My 3 Step Guide to Quickly Screen Stocks

Hey guys! Welcome back to the channel. In this video, we're going to be talking about a simple three-step method that I personally use in order to quickly screen stocks. So we're not thinking about, you know, potentially making an investment just yet. We're just looking at getting a feel for what's out there and how to quickly sort through whether a company might have some potential or whether it's a dud straight off the bat.

So, three-step method—that's what we're going to be talking about in this video. I hope you guys enjoy it. If you find it useful, please leave a like on the video; it is the easiest way to support the video and the channel. Make sure you subscribe as well if you'd like to see more content similar to this in the future, and click the notification bell if you want to be notified when I release new videos. But for now, let's get stuck into it. [Music]

So, as we know, there are four key steps to this long-term value investing approach that is modeled off of people like Warren Buffett, Peter Lynch, Monish Pabrai, Charlie Munger, and Benjamin Graham—all these people. So the first one is obviously we have to understand the business. The second one is that the company we invest in has to have a competitive advantage. Third is that the management team has to run the company with skill and integrity. And then fourth, we have to make sure we buy the shares when they're at a discount to intrinsic value; when they're at a margin of safety.

So that's the full method. However, when we're screening stocks, obviously that four-step method takes a very long time to go through to actually go ahead and make an investment. So, when it comes to screening, there are going to be some things that we leave behind a little bit, other things that we quickly focus on.

So, one of the things that we're going to leave behind is definitely valuation because valuation comes last after you've done all the research before, and to be able to value the shares correctly, you have to have a very solid understanding of the business, which takes time. And because it takes time, that's also the second area that kind of loses out when we're just skimming and screening stocks: we don't bother to go into too much depth to understand the business just yet because we're just getting a feel for whether this stock might be something that we want to look into even further.

Now, I will say straight off the bat, if you are someone that is interested in learning that full, you know, four-step value investing approach to go and actually make a proper investment, then check out "Introduction to Stock Analysis." That's an eight-hour course that I made; it's over on Profitable. Links are down in the description, but that's if you're interested—check it out.

But for now, let's talk through this three-step screening method. The first step in the process is really to make sure that the company is growing and to make sure that there's nothing that stands out as an immediate red flag with the financials. Then the second step is obviously we have to look for companies with a moat. So we're screening for companies with a competitive advantage. As we know, we never invest in a company unless it has some form of competitive advantage that keeps it ahead of its competitors.

And then the third step in the screening process is to quickly check whether the management team is running the business effectively; whether they're doing a good job, essentially. So, with that said, let's get into each of these three steps. The first is obviously screening the financials of the business and making sure that the company is actually going forwards—it's growing, it's not going backwards. Now, to do this, I always just head over to a website called Hypercharts.

Now, Hypercharts are also the sponsor of this video. So, Hypercharts actually started by a friend of mine. You might know him, Galli Russell from Hyperchange, and his friend Mo. Essentially, what the website aims to do is it takes the complicated kind of tabulated numbers out of the company's financial reports—the long boring financial statements—and it just puts them into graphs. So it just makes the financial statements really easy to understand visually, and they've done a really good job with the website too.

So if you're interested in using this or signing up to the website, then definitely I would encourage you to use the link, the referral link down in the description below because that just shows them that you've come across from the channel. Or if you want to just go through the sign-up process, use the referral code "new money." So definitely sign up to Hypercharts if you can. Otherwise, just follow along—head over to Hypercharts and just follow along for this example.

So, I'm going to show two examples: one that I would call a good example and one that I would call a less good example. So the first one I'm going to look at is Microsoft, then we're going to have a look at Uber. So firstly, let's have a look at Microsoft. And what we're looking at, first of all, you can see the first thing we're greeted with on Hypercharts is the revenue segments. What I'm looking for as a quick screen, I just want to see revenue consistently trending up over time. That's really all I'm interested in, just to get a brief overview.

What I don't want—what is a red flag—is if we see revenue going the other way and decreasing over time. I don't want anything to do with companies that aren't growing their revenue. So, you can look like obviously Hypercharts breaks it down into the actual specific parts of their revenue for Microsoft, but to me, when I'm just screening, I'm just looking overall—is it going up and to the right?

