The perfect stock does not exist... stop searching for it

I'm like everyone else. I want to find the perfect stock. That absolute sweet gem of a stock that has all the attributes of great stock market winners - a good company at a reasonable price that everyone else has missed. I've studied the market hard. I've read all the books. I know what works in stock picking. But I just can't seem to find it. I keep looking. I keep screening the market for it. But it's just not there. My stock screens are empty. Dammit. Why?

Everyone else is looking for the perfect stock too. When everyone is looking for the same thing, you aren't going to find it as they've already bought it. The market is just too efficient. But within this very human behaviour lies an incredible opportunity. What if all that searching means we all miss what's right under our nose? What if there are entire portfolios of "perfect stocks" hidden in plain sight.

Join me on my short adventure quest to discover them.

The Search

Let me put together a very typical stock screen, with a few parameters that might define the "perfect" stock. By that I mean something that's inexpensively valued, good quality, with growth prospects and market beating momentum. I'm keeping this basic, and I know everyone has their own definition - but humour me for simplicity's sake:

• When is something reasonably valued? Perhaps it would fairly priced against earnings (Price Earnings Ratio < 15) and paying dividends (Dividend Yield > 2.5%)
• When is something good quality? Perhaps it should be profitable (Return on Capital > 12%, Operating Margins > 5%) with not too much Debt (Gearing < 50%)
• When is something growing? Perhaps we'd look for strong earnings growth (EPS Growth > 15%)
• When is it showing momentum? Perhaps we'd look for relative strength better than the market index over the last year (Rel Strength 1y > 0%)

That's a good list of everyday screening rules. I'd love to find a share like that in this market. So I put together a stock screen that uses these parameters:

You can view the results of this screen at this link. Go on - click the link and come back and read more.

The title of this piece gave it away. In the UK Market there is not a single share that qualifies for those rules (except a couple of VCTs which I've excluded as they aren't individual companies). The perfect stock does not exist.

The Roundabout

What if I told you to stop looking so hard for the perfect stock and start allowing yourself to find the perfect portfolio instead?  If you give up your desire for the perfect stock you can quite easily build a portfolio of 10, 20, 50 or even more stocks that have exactly the attributes you desire... or even better... not individually, but on average.

Sequential screening rules are a destructive mechanism. They cut, cut and cut away possibilities and all the best shares. The trick is to use 'simultaneous screening' rules that don't cut away possibilities. This is the benefit of ranking the market, rather than screening the market. It is inclusive, not exclusive.

As an easy shortcut I've downloaded the top 200 ranked shares (by StockRank) in the UK stock market (though this idea applies equally to all international markets). I've 'customised' my table view so that it adds all the above fields mentioned into the view - which you can download yourself as a list here.   

I've exported them into a spreadsheet here - which I've then adapted into three sheets. The first has the top 200 shares. The second has the top 20. The third has the top 20 shares diversified across sectors (in the usual NAPS portfolio fashion).

Just look at the average and median statistics!

• The Top 200 shares have an average (median): P/E of 8, Yield of 3%, ROCE of 15%, No Debt, Margins of 18%, Earnings Growth of 65% and market beating relative strength of 4.5%.
• Both sets of Top 20 shares have even better metrics. Here are the stats for the diversified top 20... remarkable.

Below you can see all the Portfolio metrics in heavy blue versus all the individual stocks numbers. The vertical axis has been adjusted to allow an effective visualisation.

These numbers are way stronger than the original screening rules we used. If you found a share with these kinds of numbers nobody would believe you - and you can't, but we've found up to 200 of them!

Synthesising the perfect stock

So herein lies the lesson. It's not just that trying to find the perfect stock is impossible - and I'm not trying to discourage you from trying - but you may find it more helpful to focus on building the perfect portfolio instead - which is like synthesising the perfect stock.

As Ben Graham once said:

"To try to buy groups of stocks that meet some simple criterion for being undervalued - regardless of the industry and with very little attention to the individual company... my enthusiasm has been transferred from the selective to the group approach."

Buying groups of shares that meet your criteria is a better approach and is far easier than seeking individual stocks. There's also a great deal of academic research that shows that taking a ‘group’ approach ends up outperforming over time, and it's something that we've illustrated time and time again on the site. These approaches lead to strong returns as those shown from a “top 20 ranked portfolio” over the last 9 years… perhaps the kind of returns we’re all looking for from the perfect stock anyway.