Screening Stocks Based on Value & Optimizing Portfolio to Minimize Variance


The goal of this post is to introduce Fundamental Stock Analysis, specifically this post will focus on introducing key financial, operational, and equity based measures to select a handful of stocks out of thousands. The selection process aims to find a small group of stocks that should be considered as invest-able based on their fundamental performance.

We identify healthy companies whose stocks price is consistent and offers potential for security and growth by using the rules outlined in the book “Computational Finance” by Argimiro Arratia which is based on previous work on the topic conducted by Graham’s work from 1973. Graham’s rules have been adjusted adjusted for today’s financial climate (e.adjusted for inflation)

1) Adequate size of enterprise: The recommendation is to exclude companies with low revenues, consider only companies with more than $1.5 billion in revenue.

2) Strong financial condition: Use the current ratio (current assets/current liabilities) to eliminate companies who are in a weak short-term financial condition, consider only companies with a current ration of 2 or greater.

3) Earnings stability: Consider only companies with positive earnings in each of the past 10 years.

4) Dividend record: Consider only companies with uninterrupted payments of dividends for at least the past 20 years.

5) Earnings growth: Invest in companies that have growth rates of  3% or higher in earnings per share (EPS) over the past 10 years.

6) Price-to-Earning ratio: Purchase stock if the stock is adequately priced, a good range for a P/E ratio is 10-15, beware of stocks priced too cheap or too expensive relative to earnings.

7) Price-to-Book ratio: The price-to-book ratio should be no more than 1.5.

Using these criteria at the time of this post and leveraging Google Stock Screener as the filtering mechanism we have only 5 stock that meet these strict criteria for investable equities.

FCX, HP, HFC, RS, and TS

Once we have narrowed down our choices to these strong companies we must allocate our funds in a way that makes the most sense. One way to allocate funds in these stocks is to purchase the portfolio that minimizes variance (risk), this is called the Minimum Variance Portfolio and was the subject of a previous post:

Updating the code in the post above to include the ticker symbols for the 5 strong companies and running the algorithm yields the optimal allocation if one wants to minimize risk while investing in a strong portfolio of stocks:.

ScreenHunter_393 Dec. 13 18.06

ScreenHunter_394 Dec. 13 18.09