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| The Basics | Pick stocks like the heavy hitters
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Fundamentally sound
The remaining five of the top eight parameters involve valuation, profitability, and debt measures.
The price-to-book ratio compares the recent stock price to shareholders' equity, which is called book value when expressed on a per-share basis. Since Merrill didnt ask for values, I had to guess at what the pros had in mind. The average P/B ratio for the S&P 500 ($INX) is a little below 3. At the top of valuations, though, are Internet Information Providers, with an average 9 P/B, one of todays hottest industries. So I chose a high number, arbitrarily picking 10 for my upper limit.
- Screening parameter: Price/Book Value <= 10
The price-to-cash-flow ratio compares the recent stock price to a company's per-share operating cash flow. The average P/CF ratio for the S&P 500 is 13. But I decided, again, to go with a higher number, this time 40, to let in the Internet companies, whose average P/CF is around 36.
- Screening parameter: Price/Cash Flow Ratio <= 40
By the way, Google (GOOG, news, msgs), with a 24 P/B and 92 P/CF, would flunk both those tests.
Finally, in the valuation department, the price-to-earnings-growth ratio compares the P/E ratio to forecast earnings growth. Usually, PEG ratios below one signal undervalued stocks and those with PEGs above 2 are overvalued.
- Screening parameter: PEG Ratio Above 2 False Now
That convoluted statement, listed under "Advisor FYI" and "Price Ratios," instructs the screener to rule out stocks with PEGs above 2. Even Google, with a 1.7 PEG, passes this test.
Profitability matters
Return on equity measures profitability by comparing the bottom line after-tax income to shareholders equity. A company cant grow earnings faster than its ROE without raising additional cash. Most money managers that Ive talked to wont consider stocks with ROEs below 15%.
- Screening parameter: Return on Equity >= 15
Debt
The debt-to-equity ratio, which compares long-term debt to shareholders equity, is a popular debt gauge. The higher the ratio, the higher the debt. However, whats high and whats low varies with industry. So, Merrills surveyed managers probably compare a companys D/E to its industry and avoid stocks with D/Es higher than the industry average.
- Screening parameter: Debt to Equity Ratio <= Industry Average D/E
My screen turned up 21 stocks with a preponderance of home builders and banks, along with oil and gas stocks. Given the buzz about the housing bubble and the shrinking yield curve, which hurts bank profits, many money managers would likely overrule the screen and avoid home builders and banks.
| Deluxe Screener | | Company/Symbol | Last Price | Industry Name | | NVR (NVR, news, msgs) | 861.50 | Residential Construction | | KB Home (KBH, news, msgs) | 73 | Residential Construction | | Meritage Homes Corporation (MTH, news, msgs) | 82.18 | Residential Construction | | The Ryland Group (RYL, news, msgs) | 74.74 | Residential Construction | | Quanex Corporation (NX, news, msgs) | 60.23 | Steel & Iron | | ITT Industries (ITT, news, msgs) | 109.06 | Industrial Electrical Equipment | | Burlington Resources (BR, news, msgs) | 65.57 | Independent Oil & Gas | | RLI (RLI, news, msgs) | 45.80 | Property & Casualty Insurance | | Abercrombie & Fitch (ANF, news, msgs) | 64.20 | Apparel Stores | | HNI Corp (HNI, news, msgs) | 58.11 | Business Equipment | | Express Scripts (ESRX, news, msgs) | 55.54 | Specialized Health Services | | St. Mary Land & Exploration (SM, news, msgs) | 31.92 | Independent Oil & Gas | | Independent Bank Corporation (IBCP, news, msgs) | 30.04 | Regional - Midwest Banks | | Badger Meter (BMI, news, msgs) | 46.75 | Scientific & Technical Instruments | | Patterson-UTI Energy (PTEN, news, msgs) | 33.01 | Oil & Gas Drilling & Exploration | | Glacier Bancorp (GBCI, news, msgs) | 29.11 | Regional - Pacific Banks | | MidSouth Bancorp (MSL, news, msgs) | 26.80 | Regional - Southeast Banks | | Center Financial (CLFC, news, msgs) | 22.79 | Savings & Loans | | Virginia Commerce Bancorp (VCBI, news, msgs) | 25.90 | Regional - Mid-Atlantic Banks | | Seacoast Banking Corporation of Florida (SBCF, news, msgs) | 23.27 | Regional - Mid-Atlantic Banks | | Total System Services (TSS, news, msgs) | 24 | Business Software & Services |
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The momentum style that Merrills money managers favor is a relatively short-term strategy (think weeks). The screen should help you figure out which stocks these big players are looking at.
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