Be Careful of Investing By Stock Screeners

Readers often ask me what my “formula” is for investing. Honestly, I don’t have one. I like to keep it simple: I follow a small group of very strong companies and jump in when the price looks good. It’s nothing more complicated than that.

I think people find extra comfort when there’s some exacting formula like: “the dividend yield must be X or the P/E Ratio must be 0.7158 compared to its growth rate.”

The problem is that these numbers can lead you astray. That’s also why I’m leery of stock screeners. They can be interesting, but I’m careful not to place too much faith in them.

A good example is the stock Biogen Idec (BIIB). This is a terrific company and the profits are killing it right now.

When we look at Biogen we see strongly growing profits and that it’s trading at a reasonable earning multiple. The stock is going for 11.5 times this year’s earnings estimate and for 11.1 times the estimate for 2012.

Normally, that’s a fantastic bargain. The problem is that when we look more carefully at Biogen’s business, we can see several weaknesses. The company has been relying too much on price increases for growing their profits. That’s paying off handsomely now, but it’s very doubtful that this can last much longer.

In this case, the market is probably right to discount Biogen’s stock. Stock screeners don’t detect those problems. This is more commonly known as a Value Trap. That’s when you spot a stock that superficially appears to be cheap, but then you learn it’s cheap for a good reason.

Many of the stocks on the Buy List are in some way “damaged goods.” Deluxe (DLX) is a perfect example. The company has lots of problems and I don’t want to pretend it doesn’t. But in my opinion, the problems are manageable as opposed to a company like General Motors, where I’m afraid their problems are too deep to be manageable.

Are Biogen’s problems manageable? Perhaps, but I can’t say for sure. With investing, I never take a risk I don’t need to. All stocks are assumed to be “sells” until proven otherwise. That’s why I’ll keep a close eye on Biogen, but I’m not a buyer.

Posted by on February 16th, 2011 at 9:00 am


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.