Analyzing companies is fairly straightforward. Finding companies to analyze is a different ballgame. In the U.S. alone, there are more than 10,000 publicly traded companies. With the power of the internet, we can now invest worldwide-bringing the number of available investment options to staggering proportions.

Let’s narrow it down a bit.

Hemel asked,

One of my challenges has been creating screens to filter stocks. What items would you consider for this? I can understand basic things like industry, size of company etc but what about other tech and non-tech indicators?

I also got an e-mail asking,

One question I had was how do you pick which stocks to do extra [due diligence] and run the value numbers. Do you do a scan or look into up or down sectors? Do you just pick a company out of the air and run the numbers?

The Non-Method To My Madness

I have a number of different ways depending on how I feel that day.

One day, I’ll look at my Morningstar list of all companies with positive free cash flow for the last ten years-about 450 companies. Sometimes I’ll head over to the MSN free stock screener and scan for companies with 15%+ growth in earnings for the past few years. I also like to look at the companies whose products I use: Research in Motion for my Blackberry, HP for my computer monitor, Dell for my computer, etc. or stores in which my wife or I shop (she can single-handedly increase a company’s owner earnings!)

I also check the NYSE and NASDAQ sites daily to see which companies have had the biggest daily drops. When a company plummets quickly, it’s usually because of bad Wall Street news. I like to check those stocks out because they may still be wonderful businesses that the stock market is overreacting to.

I don’t have a specific method to my madness. I try to find opportunity wherever I can.

Use The Tools They Give You

When running free stock screeners, you’ll have to play Wall Street’s game to generate an initial list of targets. By that I mean that you’ll have to use their criteria for searching: growing earnings, high returns on equity and invested capital, etc.

I generally start by setting all of the growth rates to 15% or greater. After I get through that list, I’ll run it again with 10% growth rates.

If using the Morningstar premium screener, scan for companies with positive free cash flow for at least 6 or 7 years-preferably ten years.

The Big Losers

When a stock drops 5%, 10%, 20% or more, it may be that Wall Street is overreacting to news that will otherwise not affect the future health of the company. A prime example (which I screwed up on) was Bankrate in 2004. I bought the company around $11 a share.

A few days later, near the end of October, Wall Street overreacted to a less-than-stellar earnings report and pushed the stock down 16% to as low as $9.20. Stupid me-I panicked with them, convincing myself that they knew something I didn’t. I sold for a one week 10% loss. I was thinking like a gambler, not a business owner.

Two years later, it was a $50 stock. (As an aside, that was the very last time I ever listened to Wall Street.)

Find Opportunities Everywhere

Unfortunately there is no secret list or magic screener that will identify the best businesses. To drive this home, we turn to investment stud Peter Lynch:

The person that turns over the most rocks wins the game.

Of course, don’t expect to run a screen, analyze a business, and run out and buy one today. Sometimes there are great companies on sale; sometimes you’ll sit on the sidelines, accumulating cash and waiting weeks, months, or even a year or two for an opportunity. As Buffett says,

You do things when the opportunities come along. I’ve had periods in my life when I’ve had a bundle of ideas come along, and I’ve had long dry spells. If I get an idea next week, I’ll do something. If not, I won’t do a damn thing.

Remember: Finding a business worth buying is much more difficult than the act of buying. Turn over rocks-you’ll see a lot of grubs, worms, and dirt. Still, the very next rock may be sitting on a box of gold.