Selecting good stocks isn't easy. The sheer volume of companies makes zeroing in on a good stock difficult and the huge amount of data on the internet doesn't make things any easier — it's hard to sort out the useful information from the worthless data. Fortunately, a stock screener can help you focus on the stocks that meet your standards and suit your strategy.

Stocks screeners are effective filters when you have a more specific idea of the kinds of companies in which you are looking to invest. There are thousands of stocks listed on exchanges in the United States alone; it's just not feasible to track all of them on your own. A stock screener limits exposure to only those stocks that meet your unique parameters.

Here we look at what a stock screener is and how it can work for you.

How Stock Screeners Work

Stock screening is the process of searching for companies that meet certain financial criteria. A stock screener has three components: a database of companies, a set of variables and a screening engine that finds the companies that satisfy those variables and generates a list of matches.

Using a screener is quite easy. First, you answer a series of questions such as the following:

  • Do you like large-cap or small-cap stocks?
  • Are you looking for stock prices at all-time highs or companies with stocks that have fallen in price?
  • What range for the price-to-earning (P/E) ratio is acceptable?
  • Are you looking for stocks in a particular industry?

The good screeners will allow you to search using just about any metric or criterion you wish. When you finish inputting your answers, you get a list of stocks that meet your requirements.

By focusing on the measurable factors affecting a stock's price, stock screeners help their users perform quantitative analysis. In other words, screening focuses on tangible variables such as market capitalization, revenue, volatility and profit margins, as well as performance ratios such as the P/E ratio or debt-to-equity ratio. For obvious reasons, you cannot use a screener to search for a company that makes, say, "the best products."

Using Customizable Screeners

Some of the best free screeners on the web include those offered by Yahoo! Finance, StockFetcher, Zacks, Google Finance and FinViz. They all offer users a series of basic and advanced screeners.

The basic screeners have a predetermined set of variables whose values you set as your criteria. For example, one of the variables on the FinViz basic screener filters stocks by market cap, giving you the option of finding companies that, for example, exceed or fall below $300 million in market capitalization.

Although there are some good free screeners out there, if you want the very latest and best technology you will likely have to get a subscription to a screening service.

To demonstrate how screeners work, let's look at an example using FinViz's free screener. Let's say we are looking for an apparel company that trades on the NYSE, has a P/E ratio under 25, has an EPS growth of over 10 percent over the last five years and a debt/equity ratio over 0.1. Before the age of the internet, searching for companies to meet these criteria would have been a massive undertaking — it could have taken days. With a screener though, it's easy.

Here is what the screener looks like on FinViz:

After we enter these criteria into the screener, it gives us the companies that make it through each of the filters of our search. (Note that these figures were correct at the time of the search, but are likely to change continually as stock prices fluctuate and new financials are reported.)

Type of Screen Companies Remaining
Apparel companies 32
Trading on the NYSE 19
P/E ratio under 25 11
EPS growth past 5 years over 10% 1
Debt/equity over 0.1 1

Now that we have the results of the stock screen, we have one candidate worthy of further analysis - that is, if we are confident in our criteria and the values we choose for them. The company that the screener gives us are only as valuable as the searching criteria we enter. Also, it's important to remember that the screen is not the analysis itself. The screen can't guarantee that the company that made all our criteria is the best purchase, so we have to dig deeper to find out more.

Knowing What to Screen For

The big challenge with using screens is knowing what criteria to search for. The hundreds of variables make the possibilities for different combinations nearly endless.

Screeners are extremely flexible, but if you don't know what you're looking for or why, they can't do much for you. To help investors, some sites have predefined stock screens, which have their variables already entered.

The following sites offer some of the better predefined screens (these are just a few examples of what's out there):

  • Yahoo Finance - This site includes three predetermined screens: "Undervalued Large Caps," "Day Gainers" and, most notable, "Portfolio Anchors." The search criteria of each predetermined screen are clearly explained so you can understand the screens' underlying principles.
  • MSN Money - Includes a series of popular screens that can further be filtered and sorted by category.
  • FinViz - The screener includes a "signal" dropdown menu that filters for criteria such as "top gainers," "recent insider buying" and "wedges."

Watch Out for These Limitations

Although they are useful tools, stock screeners have some limitations. Here are some things you should keep in mind:

  • Most stock screeners include only quantitative factors. There are still many qualitative factors to keep in mind. No screener provides information about things like pending lawsuits, labor problems or customer-satisfaction levels.
  • Screeners use databases that update on different schedules. Always check how fresh the data is — if a screener's data isn't timely, your search could be meaningless.
  • Watch for industry-specific blind spots. For example, if you are searching for low P/E valuations, don't expect very many tech companies to show up.

The Bottom Line

Remember, stock screeners are not the "magic pill" for selecting stocks. Nothing will ever replace good old-fashioned nose-to-the-grindstone research. However, screens can be a good place to start your research process as they can save time and narrow your options down to a more manageable group.