline Retail, Specialty Retail, Biotechnology, Commercial Banks, Thrifts & Mortgage Finance, Diversified Financial Services, Consumer Finance, Capital Markets, REIT’s, Industrial Conglomerates, Insurance, and Real Estate.

Finally, from the remaining list of ‘qualifying’ companies, stocks are ranked (sort-ordered) by the key ratio ‘Recent FCF/Capital Yield to Historical Average FCF/Capital Ratio’, from the highest value to the lowest.

The top 8 stocks from the final ‘FCF Growth’ ranking are published. The Select10 strategy invests in the top 5 stocks from this list. So, for instance, assuming $20k of total capital, the second $10k is allocated to the 5 stocks from Screen Two, with an equal dollar value of $2k each.

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