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Here Is Why You Should Not Blindly Follow Your Stock Screeners When Investing

In an earlier article today, I had produced a list of companies that came through a stock screen I had built using financial characteristics which I find attractive.

However, in the article, I also noted that the screen alone is not enough for me to make a definitive decision on which company to invest in. This is because there are some pitfalls associated with stock screeners. Here are just a few.

The time frame used is critical

One of the key issues with a stock screener involves the time period we’re looking at. For example, in my article, one of the criteria I used for my screen is “a compounded net income growth rate of at least 5% per for the past 10 years.”

The three words that were emphasized – “past 10 years” – is very critical.

If I were to change it to the past 8 years, or past 9 years, the list of companies which will pass through the screens may look completely different. And that’s because the starting and ending points can matter a lot.

Perhaps a firm had gone through some huge trouble in the year we used as the starting point – that would have artificially depressed its net income for that year and caused the firm to have a very high net income growth rate for the period I’m looking at that’s not reflective of the reality of the situation.

The same goes for the ending point. If a firm clocks a huge one-time gain due to the sale of some asset in the year we use as an end-point, it can artificially juice its net income growth rate in a manner that’s again not a good representation of how things really are.

Thus, it is important for us to reinvestigate the numbers after each screening test.

Accounting

Another key reason for digging deeper after performing a screen is due to the accounting adjustments we might need to make when analysing a company.

For instance, Global Logistic Properties Ltd (SGX: MC0) tend to have a huge portion of its income come from revaluation gains from its property portfolio. These revaluation gains or losses can be inconsistent from year-to-year and can easily skew the firm’s net income figure upward or downward.

When we screen for companies that exhibit certain historical growth rates or returns on equity, it’s likely that the screens will parse through data from companies that are unadjusted for any non-recurring items. This may then distort the real picture with a company.

Data error

The last point might seem obvious, but it’s certainly worth pointing out. In many stock screeners, both from free-to-use sites or paid services, there is no way we can be sure that the data inside the system is accurate.

If there is an error in the data files the screener uses, the results that we obtain will not be accurate and this can have obvious negative implications on our investing results if we depend solely on screens.

Foolish Summary

These are just a few of the many issues associated with using a stock screener. This is why it’s preferable that screeners are used only as a starting point in our investing research.

Reading the annual reports and going through the presentations prepared by the companies we’re interested in is still the best way to get a better sense of their business operations and growth prospects.

For more investing analyses and important updates about the financial and stock markets, sign up for The Motley Fool Singapore's free weekly investing newsletter, Take Stock Singapore. Written by David Kuo, it can help you grow your wealth in the years ahead.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Stanley Lim does not own any companies mentioned above.