Benjamin Graham and David Dodd invented the value investing approach to security selection and subsequently popularized it with the publication of “Security Analysis” in 1934. Graham’s landmark book “The Intelligent Investor” followed in 1949 and is one of the most influential guides to investing ever published. The central tenet of value investing is that the market occasionally offers stocks at a discount to their intrinsic value. In this final installment of our three-part stock screening series, we detail how to create a value screen.

Value investing involves discovering stocks with solid fundamentals such as growing earnings and strong cash flows that are nevertheless out of favor with the market. Stock screening is just the first step in researching possible value plays. Once you’ve built a list of candidates for your portfolio, it’s imperative that you perform your due diligence on each company in order to ensure you don’t fall prey to a value trap—a company whose shares have been beaten down for good reason. It’s also important to take a long-term perspective toward value investing because it can take time for the market to recognize a company’s worth.

The Process

Because value stocks by definition trade below their intrinsic value, you’ll first want to screen for stocks with a price-to-book (P/B) value of less than one. While many of the books on value investing encourage the purchase of stocks at a price below intrinsic value—the calculation of which can be complicated—you’ll find very few screening services which offer that as a data point. But they all offer a straightforward P/B data point—calculated as stock price divided by total assets minus intangible assets and liabilities. That’s an excellent starting point.

The next criterion is to look at price-to-earnings (P/E) ratios. I like to screen for companies with P/E ratios below their industry averages in order to find truly out-of-favor names.

Based on those two criteria alone, you’ll uncover many companies that aren’t just unloved, but are downright loathed by the market. But you don’t want to fall into a value trap, so you’ll need to add a layer of fundamental criteria to your screen.

That means you’ll want to identify companies that are profitable and growing earnings. Additionally, firms should have relatively strong balance sheets, so that they can weather whatever adverse circumstances caused them to become value plays in the first place.

As such, I look for stocks that have a price-to-earnings growth (PEG) ratio of less than 1 because that indicates a stock is undervalued relative to earnings-per-share (EPS) growth. I also screen for companies that produced EPS growth of at least 15 percent annualized over the past five years.

In order to limit my results to companies with reasonably strong balance sheets, I look for debt-to-equity ratios of less than 1 and current ratios of at least 1.5.

The Selection

Once you have a list of stocks that meet your criteria, you’ll need to conduct further research to ensure that a company’s shares are undervalued due to a short-term event or headwind rather than a long-term trend. For example, a company whose sole business is to produce typewriters in this digital age would obviously be a value trap. So you’ll want to identify what made the stock a bargain—which can be as simple as a short-term earnings miss—and then identify a potential catalyst that can lead to a turnaround.

A value screen doesn’t produce as many results during bull runs as it does during downturns, so you might be tempted to loosen your criteria in order to produce more candidates during a rising market. That can be dangerous. It’s sometimes tough to distinguish between a value stock and a long-term laggard. Remain disciplined with your fundamental criteria and don’t force your results.