The Simplest, Most Powerful Stock Screen Ever Created

The advent of computers and the internet changed pretty much everything in the world of investing.

Suddenly, even the rudimentary computers of the 1980s and 1990s could do some pretty impressive things. The internet further accelerated that, plus it made it much easier for investors to communicate those ideas with each other.

One big way this manifested itself with investors was with stock screeners. Screeners were first used by big investors with the resources to invest in computing power, who could also find the data to compute. But the internet changed that quickly, and by the late 1990s stock screeners were everywhere.

Screeners have gotten incredibly robust since. You can now screen for hundreds of different variables, and you can use data that goes back decades.

Naturally, investors embraced this complexity. They started creating more and more elaborate screens, using those screens to narrow down a large universe of stocks into a handful of names that passed very specific tests.

I started using stock screeners when I got serious about investing in the stock market in the early 2010s, using them to identify the kinds of cheap deep value investments I favoured at the time. But I’ve since moved on from using them, choosing instead to start with fundamental analysis.

I research the company, look at the underlying drivers of the earnings, and first decide whether it’s a quality business that I would like to own over the long-term. Only after all that is when I look at the stock’s valuation. I decide what’s a reasonable price and if the stock is trading at or below that level, then I’m excited to buy.

One reason why I soured on stock screeners is I realized it was an exercise in bias. I would put my favourite variables into a computer and get the same results, with largely the same companies on the list. In a world filled with stocks I was only searching in a small corner.

Besides, all a stock screener can do is look backwards. That’s a limiting outlook.

Once I realized the limitations of stock screeners, I stopped using them. I replaced them with a simple process that I can do in about 15 seconds in my head, something I shamelessly stole from the greatest investor of all time.

How the Buffett Rule changed everything for me

Todd Combs is half of the duo Warren Buffett personally chose to manage Berkshire Hathaway’s investments when he’s gone.

Often, Combs will go to Buffett’s house on a Saturday to talk stocks. What he realized is over and over again Buffett ran investments through a very simple set of criteria. If they didn’t check three boxes, he simply wouldn’t invest.

I realized the power of this and latched onto it immediately. It’s now the number one rule I use to screen potential stocks.

It’s very simple. We’re looking for stocks that:

1. Trade for under 15x earnings

2. Have a > 50% chance of growing earnings by > 7% per year for the next five years

3. Have a > 90% chance of growing earnings at all over the next five years

What I love about these rules is not only how simple they are, but how they capture the key elements of Buffett’s style in such an easy way.

Buffett is a value investor, so the 15x earnings screen is in there so he doesn’t pay too much.

He realizes growth is important — after all, many of his greatest investments came from the underlying earnings growth — so he insists on it. But he also knows that predicting growth a half decade out is tricky, so he assigns odds.

And finally, the last rule is a wonderful application of Buffett’s famous “don’t lose money” quote. If earnings growth doesn’t pan out, he wants to at least have consistent earnings that are unlikely to collapse. This protects the downside.

By limiting himself to just the few variables that really matter, Buffett takes a potentially complex situation and makes it as simple as possible. That’s the real beauty in this approach — and why I copied it almost immediately.

Once you realize Buffett thinks this way, it’s easy to see the concept applied in some of his other main investments. Combs has said that those three simple rules were what Buffett used to identify Apple as a potential investment. They’d kick around ideas that met the criteria and kept coming back to Apple as the no-brainer choice.

The screen was also likely used to pick many of Berkshire’s other big winners — like Coca-Cola, GEICO, and See’s Candy. These are all deals Buffett is said to have “paid up” for, and it simply isn’t true.

Five Canadian stocks that pass the Buffett Rule

Let’s turn theory into reality and highlight a handful of Canadian dividend stocks that pass the Buffett Rule today.

The first one is a stock I’ve written about extensively before, both for free and premium newsletter subscribers. Algoma Central (TSX:ALC) is a boring niche shipper with a dominant position in Great Lakes shipping. It trades for under 10x earnings, has a number of growth paths going forward, and consistently delivers gobs of free cash flow to shareholders.

Oh, and it also pays a 5%+ dividend, a payout it can easily afford.

Up next is a stock that most assume has pretty much zero forward growth, TC Energy (TSX:TRP). The artist formerly known as TransCanada has shed its slow-growth oil pipeline assets into South Bow (a spin-off that was covered in detail on the premium side of the newsletter), which paves the way for a new company that has greater growth potential, a solid balance sheet, and that still trades for a reasonable valuation.

There are a few different ways TC Energy can grow its earnings by about 7% per year over the next few years. Lower interest rates will help cut costs, as well as making potential investments more attractive. Coastal Gaslink will start contributing to the bottom line in 2025. And longer-term nuclear power expansion in Ontario will also help boost earnings.

And although the stock has ran up lately, it still pays a generous dividend.

Bonus stock!

I wrote about Polaris Renewable Energy (TSX:PIF) over on Seeking Alpha, an under-the-radar name that gets virtually zero attention. That’s despite trading for about 6x free cash flow, achievable growth plans, and other near-term catalysts.

Next up I’ll profile Imperial Oil (TSX:IMO), which might be my favourite energy stock. It has one of the best balance sheets in the business, an enviable record of dividend growth, a robust share repurchase program, and some of the best oil assets on the planet.

The beauty of the share repurchase program is it protects the stock against huge swings in oil prices. As the company gobbles up more and more shares, its exposure to oil matters less and less on a per share basis. Besides, Imperial has robust downstream operations which deliver much more consistent profits.

Imperial trades for under 10x forward free cash flow, gushes cash even at $75 oil, and has an easy path forward to increase cash flow on a per share basis, thanks to that excellent share repurchase program.

I could easily include most of Canada’s banks here, but instead I’ll highlight what I think is an excellent under-the-radar insurer, Industrial Alliance Financial (TSX:IAG). Despite shares moving up more than 35% so far this year, the stock is still cheap at just over 10x forward earnings.

The company also has a strong history of growth via acquisitions, improving return on equity, and one of the lowest dividend payout ratios in the entire Canadian insurance space. It has grown book value by about 9% per year since its 2000 IPO.

And finally, a quick look at a stock that many of you have written off as a growth stock. IGM Financial (TSX:IGM) has quietly amassed an interesting portfolio of growth assets to go along with its traditional financial advisory business. These businesses — which includes a stake in Canada’s fintech darling, Wealthsimple — are poised to grow the business over time.

Even after moving up more than 20% in the last year, IGM shares still trade at under 11x forward earnings estimates. And management has gone on record and told investors they expect to grow the bottom line by 9% annually over the next five years.

IGM hasn’t delivered much in earnings growth over the last decade, so I can understand the skepticism. But that’s lulled investors into a false sense of security. There’s something going on behind the scenes here, and I like it.

From the archives

My detailed look at when I’ll sell a stock, and how some of the worst mistakes I’ve made in my investment career was when I sold too early.

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