How To Build Your First Stock Screening Watchlist From Scratch

Most initial watchlists aren’t actually watchlists. They’re just a list of the companies you already know about, e.g. the brand of your phone, the coffee shop you went to, the thing that was hot last week. That’s a perfectly valid starting point, just not actual stock screening. You’re probably just going to end up watching the same big names as everyone else.

A good watchlist is small (might even be a bit boring), but it’s far more useful. Here’s how I’d build one if I were starting from scratch.

Decide What You’re Looking For First

Before you start screening the stocks, think about what kind of company you actually want to own.

This may seem obvious but most people don’t do it. You end up with a list which is a mixture of fast-growing techs, slow-growing utilities, and a couple of turnaround stories, so no one set of filters really works for them.

Start with one type of company. Perhaps you’re after the steady growers with earnings that are on the rise, or the undervalued stocks, or the companies that have a long track record of paying dividends. You can always make another list later on. For the moment, though, having one clear objective will help you to set your filters.

It also helps to know what “good” looks like before you start. Spend an evening with stock screening charts that put a company’s earnings history next to its share price over ten or fifteen years, and pull up a few businesses you admire. You’ll start to recognize what consistent earnings growth looks like on a chart, and that gut sense makes every filter you set afterward easier to judge.

Start With Four Filters

Stock screeners give you a multitude of options. Don’t go and use too many at once.

For your initial stock screen, you’re going to want to stick to four filters. A market cap minimum of about $2bn to get rid of a lot of the thinly traded, poorly reported companies (you can of course adjust this later). Require positive earnings for each of the last five years as the next filter. That single filter will eliminate a huge number of the speculative stocks.

The third filter is debt. Set a debt/equity ratio that is appropriate for the sector (banks and utilities will always have more debt than software companies). Look at companies in the same sector and compare them. If you don’t do that you may end up removing all the banks and be left with just the tech companies.

Right at the end of the day, look at valuation. Rather than simply using a fixed P/E ratio cut-off, look for companies trading at or below their own long-term average multiple. A P/E of 25 may be a bargain for one company and a premium for another.

That’s all you need. With just four filters, you’re likely to end up with a long list, and that’s perfectly fine for now.

Cut It Down to Something You’ll Actually Read

A list of 300 stocks isn’t a real watchlist. It’s just a pile of homework you’ll never get through.

Try to whittle your list down to 15-25 names. That takes a bit of manual work, but that’s where you really learn. Go through your list and eliminate any company you can’t explain in a sentence or two. Of those that remain, read the business section of their most recent 10-K. It’s right at the front and actually quite readable.

You’ll end up cutting a lot of names. That’s a good thing.

Some shares may pass all your filters and still seem suspect once you’ve read the story. The company may be dependent on a single customer, or its earnings may have shot up as a result of it selling a division. If it just ‘feels’ wrong, then trust your gut and dig into it further before you keep it on your list.

Keep It Alive

It took me a while to get my head around the idea that stock screening isn’t a one-off exercise. Companies change and a watchlist you put together in January can be completely out of date by December.

For each stock, write a short note as to why it’s on your list and what price/valuation would get you interested. Check your list after each earnings season (companies report every quarter) as your filters could well have changed. Run your screen every few months to see what’s new and what’s gone. If one of your favorite stocks drops off, don’t get too concerned. It could be a genuine problem but it could just be a bad quarter. The research you did earlier will help you to determine which it is.

That one line is actually more significant than it appears. After six months, you’re likely to have forgotten why you added half the stocks in the first place. You may well just keep the stocks simply because you’ve been doing it.

Conclusion

Your first watchlist doesn’t have to be anything fancy. If it has one clear objective and you can articulate why each individual stock is on it then you’re already well ahead of the majority of novices.

Stick with it and stock screening will become more of a research habit than it is at the moment (i.e. just a list of tickers). Your watchlist will be very different in a year’s time, and that’s absolutely fine.