How to Build Your Own Stock-Screening Tool Using a 3-Factor Strategy

How can investors use technical terms to assess stocks like Constellation Software Inc. (TSX:CSU) without the need for a portfolio manager?

| More on:
The Motley Fool

Not all investors have portfolio managers, but those who do may be aware of the ranking tools they use. What these tools do is to screen stock performance using specially weighted indices. You’ll find very basic versions of the same thing on some stock market advice websites, although usually the inner workings of these tools are the hidden domain of financial advisors.

Below is a rough, jargon-free approximation of these sorts of tools based on three main factors used to assess individual stocks in determining whether they are improving or deteriorating. Let’s take a look at the hidden trends of the TSX and see how to calculate the true worth of a stock.

Value

To build a basic tool, the first objective should be ease of use. To make things simple, each of the three factors used will be split into three subsections. Let’s assign a 33-point weighting to each factor, so that it’s possible to calculate a total score out of 100. Each subsection will be scored out of 11 so that they’ll add up easily.

To come up with a value weighting, let’s use price to earnings (P/E), price to book (P/B), and dividend yield. Quality investment usually takes into consideration a stock’s value and its growth. However, for the purposes of our stock-screening tool, we’re going to give quality its own weighting based on a company’s ability to grow.

Quality

Let’s use return on equity (ROE) as an indicator of quality, since it’s a reliable measure of a company’s ability to reinvest in itself to generate growth, as well as to make acquisitions in order to expand or repay earnings to its shareholders either in the form of dividends or share buybacks. We can also use earnings per share (EPS) and expected growth in earnings as our other two subsections.

Momentum

Price momentum over time is the most obvious subsection here. This can be calculated over 10 days, or five, or however long an investor deems appropriate to test whether a stock’s price has momentum. In this strategy we’ll use five days.

Price volatility will also be assessed, based on a stock’s beta, which is a measure of an asset’s variability relative to the market (which has a default value of one). Lastly, let’s use valuation based on a share’s current price comparative to its future cash flow value.

Practical example

Let’s take a look at a popular tech stock, Constellation Software Inc. (TSX:CSU), and see how it fares with our basic screening tool.

Value: Constellation Software has two very bad multiples in its P/E of 64.4 times earnings and P/B of 26.7 times book. Add in a low dividend yield of 0.48%, and this stock gets 5/33, mainly for trying.

Quality: Constellation Software’s ROE of 41% is nice and high, while its EPS of $12.6 shows excellent growth. Throw in a 17.5% expected annual growth in earnings, and we have a score of 28/33.

Momentum: Despite Constellation Software’s year-long climb, this stock has now lost upward momentum and is in free fall, having shed -4.44% in the last five days. Its beta of 0.48 shows low volatility, and its share price is overvalued by 6% compared to its future cash flow value. This gives a score of 14/33.

What’s the verdict?

Altogether, Constellation Software gets 47%. That’s a pretty solid hold signal, and it correlates with current analyst calls, which shows that our simple tool might be fit for purpose! While other stock-screening tools go into more detail than the one we’ve built here, using this three-factor strategy gives a quick and fairly accurate reading for any given stock.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Victoria Hetherington has no position in any of the stocks mentioned.

More on Tech Stocks

investment research
Tech Stocks

Is OpenText Stock a Buy, Sell, or Hold for 2025?

Is OpenText stock poised for a 2025 comeback? AI ambitions, a 3.8% yield, and cash flow power make it a…

Read more »

The virtual button with the letters AI in a circle hovering above a keyboard, about to be clicked by a cursor.
Tech Stocks

Emerging Canadian AI Companies With Big Potential

These tech stocks are paving the way to an AI-filled future, but still offer enough growth ahead for a strong…

Read more »

Young Boy with Jet Pack Dreams of Flying
Tech Stocks

Is Constellation Software Stock a Buy, Sell, or Hold for 2025?

CSU stock has long been a strong option for high growth, high value stocks. But are there now too many…

Read more »

An investor uses a tablet
Tech Stocks

Canadian Tech Stocks to Buy Now for Future Gains

Not all tech stocks are created equal. In fact, these three are valuable options every investor should consider.

Read more »

dividend growth for passive income
Tech Stocks

2 Rapidly Growing Canadian Tech Stocks With Lots More Potential

Celestica (TSX:CLS) and Constellation Software (TSX:CSU) are Canadian tech darlings worth watching in the new year.

Read more »

BCE stock
Tech Stocks

10% Yield: Is BCE Stock a Good Buy?

The yield is bigger than it's ever been in the company's history. That might not be a good thing.

Read more »

Happy shoppers look at a cellphone.
Tech Stocks

So You Own Shopify Stock: Is it Still a Good Investment?

Shopify (TSX:SHOP) stock has had a run, but there's still room to the upside.

Read more »

A person uses and AI chat bot
Tech Stocks

AI Where No One’s Looking: Seize Growth in These Canadian Stocks Before the Market Catches Up

Beyond flashy headlines about generative AI, these two Canadian AI stocks could deliver strong returns for investors who are willing…

Read more »