Then if we screen, we go down next, we hit revenue and operating income. So what you want to see with operating income: we've got our gross profit, okay, first of all, which is our revenue minus cost of sales. And then after you take out the operating expenses, then you're left with the red, which is the operating income. So, what we want to see is we want to see that gross profit over time is increasing and operating income is also increasing.

So operating income, that means that over time if it's going up and up and up, it means that the operations of the business are performing better and better and better every year, and they're generating more and more money. So that's what we like to see. And then here, here's a red flag: if net income is going down over time. So net income is the bottom line of the income statement. The income statement starts with revenue, and then that's the total amount of money that a company is pulling in, and then after that, you just take away—you slowly chip away—the income statement's all about chipping away, taking away all the expenses until you're left with net income for that time period.

So for net income, again, what we want to see is that it goes up and to the right. And yeah, definitely red flag if you're seeing net income going down over time or being very choppy. That's another red flag as well if it's just really inconsistent. As you can see with Microsoft, pretty consistent up to the right—that's what we like to see.

Now, moving down, we can have a look at gross margin, operating margin—all that you want to see, obviously gross margin is going to always be higher than operating margin because there are operating expenses that take away from the gross margin eventually down to the operating margin. But what you really want to make sure of, just as a quick screen, is that the operating margin—so the operating margin is how much of the revenue does the company get to—what percentage of their revenue do they get to keep after you take away all of their operating expenses?

And what you want to see is you absolutely want to make sure that the operating margin is positive. So, an operating margin that's negative but a gross margin that's positive just means that, yeah, sure, the company can generate some revenue, whatever—but when you actually take away their operating expenses, if the operating margin is negative, it means that they're not keeping any of their revenue.

So if we scroll down further, operating expenses—we can kind of scroll past this because that's kind of what the margins we're just talking about. Skip past the growth here, and then we get to the cash flow. Obviously, cash flow is really important for our type of investing strategy. What we want to see, first of all, is what we should see—the operating cash flow. This is the amount of cash that the operations of the business produce over whatever time period it is—in this case, it's quarterly.

We want to see the operating cash flow up to the right, growing over time, and the capital expenditures—they may increase over time, so they may take more money away from your business. But what the free cash flow is here is it's just the operating cash flow minus the capital expenditures.

So when we add this number in, as you can see here, here was the operating cash flow: 19.335 billion, and you take away the capital expenditures of 4.907 billion, and then you're left with free cash flow of 14.428 billion. What you want to see is you want to see that cash flow—free cash flow over time goes up.

Now, as you can see here, it looks a little choppy, but because we're looking at a quarter-by-quarter analysis, you can actually see that, look, there's one, two, three bars of good, and then one bar of reduced free cash flow, then one, two, three bars of good, and then another bar of reduced free cash flow, then one, two, three bars of good, and then another one, and then one, two, three, and then another one.

So what this is indicating—this is nothing too much to worry about; it just indicates that there is some seasonality to Microsoft's free cash flow. So their Q2 is seasonally weak, and then they have very strong Q3, Q4, and into Q1 of the next year. So what we want to see: free cash flow basically has to be positive. I only like to look at companies that are generating cash flow for the owners of the business, and we like to see this as well going up and to the right.

So that's Microsoft—I would call that a pretty decent first glance at a company. So that would get a tick. If we flick over to a company like Uber, then this is a couple of company-specific things that we're not going to look at. We're going to start again with revenue. As you can see, revenue was increasing over time, but now recently with the lockdown, it's been very choppy. So I would see whether you think that that is actually all due to the lockdown or whether there's something else that's going on, but immediately that's a bit of a question mark—certainly not as good as what we're just looking at with Microsoft.

And if we scroll down—oh, okay, all right, here we go—operating income. So how much income is the business operations generating? This number is negative, so that's a red flag. We like businesses that have obviously positive operating income—Uber, unfortunately, not there. Scrolling down—net income, again, this is raising question marks—is a bit of a red flag. Net income consistently negative, and it looks like it's had the last year or so has been a little bit worse as well.

