We live in a world where there is a paradox of choice. When choosing what to invest in, the sheer number of options available can paralyse retail investors. The number of approaches to begin screening for investment ideas is equally overwhelming.
You may adopt a top-down approach by using economic indicators to decide which sectors to look at, followed by coming up with qualitative and quantitative criteria to help you narrow potential candidates. Conversely, the bottom-up approach by shortlisting investments based on some parameters and justifying them with macroeconomic factors work as well. In this piece, we hope to provide a structure for investors to choose their investments in a more methodical fashion.
Step 1: Spot current trends and headlines
One fantastic starting point is the news. Regardless of whether you are a stock, bond or real estate investor, the markets for these assets move in response to world happenings. Market participants buy and sell assets based on their view of the financial and economic conditions of the world, entire countries, industries, and companies. By regularly keeping oneself abreast of current events, investors are better able to capture new opportunities in a timely manner and minimise the risk of missing out on them.
Another great starting outlet is to observe what is happening around you. Companies are profit-driven entities that provide goods and services to meet the demands of everyday consumers like us. Let’s use food delivery to elucidate. Food delivery has been around since the late nineteenth century. Yet it was only with the rise of hardware like smartphones that culminated in the rising popularity of such services. Along the way, factors like rising disposable income and pandemic lockdowns accelerated the growth of food delivery. By observing everyday trends and noting what is becoming more popular, investors become conscious of the industries and companies which provide these services. For instance, just trying to stay out of the way of copious Food Panda bicycles when walking on the streets may prompt investors to look at Delivery Hero (FWB: DHER).
Step 2: Search for industry insights
The next step is to understand the various industries. While many in-depth industry reports and articles require purchase or are hidden behind paywalls, there are nevertheless free reports available. Many of these are published by consulting thinktanks like Wood Mackenzie and big four accounting firms like Deloitte. To find these reports, investors can utilise more savvy search methods on engines like Google. For example, most reports are in a pdf format. A quick way to restrict search results is to type “filetype: pdf” before or after your search phrase. As alluded to above, markets move responsively to events in real time. To ensure that the information absorbed remains relevant and recent, the “Tools” option below the search bar enables search results to be filtered by criteria like time and location. Search operators like “OR” and “And” can save vast amounts of time and deliver more precise results. The list of search tips and tricks is extensive, but over time, investors may realise that they only need to grasp a few to become a more efficient investor.
Primers and reports tend to paint a bullish picture of whichever industry they focus on. Optimistic qualitative trends backed by figures like high compound annual growth rates of serviceable market sizes can lead to confirmation bias. Investors taking in such hopeful information may unconditionally believe that their initial identification of upcoming opportunities was right. We advise investors to maintain a healthy level of scepticism. Some reports will include a section discussing the risks and potential headwinds that may jeopardise the growth of an industry. For example, a McKinsey article on Web3 allocates a section on risks and challenges. These sections are particularly helpful for investors to develop a contrarian view, instead of blindly jumping on the bandwagon.
At this stage, investors should have a better understanding of prospective industries. Ideally, this means that one is aware of what are the key indicators to look at, how the industry is being valued, what growth rates can be reasonably expected etc. This is where screening tools come in. There are times when industry-related metrics are unavailable as input options because they are overly specific. Fortunately, an effective investment screen often utilises general filters that can be applied across different types of businesses. Some common ones include valuation metrics like P/E, financial performance like EPS, margins and growth, amongst a host of other selections. Given how widely used some of these are, it is helpful for investors to learn what they mean and when they can be appropriately applied.
Step 3: Filter with a stock screener
Stock screeners are powerful tools that help investors narrow down their investment options based on specific criteria. These criteria can include factors such as market capitalization, price-to-earnings ratio (P/E), dividend yield, revenue growth, and other financial indicators. By inputting these desired criteria into a stock screener, investors can quickly sift through the vast universe of stocks and identify the ones that best match their investment preferences.
After inputting the desired criteria, stock screeners will sift through the universe of stocks to find those that best fit the parameters. There are many screening tools out there with varying levels of customisation available, such as finviz and Zacks. Ultimately, the best stock screener should be user friendly, well-organised and intuitive to use. Many of these platforms have premium functions that require a monthly or yearly subscription, but some of them are available for free, albeit with more limited features.
It’s important to note that while many stock screening platforms offer free versions, some also offer premium functions that come with additional features and data. These premium functions often require a monthly or yearly subscription fee. However, for investors with more limited needs or budget constraints, the free versions of stock screeners can still provide valuable insights and help in the investment decision-making process, albeit with certain limitations.
Investors should consider their specific requirements and preferences when choosing a stock screener. Some may prioritize advanced customization options and access to extensive data, while others may prefer simplicity and ease of use. Exploring different stock screening tools and trying out their free versions can help investors find the one that best aligns with their investment goals and provides the necessary information to make well-informed investment decisions.
Step 4: Read reports and financial statements
By now, investors should have a shortlist of possible companies to invest in. The task now is to further eliminate candidates which requires an innate understanding of each company’s business model before uncovering what exactly sets them apart. Suppose our screening leaves us with five publicly listed defence firms. What then separates Lockheed Martin (NYSE: LMT) from say Raytheon Technologies (NYSE: RTX)? One immensely useful way to dive deeply into individual companies is to read their equity research reports. These are published by large brokerage and financial firms such as the likes of Morgan Stanley or Credit Suisse. However, they are often only accessible with hefty subscriptions to a Bloomberg Terminal or Thomson Reuters Eikon, which incurs an annual cost ranging anywhere between US$3,600 to above US$20,000.
An alternative, economical method to learn about the intricacies of a company is to read their filings found under the investor relations page of their websites, which can be accessed for free. Listed companies report their earnings every quarterly or half-yearly. These comprise financial statements and presentations that go into great detail about a company’s latest performance, sometimes paired with management guidance about near-term outlook. We think this is more than sufficient for investors to formulate a reasonably robust view to aid investment decisions. By subsequently comparing companies’ performance against other competitors, investors can unveil superior picks.
The fifth perspective
Having a framework to follow helps investors who are starting out and those who find themselves at a loss on where to begin or how to proceed. It is essential to not be bound to these steps. They are not meant to be prescriptive; instead, they should serve as guiding principles. With sufficient repetition, investors can tap on their experience to come up with their own methods of uncovering the next Amazon (NASDAQ: AMZN).
It is equally important to maintain realistic expectations. An exceptional and thorough screening procedure does not translate into a windfall. There are many factors beyond the control of investors. Even if we set our sights on the right company, market conditions can be thrown into upheaval, resulting in losses. In trying times, investors should remain patient and continue to apply a coherent approach towards their analysis. By excellently executing what is within our control, the odds will be stacked in our favour.
