How Do I Screen For Investment Opportunities?

By Joe Ponzio on October 10, 2007  |  16 comments

I'm a business owner so I know what it means to be cheap. Okay, that sounded bad; still, I like the philosophy of "why pay for what you can get for free." In business, just as in your personal finances, cash is king—so you don't want to blow it unnecessarily.

There are three rational ways to value a business: break-up value, ongoing enterprise (F Wall Street) value, and buy-and-resell (Pabrai or Williams) value. If you can buy at a discount to any of those three valuations, you'll be on your way. Let's find some opportunities.

Break-Up Value: Price To Book Ratio

The break-up value of a company is its liquidation value—the cash left over if operations ceased and the company's assets were sold, liabilities paid, and cash dispersed to shareholders. MSN Money has a nice (free) deluxe screener that allows you to pinpoint opportunities.

I set up a screen for Price/Book Value : <= : 0.75 and Market Capitalization : >= : 250,000,000 and was presented with a list of 165 companies that are trading at or below 75% of their break-up value. But don't run off and buy them just yet—they require further research.

For example, I was looking into Citadel Broadcasting—trading at what seems to be 60% of its break-up value. When I started reading the last annual report, I saw that the company was in the process of being sued by its bondholders. The long and short of it is that the bondholders feel that the company defaulted on its obligations when Citadel merged width ABC Radio—and the bondholders want their $330 million.

High uncertainty? Yes—Pabrai would love it. But if the suit is successful—and it appears that it may be (they have a good case)—Citadel may have to start selling stations or issuing stock to cover the hit. In that case, the book value would drop—and we wouldn't be buying it at a discount today.

The moral of the above story is that the stock screener is a starting point for further research.

Ongoing Enterprise Value And Buy-And-Resell Value

When screening for solid businesses to own for the long-term—be it forever or for a few years—the goal is to find businesses with positive owner earnings or free cash flow. We can forgive one or two tough years in ten (even last year), but not much more than that.

We also have to find those businesses when the markets have beat them up or held their stock prices back. To do that, we have to play Wall Street's game by using their screening criteria.

Yahoo! has a nice screener that allows you to search for companies with positive free cash flow. If you've read the past posts, you'll know that I pay for Morningstar's premium service because it allows a more comprehensive screen to find companies with ten years of positive free cash flow.

Combining The Tools

On Morningstar, I find 19 companies with 10 years of positive free cash flow and a price to book of less than 1. Now that's interesting—and worth researching. One such company is Lee Enterprises, down more than 60% this year alone, is offering a 4.15% dividend, and looks to be selling for 80% of book value. Or La-Z-Boy, down 50% on the year. La-Z-Boy is paying a 6.14% dividend and appears to be trading at 90% of book value.

Wait! I'm not saying buy them—but I'm going to be looking. They're worth a few minutes of my day.

Today's Debacles

Remember that Mr. Market punishes uncertainty by beating down stock prices. I like to quickly check out the day's debacles by heading over to Yahoo!'s collection of the biggest price losers (on a percentage basis). Every once in a while, you might find something interesting.

F Wall Street User Contributions

In addition to the above tools, a few visitors have been playing around with screeners and the spreadsheets here. Robert set up an Excel spreadsheet that pulls data from Morningstar to help automate the process, and a few visitors have expressed an interest in using it. If he sends it to me (and allows it), I'll post it here.

In addition, Sanjay Shetty who blogs at India Investor posted a list of free stock screeners. Check it out.

Always Remember...

You are not looking for the next hot stock—you are looking for the companies that Wall Street is punishing for whatever reason. Let the gamblers and traders overreact. That's how we make big money.

And Congrats...

...to Allen who reported a handsome one-month gain. Though we do not look for short-term gains, we aren't upset when we get them. Allen purchased a company at a substantial discount and that company was (one month) later acquired for right around fair value.

That's the joy of buying $0.50 dollars!

Also Filed Under "How to Search for Opportunities"

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