How to go about short listing stocks

The Bombay Stock Exchange (BSE) has over 5,000 listed companies on the exchange, making it the largest exchange in the world in this aspect. The market capitalization of the exchange is well over US$ 1 trillion (Data as at the end of December 2011. Source: Wikipedia). However, less than 10% of the companies listed on the exchange form more than 90% of this market capitalization figure.

Nevertheless, the 10% figure would also leave investors with a big enough list of decent sized companies. As such, a process of short listing stocks would be required. There are many ways to go about short listing stocks. Broadly, one could take a top-bottom approach or a bottom-up approach. The former approach i.e. the top-bottom approach involves analyzing the big picture where in various broader trends in the economy are gauged. Then within the economy, industry performances are studied and eventually companies within the industry are narrowed down. The bottom-up approach, on the other hand, focuses on company specific parameters as compared to the broader economic trends. The key idea here is to seek companies with strong moats and numbers, with good growth potential and not focus on the broader economy (not that it should be ignored completely). Advocates of the latter i.e. the bottom-up approach would usually start their short listing process with stock screeners. Given that there are over 5,000 stocks listed on the BSE, one definitely needs a place to start with the short listing process. And what would be the key factors that one would start with - historical performances. What the future holds is anyone's guess, but one could only start the process based on historical performances. For long term investors, many parameters are important and would be considered while short listing stocks. Some of key ones include:

• the size of the company in terms of market capitalization,
• trend in sales and profits over a long period,
• trend in operating and net profit margins - stable or volatile,
• the health of company's balance sheet,
• trend of return ratios,
• promoter holdings, and
• finally the valuations - price to earnings ratio and price to book value ratio.

While this list is not exhaustive, it would be a good place for investors to start their short listing process. We would like to take this opportunity to introduce Equitymaster's 'Advance Stock Screener', a stock screening feature that has recently been launched on the site. The screener allows the user to shortlist from over 600 stocks that are a part of the Equitymaster database. With this service, one would be able to short list stocks from both the banking as well as the non-banking space. The process can also be conducted on a sector wise manner. Users of this service would be able to run queries and screen stocks based on historical financial data from five years ago i.e. from FY08 till the latest year - FY12. The 'most popular section queries' section allows investors to run overall queries. Some of these include:

• Most under and overvalued stocks - based on price to earnings and price to book value ratios,
• Companies with the highest debt levels,
• Companies with strong return ratios, and so on.

Investors can also run queries on banking and finance companies - apart from the common parameters mentioned above, results can be pulled out on the basis of important parameters such as net interest margins and net NPA levels, amongst others. In conclusion It would be important for investors to understand that the usage of stocks screeners is only an initial process of picking stocks. This is because it only helps towards eliminating companies - which do not fit the parameters - and short listing those that do. As such, post the short listing process, it would be very much required and advised for investors to do their own research on companies (and the industry it belong to) before making any decision relating to purchasing the shares. One must keep in mind that there are factors that stocks screens will not tell you. As such blindly basing stocks picking decisions based on the results of stock screens is not advised. Equitymaster.com is India's leading independent equity research initiative