A.4 Fundamental Analysis & Screening

Basic Prerequisites: Core Financial Ratios (the ratio catalog and its lookup table) and Equity Valuation (what “value” means before you screen for it). (these are the folder-level prerequisites for pages 02–06; page 01 states its own, smaller, entry requirements)

1. Intuition & Practical Objective

Ratios describe; screens decide. This folder is the bridge from the ratio catalog to an actual portfolio of candidates: it turns Graham’s value-investing criteria, the owner’s practitioner workflow, and the academic screening evidence into mechanical rules you can run over a universe of stocks. The governing idea, straight from the Graham school, is margin of safety - you do not buy the best business at any price, you buy a good-enough business at a price that leaves a cushion against being wrong.

This folder is the hub. It (a) gives you the fast screen-criteria lookup table below (the Graham defensive tests as inequalities, plus the modern screening metrics - this is the single best lookup page in the area for “what thresholds do I actually apply?”), and (b) routes you to six sub-pages that walk from zero intuition, through the Graham criteria and value-investing logic, the screening metrics, the human research workflow (reading 10-Ks), the failure modes, and the quantamental extension layer.

The one-sentence essence. “Screen on numbers to shrink the universe, then read the filings to reject the survivors - because the numbers nominate and the business case confirms; a screen that skips the reading is a value-trap generator.”

Audience arc: beginner reads what a screen is and why a margin of safety matters; intermediate reads how to build and run a fundamental screen; expert reads how to combine discretionary judgment with quantitative factors. The sub-pages below are ordered for exactly that climb.

2. Mathematical Ground Truth & Lookup Table

Notation: $S$ sales/revenue, $CA/CL$ current assets/liabilities, $LTD$ long-term debt, $WC=CA-CL$ net working capital, $EPS$ earnings per share, $BVPS$ book value per share, $P$ price, $\text{EBIT}$ operating income, $\text{EBITDA}=\text{EBIT}+D\&A$, $ND=\text{TotalDebt}-\text{Cash}$ net debt, $FCF$ free cash flow, $\text{MC}$ market cap.

Graham’s seven defensive criteria (The Intelligent Investor, Ch 14), as inequalities. A defensive-investor stock must satisfy all seven:

The Graham Number. Criteria 6 and 7 together bound price: $P^2\le 22.5\cdot EPS\cdot BVPS$, so the maximum defensible price is $P_{\max }=\sqrt{22.5EPS\cdot BVPS}$ - the classic Graham Number, the price at which $P/E=15$ and $P/B=1.5$ simultaneously.

Modern screening metrics (the practitioner’s workflow). Where Graham asked “is it cheap and safe?”, the working screen asks “is it a good business that is also reasonably priced?”:

(All lookup values are computed and reproduced exactly in §3 and re-verified on each sub-page; the sample universe “Alpha Machine Works, Delta Chemical, …” is fully specified on each sub-page.)

Critical distinction - screen vs. decision. A screen is a filter, not a verdict. Graham’s own criteria were designed to “eliminate the great majority of common stocks” - that is the point. The screen’s job is to make the reading cheap; the reading (04 · The Research Workflow) is what makes the decision.

3. Computational Implementation - the Graham defensive screen

Runs on the standard library only. It applies Graham’s seven defensive criteria, expressed as the inequalities above, to a six-company sample universe and reports each company’s pass count and the survivors - the exact mechanical screen the textbook describes.

Note how the screen behaves exactly as Graham promised: it eliminates half the universe, and the elimination is informative - Beta fails on growth and leverage, Epsilon on earning stability, and Zeta Steel passes 8 of 9 despite being the obvious value trap (cheap on P/E and P/B, but shrinking earnings). That single survivor-of-the-filter-that-shouldn’t-be is the whole reason 05 · Failure Modes exists.

4. Failure Modes & First-Principles Breakdowns

Hub signposts - the folder’s failure-mode analysis lives in 05 · Failure Modes & Practice. In one line each:

1. The value trap. A stock is cheap because the market expects the business to deteriorate; if the deterioration is real, the low multiple is a correct forecast, not a discount (Zeta Steel above).
2. The falling knife. Cheap-and-falling attracts the screen; momentum keeps falling. Cheapness without a catalyst or a floor is not a value signal.
3. Screen data quality. Survivorship, restatements, look-ahead, and stale filings silently corrupt every screen - a screen is only as honest as the point-in-time data behind it (Data Sources & Corporate Data).

5. References

• Graham, Benjamin & Dodd, David: Security Analysis (McGraw-Hill, 6th ed. 2008)
• Graham, Benjamin: The Intelligent Investor (rev. 1973; HarperBusiness annotated 4th ed. 2003, Jason Zweig)
• Fisher, Philip A.: Common Stocks and Uncommon Profits (Wiley reissue)
• Greenwald, Kahn, Sonkin & van Biema: Value Investing: From Graham to Buffett and Beyond (Wiley, 2001)
• Dorsey, Pat (Morningstar): The Five Rules for Successful Stock Investing (2004)
• Piotroski, Joseph D.: “Value Investing: The Use of Historical Financial Statement Information to Separate Winners from Losers” (JAR, 2000)

6. Connected Graph Bridges

• Foundational base: Financial Statements & Accounting · Financial Statement Analysis · Core Financial Ratios (the ratios every screen is built from)
• Sibling topics: Equity Valuation - DCF, Comps & Value Logic (the intrinsic value a margin of safety is measured against) · Quantitative Fundamental Investing (the systematic factor translation of these screens) · Accounting Quality & Red Flags (the defense layer a screen cannot replace)
• Data layer: Data Sources & Corporate Data (EDGAR/XBRL, point-in-time Compustat - where screen inputs come from)
• Quantitative bridge: Fundamental Multi-Factor Models (value, quality, and profitability factors as screened portfolios)

Sub-pages (in-folder): 01 From Zero · 02 Graham Criteria & Value Investing · 03 Screening Metrics · 04 The Research Workflow · 05 Failure Modes & Practice · 06 Advanced Extensions

Beginner: start at 01 · Practitioner: start at 05