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September 20, 2006 - ICLUB News
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ICLUB InsiderSeptember 20, 2006


Stock Screening for Long Term Value
by Marc H. Gerstein

Marc Gerstein is the author of two books on Value Investing, Screening the Market (Wiley 2002), and The Value Connection (Wiley 2003), and is a stock analyst by training. With over 25 years of investing experience, Marc spent nearly two decades as a securities analyst covering two recessions, a major market crash and powerful bull phases. In 1999 he joined Market Guide as Director of Investment Research. Market Guide was acquired by Multex, which was in turn acquired by Reuters, a global provider of investment information and technology solutions to the financial services industry.

Gerstein champions the discipline of stock screening, and encourages investors to go beyond the hot stocks of the day and to search far and wide for companies demonstrating some measure of fundamental excellence. He also urges investors to resist selling based on every negative event. Instead, he advocates a strategy that identifies stocks investors should be willing to hold, even in times of temporary adversity.

What kind of stocks do you like?

We all have our opinions, and we have little trouble articulating them. After all, we read the same how-to books. We know what to look for: companies with solid long-term growth prospects, stocks that are reasonably valued, and so on and so forth. It's easy. Right?

Easy to discuss, yes. Easy to implement in the real world, to the point where we can type three or for tickers into the trading screens on our online broker accounts? Perhaps not.

How, exactly, does one find a company with solid long-term prospects? How do we determine if the stock is reasonably valued?

Stock screening can help. These software tools, readily available online nowadays, sift through modern databases to find stocks that contain the exact mix of ingredients we specify. Finding a needle in a haystack is tough, but when it comes to stocks, if you can say ahead of time what the needle looks like, stock screening actually makes the task pretty easy.

Consider how we might search using's PowerScreener 3.0 screening tool.

We can start by specifying what we mean by "good long-term prospects." Perhaps we'd like companies whose earnings per share (EPS) are growing 50 percent a year. PowerScreener 3.0 can certainly produce a list like that.

But is that really such a great thing? Businesses tend to grow the same way humans do; very rapidly in the earliest formative stages and then progressively more slowly as they continue. Companies growing 50 percent per year now are more likely to transition to 20 percent in the future, rather than stay at 50 percent. That's not necessarily the end of the world -- growth rate deceleration is normal -- except when the market is enthusiastic about 50 percent growth, and the stock is priced accordingly. In such cases, the inevitable deceleration can be quite painful to stockholders.

So, let's throttle back a bit. How about a company growing 20 percent per year? That's better for our long term prospects, and most stock screeners will enable us to create these kinds of simple lists. But PowerScreener 3.0 lets us turn it up another notch: consider seeking companies growing, say, 25 percent more rapidly than their industry peers. After all, we're looking for stocks that are better quality than others in their field, to maximize our long term gains. If the industry average is 5 percent, that means a 6.25 growth rate would be acceptable. It's not as sexy as 20 percent…but 20 percent would be awful if the industry-average pace is, say, 25 percent.

The key: all businesses experience good times and bad, but through it all, some companies are fundamentally better than other similar firms -- and they might not be the ones we've all heard of, or read about in the newspapers. Let's screen for superior companies, and count on the fact they'll stay superior as industry cycles ebb and flow. We do this by adding to our screen a criteria that looks for growth rates that are 25 percent better than industry averages. We can do this for sales, earnings per share, or both. We can impose such requirements for a five-year time frame, or a past-12-months period. We can do likewise for other fundamentals indicators like return on equity.

So now we've identified a short list of companies who are out-performing their industry peers -- what about stock valuation? We can follow an analogous approach by looking for companies with below-average price/earnings or price/sales ratios. An interesting alternative would be to recognize that greed isn't always all it's cracked up to be. Let's recognize that if we have such substantial company superiority -- 25 percent plus superiority relative to peers -- we need to pay for it. After all, 'value' cannot be defined by price alone. If I'm getting companies that are out-performing their peers by at least 25%, I'm comfortable paying a premium of 10 percent. Let's just avoid overpaying. How about setting a screening test that allows valuation ratios to be as much as 10 percent above industry averages?

Many value investors will miss such opportunities, because they always demand low ratios. We're not quite as vigorous in our approach, but we're getting more in company merit (superiority of at least 25 percent) than we're paying for (up to 10 percent above the norm). Getting a lot relative to what you're paying -- that's value!

But there's one knock against even the best implementations of value investing methods: patience is needed. We're investing for the long haul, and while eventually the market recognizes true merit it sometimes takes a while.

We can use screening to get a jump on this. We can add a test that measures here-and-now investment community sentiment, reasoning that it's better to have the market reflect underlying quality sooner than later. Let's add a test requiring recent share price performance to be better than industry averages.

A screen like this really works. These concepts actually serve as the building blocks behind the Reuters Select Relative Value Screen, created using PowerScreener 3.0. Between January 28, 2000 and the end of August 2006, it gained 339 percent. Over that same period, the S&P 500 lost 3.6 percent.

What kind of stocks do you like?

Easy to discuss, yes -- as always. Easy to implement in the real world? Now it is.

Try Reuters PowerScreener 3.0 FREE for 30 days.

ICLUBcentral Software Manuals Now Available for Purchase

It's probably happened to you a zillion times -- you have a question about one of our software programs, but it just doesn't seem worth a call to technical support. Maybe it's a simple menu question about Toolkit, or you'd simply like a tutorial for using some of the more obscure reports in Club Accounting 3.

Now, instead of letting your concerns fade into oblivion, you can look up the answers for yourself by flipping through one of our new software manuals.

Available for Toolkit, Stock Analyst, Club Accounting 3, and Club Accounting Online, these workbook-style manuals are comprehensive desktop resources for all your stock analysis and accounting needs, regardless of your experience level. Advanced users will enjoy the descriptions of our high-end features, while novice investors will most certainly benefit from the step-by-step Getting Started guides.

Each manual is printed on high-quality paper stock and is bound with Wire-O spiral binding, allowing it to rest flat for easy desktop use.

Training a new treasurer on Club Accounting? Order them a manual to help them get with the before tax season. Trouble with Toolkit? Check the index of your new manual to find out where you went wrong. Whether you've been investing for two weeks or two decades, it's always nice to have the answers to your questions at the tip of your fingers.

Order your printed manuals today!

Investor's Toolkit 5
Stock Analyst 3.2
Club Accounting 3.1
Club Accounting Online

Remembering Easyware's Bob Lindsay

We recently received word of the passing of Bob Lindsay, one ofthe co-founders of Easyware Software, the original developers ofthe NAIC Club Accounting software program. (Easyware was acquiredby ICLUBcentral in 2001.)

Many investment club treasurers may remember Bob from CompuFestand local chapter investors fairs as the public face of clubaccounting software. His earnest and cheerful demeanor helpedspread the word about how software could indeed make thetreasurer's job easier.

Bob worked at Hewlett-Packard for 24 years as a design engineerand, in later years, as a sales engineer. After taking earlyretirement, he helped start Easyware Software, which grew in thenext decade to reach its position as the pre-eminent provider ofclub accounting software.

All of us here at ICLUBcentral mourn Bob's passing, whilerecalling his grace and infectious optimism with fondness. Weextend our condolences to all his friends and family, includinghis wife Sharon.

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Some ICLUBcentral products use the investing methodologies of BetterInvesting, a national nonprofit organization dedicated to investor education. BetterInvesting assumes no liability or obligations with respect to the investment education information or other content presented in the ICLUB Insider. For more information on BetterInvesting, please visit

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