I don't know what happened here; this was very negative net income. But overall, this is another bit of a red flag. We like companies that are making money—are in the positives. This is consistently negative for Uber. Now we go to the margins. Remember what we were talking about before? The gross margin is always going to be higher than the operating margin, so Uber, wow—they have a gross margin of about 50 percent. However, when you take into account all of their operating expenses, how much of their revenue do they actually get to keep as operating income? Well, none of it.

In fact, it costs them money. Currently, their business plan—their business, how it works—is costing Uber money. And as you can see, it doesn't look like it's particularly improving. It's very scattered, obviously, but we want to see positive operating margin, not negative operating margin.

Anyway, scrolling down, operating expenses—we kind of talked about that through the margins, growth—we skipped past, and then here's our cash flow—our free cash flow—consistently negative. So this is a company, to me, and you can see—look at this, the free cash flow is consistently negative. And what does that do to their cash pile? It dwindles it over time; it takes more and more away from their cash pile.

So overall, this is Hypercharts, and this is the way that I quickly screen whether I might be interested in a company. So, if we go back to Microsoft, yep, I'd be pretty interested in that one. When it comes to Uber, I'm probably not going to look any further into Uber because there's just too many red flags. So that's the first step in determining whether I'm going to be even remotely interested in this company—just to make sure that, you know, from a quick glance, that the financials are all in check.

And then from there, the next thing I like to look at is, of course, whether the company has a moat. So a big part of my long-term investing strategy is to make sure that the companies that I invest in show very consistent, steady growth over time because growing consistently over time—that is what really indicates that the company has some sort of competitive advantage.

So that's really the highlight phrase here: consistent growth over time. And to actually have a look at this, to do a quick screen of this one, we're going to use a different website. So I want you guys to head over to quickfs.net. So here I'm looking at Amazon, and immediately on the overview page, you can see that you're actually given—we're given three out of the four numbers that we're looking for here.

So we're given the 10-year compound annual growth rate of revenue, which is the top line, and then EPS, which is essentially the bottom line, and then free cash flow, which is an extremely important number to our style of investing. And the one that we're missing here that we would like to see as well is equity growth.

So firstly, what we want to see here is that all of these numbers—these three numbers and also equity growth—they're straight away showing long-term average annual growth rates of more than 10 percent. As long-term shareholders, we want to see that the trend over time is that this company, for one reason or another, has been able to continually post, you know, at least kind of 10 growth every single year in each one of these numbers. Shows that consistency over time; it shows that, you know, this shows a competitive advantage because it means that while there are heaps of competitors, then no company has effectively been able to claw away at their business and cause them to have years where they don't grow at all.

So as I said before, the one number that we're missing here is equity growth. So all you need to do in order to figure out equity growth is just type into Google "equity growth rate calculator." The one that I use is this one here—rule the Rule One website equity growth calculator. And then go back to quickfs.net, and what you need to find is you need to navigate, firstly, to the balance sheet, and then from there we need the equity value from 10 years ago, which in this case was 5.257 billion for Amazon, and then what the equity value is now, which is 62.060 billion, and plug those numbers into the equity growth rate calculator.

And then the time period here is going to be 10 years, so plug 10 years in, and then what you can see is that you get a 10-year compound annual growth rate of 28—fantastic! So we've got the first three numbers, and now also equity growth—they all have compound annual growth rates over 10, which is fantastic and definitely indicates that this company, Amazon, has some sort of competitive advantage—something that lets it grow basically uninterrupted, which is fantastic.

And then moving on from there, the last—the third key step in just doing a quick screen for the stock or screening for potentially good investments is to have a look at whether the management team is running the company well. And while through the investing process it will take us quite a while to actually sift through and do our research into the management team and figure out, you know, whether they are on the same side as the shareholders, there are a couple of quick screening numbers that we can immediately point to to see whether the management team is actually running the company with good amounts of skill.

So the first number that we're going to have a look at is the return on invested capital. Now this number assesses the management team's efficiency at allocating the capital under their control to profitable investments, so it gives you a sense of how well the company is using its money to generate further returns. How well is the management team reinvesting the capital it's got at its disposal to make the business grow, to generate more and more profits?

So what we want to see for return on invested capital is that every year the management team is able to keep this number above 15; that is ideal. 10 is an absolute minimum; we love to see 15 or more. So to check out this number or to do a quick