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Unless you are a purely mechanical investor, a la the Magic Formula,
…As a new investor I am looking for an easy way to select stocks. I was looking at some screens at the MSN site and noticed a power search called “Highest-Yielding S&P 500 Stocks”. This stocks list undervalued stocks based on dividend yield. Why would I not just buy the top 5 on this list and be done with it?
Fair question. We are all busy people with limited time and the natural inclination is to search for quick and easy ways to get things done. However, using stock screens in this way is dangerous and adds great risk to your portfolio. Here is what I see as the problem with these types of stock screens.
If you head over to the MSN Stock Power Search page you will see quite a large list of stock screens that MSN has put together. The intention of these screens is purely to provide investors with a list of stocks that further research can be conducted on. In the example from the email, the Highest-Yielding S&P 500 Stocks filters for only two criteria: the stock must be a part of the S&P 500 and the stock has the highest dividend yield of that group of stocks. Does this criteria alone tell us that the stock is worth buying. No, I do not think it is. Sure, a historically high dividend yield can indicate value (see this post), a very high dividend yield can actually spell trouble. Think about Citigroup right now. The yield is great but that yield represents the huge risk that investors are taking to own the company. High dividend yield alone is not a reason to buy a stock.
If ease and time are your bottlenecks, then a much better strategy would be to invest in index funds. This will provide you with broad diversification and protect you from individual security risk. Selecting stocks simply using a stock screen is risky. They are great to identify potential investments, but only after additional research is completed on the stock.