Value investing is a disciplined investment approach using valuation measures that help to avoid the emotional traps of the market. Stocks and markets are driven by emotions that often push prices from their intrinsic value. The value strategies seek to profit from other investors' misjudgments by seeking stocks that are out-of-favor or neglected by the market and by avoiding the high-flying fashionable stocks that have been swept up by market euphoria. Eventually the market rediscovers out-of-favor stocks and lets the high-fliers fall back to earth. This is why value investing is sometimes called contrarian investing.

Value investing selects stocks that are priced low relative to measures of worth, such as sales, earnings, operating cash flow, assets and equity. Common measures of value include low price-earnings, price-sales, low price-to-operating cash flow, low price-to-book ratios and high dividend yields. This is not to say that all firms with lower price-X ratios or high dividend yields are good values. To be a good value, they must be able to show some potential. Realize that many stocks with low price-X ratios have little potential and deserve their low multiples!

As a general rule of thumb, screens that focus primarily on value stocks tend to produce a set of stock that can show less price volatility than screens that focus on pure growth stocks. Further, value stocks tend to have less portfolio turnover. Typically, they do not invest in smaller firms, preferring to focus on companies that are more mature and mid-sized or larger in terms of market capitalization. Historical earnings growth rates are rarely much above the market average, and the prices of the selected stocks do not tend to have momentum relative to the market. Value approaches tend to outperform other approaches during bear markets, but they can fall behind during bull markets, particularly during the strongest portion. However, as with all screens, a study of the annual report and an understanding of the company, its products, and its industry are required.

Refer to the AAII article, "Constructing Winning Stock Screens" by John Bajkowski to create YOUR OWN value screen using a stock screener of your choice. See the article "5 Best Free Stock Screeners" for a selection. Keep your screen simple. Use three (3) primary criteria and three (3) secondary criteria in your screen. As a general rule, the more criteria you specify and the stronger (the more limiting) your criteria, the smaller will be your sample of stocks that pass your screen.

Q1. LIST the both the primary and the secondary criteria you have selected for your screen and EXPLAIN your screening criteria choices.

Q2. LIST the total number, not names, of firms that your screen generates.

Q3. Based on what you have learned so far in the course, select what you believe to be the best two (2) firms from your list for immediate investment. PROVIDE the names of these two firms in your report. DESCRIBE their products and/or services that they offer.

Q4. JUSTIFY your selection on the strength of the firm's observed secondary (conditioning) criteria. For example, a firm with a low P/E ratio may have higher earnings growth over the past several quarters (or years) compared to the other firms in the same industry.


Growth Screens - 33 points

Growth investing is concerned with selecting stocks that will exhibit above-average and increasing growth. Growth investors look for industries and companies that are in the aggressive growth and growth stages of their life cycle-a period associated with rapid and increasing growth rates in sales and earnings with still-reasonable profit margins.

Minimally, growth companies are growing above the rate of the overall economy. Practically speaking, however, the benchmark for being classified as a growth stock is a 15% to 20% annual growth rate in earnings per share. Unless you are looking at a cyclical company coming out of a slump, growth rates this high generally require capital spending to maintain expansion. Growth stocks will therefore retain most of their earnings and have low dividend yields. Investors looking for high-dividend-yielding stocks will generally look for firms late in the growth stage or in the mature stage. One weakness with growth stocks, especially those in the aggressive growth stages, is that internal cash flow may not be able to support growth and, thus, more capital by issuing additional shares will be required. These firms will normally generate a negative FCFF. This may have the effect of diluting the existing ownership of shareholders.

Stocks with high growth and good prospects attract a great deal of attention. Price tends to be bid up with high anticipation. High expectations relative to current levels of earnings lead to high price-earnings, P/E, ratios along with high P/S and P/BV ratios. It is not uncommon to see highly touted growth stocks with price-earnings multiples two to four times the market. As long as a firm maintains its earnings per share momentum and exceeds the growth expectations of the market, its stock price can be expected to increase tremendously. Growth stocks, however, tend to be volatile. A small deviation from market expectations during a quarterly earnings announcement can send the price flying in either direction. Institutional investors own a large percentage of growth stocks and when they all try to head for the exit door the price can tumble.

Growth strategies want to buy growth, period. Their focus is on companies that are rapidly expanding their sales and earnings. Often, these stocks are already on the move, with prices typically moving up faster than the market. The approach tends to be more volatile-prices can move up or down substantially, with small changes in expectations-and it tends to perform better on a relative basis late in the bull market or when the economy is slightly down. For these reasons, investing in growth stocks requires close monitoring.

As in Q1, refer to the AAII article, "Constructing Winning Stock Screens" by John Bajkowski to create YOUR OWN growth screen. Keep your screen simple. Use two (2) primary criteria and two (2) secondary criteria in your screen. As a general rule, the more criteria you specify and the stronger (the more limiting) your criteria, the smaller will be your sample of stocks that pass your screen.

Q5. LIST the both the primary and the secondary criteria you have selected for your screen and EXPLAIN your screening criteria choices.

Q6. LIST the total number, not names, of firms that your screen generates.

Q7. Select what you believe to be the best two (2) firms from your list for immediate investment. PROVIDE the names of these two firms in your report and DESCRIBE their products and/or services that they offer.

Q8. JUSTIFY your selection on the strength of the firm's observed secondary (conditioning) criteria. For example, a firm with a higher earnings growth over the past several quarters (or years) compared to the other firms in the same industry may have a lower P/E, P/S or P/BV ratios than comparable firms or a higher profit margin.

"Remember, screening is a multi-step process. The first step is to apply the quantitative filters to the stock universe to help you arrive at a set of candidates that all share the same base set of characteristics. This doesn't necessarily mean they are all good investments. It is important to take your list of passing companies and, at a minimum, perform some cursory qualitative analysis to decide whether or not they are right for your stock portfolio." - Wayne Thorpe, AAII