Filter

What Is a Filter?

In investing, a filter is a criterion used to narrow down the number of options to choose from within a given universe of securities. This process is also referred to as screening securities; the terms "filter" and "screen" can therefore be used synonymously in this context.

Understanding Filters

The specific filters used will depend on the strategy of the investor in question. For instance, value investors will likely use factors relating to the fundamental strengths of the company in question, such as the strength of its balance sheet or the quality of its earnings. Technical analysts, on the other hand, might be more interested in factors relating to its recent price history, such as whether it is trading above or below its 200-day moving average.

For any investor, the filtering process typically begins with a general set of parameters designed to rule out companies that clearly do not fit the investor's style or objectives. For instance, a North American investor who does not wish to trade in any foreign stocks might begin by filtering out all companies except those that are listed on American or Canadian stock exchanges.

Once these general parameters are put in place, the investor can then apply increasingly specific filters so that the remaining companies closely match their chosen investment strategy. 

Example of a Filter

Emma is a value investor with a clearly defined investment strategy: she aims to purchase only Canadian and American dividend-paying companies that are trading at a price-to-book (P/B) ratio of no more than 1.00. She has $30,000 to invest and is looking to create a portfolio of 30 holdings, allocating $1,000 for each investment.

To begin her search, she uses an online stock screening software tool to eliminate all companies that are not traded in Canada or the United States. This produces a vast list of companies, so she adds an additional factor in order to further refine her results: filtering out all companies that do not offer a dividend yield of at least 1%. The resulting list of 1,500 is much reduced, but still far larger than the 30 companies she is looking for.

As a next step, she adds her P/B filter, removing all companies with a ratio greater than 1.00. This further reduces the list, leaving about 250 candidates.

At this point, Emma reasons there are two ways she could proceed. One is by adding additional filters until the number is reduced to near her 30-candidate cutoff level. The other is by ranking the 250 candidates in terms of one of her factors, or in terms of an additional factor.

She decides to select her 30 investments from among her existing list of 250, by ranking them in terms of their P/B ratios and selecting the 30 candidates with the lowest ratios. This produces a portfolio of 30 investments in which the average P/B ratio is 0.40 and the average dividend yield is 9%.