Secrets Of Success: Screening is the new secret weapon

If you are a serious follower of the stock market, it is good to know that technology is working on your side. The range of ways that you can help yourself to become a more successful investor by using the internet grows ever wider. The fund supermarket concept, which enables private investors to find out more information about funds than most professionals were able to obtain 10 years ago, is one good example.

Another area where the internet is providing investors with raw analytical power they could only dream about until recently is in the field of stock screening. For several years I have used Company Refs, the stock-screening system devised by Jim Slater. It is invaluable for finding interesting stocks and as a way of tracking overall trends in market value (such as the number of stocks with high dividends, low price/earnings ratios etc).

Having originally been a monthly paper product, and then a CD as well, you can also subscribe to Refs online and rank or search all the quoted companies in the UK, down to and including Alternative Investment Market stocks, on a daily basis. (For reasons that are now lost in time, the online and paper versions for many years were produced by different companies, a legacy of some of the barmy things that happened during the internet bubble.)

At the same time, you can use Refs to create filters to find stocks that qualify under a range of different criteria, some based on Slater's own ideas, others on ones that you can create yourself. I have a method of looking for defensive stocks that has served me well over the years, for example.

I also keep an eye on the low price/earnings growth methodology that Slater helped to popularise (although the idea of comparing p/e ratios with earnings growth rates is almost as old as stock market analysis itself). The one-page stock summaries on Refs are another invaluable resource.

There are other providers that offer a similar service, usually with a variety of graphing packages thrown in. All these services suffer from one serious drawback: they cost money. What has been lacking, at least as far as I am aware, is a readily accessible free stock-screening service. Reuters had one for a while, which was US-based, but it has recently started to charge for it. No doubt a free UK service will come in time.

The next best thing could be DigitalLook's recently launched Market Stars stock screening service, where four basic stock screens are provided free to all users, with a free trial and subscription option for those who want to go on to use its more advanced searches and to customise their own screens.

I have been experimenting with this new offering for two to three weeks now and, although it is still in final testing phase, I think it has real potential for inquisitive private investors. I hope to publish some regular screening tests from this and other sources next year.

What you get with this new service is the ability to filter the entire universe of UK stocks on the basis of a wide range of criteria, including all the major metrics, such as market capitalisation, dividend yield, p/e ratios and so on.

In addition, once you have identified a filtering system, or created your own, it allows you to back-test how effectively that screening system would have worked had you applied it historically. This, as far as I am aware, is not something that you can do with any other screening service.

Having written several times about the merits of simple screening systems, such as Dogs of the Dow, Joel Greenblatt's Magic Formula, High Yield Stocks and so on, I know that many readers share my interest in these formulaic, but often highly effective, investment approaches. When simple screening systems work well, they tend to do so for two good reasons.

One is because they are based on observable facts of investment life (for example, that high-yield stocks produce the best long-run returns, especially when dividends are reinvested). The second is that they remove human discretion from the stock selection process, something that any student of behavioural finance will tell you is an invaluable aid in picking winners. A good screen directs you to stocks that you might otherwise not think of trying.

The DigitalLook service allows you to test away a variety of strategies to your heart's content, to the point of allowing you to download and analyse every stock that would have qualified for the past five years under the filtering system you have chosen, with links to key financial data on individual companies.

At the moment the ability to back-test only goes back five years, but DigitalLook intends to extend this to 10 years next year.

This is important, because a back-testing period that is limited to five years may give seriously misleading results if style factors have favoured a certain kind of investment approach over that period. Over longer periods, these style effects tend to cancel out. A good screen, in my view, must produce a manageable number of qualifying stocks to buy and hold, so it is important to be able to edit the filtering criteria yourself, as you can do with both Refs and Market Stars.

You also need to bear in mind the impact of transaction costs when looking at strategies that seem to back-test well. They may be costly to apply successfully in practice. Quality of data is another issue.

However, despite these standard caveats, for serious students of the market, who know what they are trying to achieve and why, DigitalLook's offering marks a new and welcome step forward in the empowerment of the individual investor that the internet makes possible.

jd@independent-investor.com