How to find undervalued quality stocks: screener criteria and a checklist
Most “undervalued stock” screeners sort by a low P/E or price-to-book ratio, which tends to surface companies whose earnings are about to fall. Most “quality stock” screeners surface excellent businesses at any price. An undervalued quality stock screener has to do both jobs at once, and the details of how it does them matter more than the label.
This guide publishes every factor, threshold and knockout in StockOverlap's two scans, so you can judge the logic for yourself or reproduce the parts you like on whatever screener you already use.
Quality vs value: two different questions
Quality is about the business. Does it earn high returns on the capital shareholders have put in, year after year? Have its earnings grown steadily rather than in lurches? Are its gross margins stable, which hints at pricing power? Is it carrying a manageable amount of debt?
Value is about the price and the mood around it. How much free cash flow and earnings do you get for each dollar of market value? Is the share price near the bottom of its recent range, and is the market unusually pessimistic about it, or is everyone already excited?
The two questions need different data, and a stock can score well on one and badly on the other. A cheap stock with collapsing margins is a value trap. A wonderful business at 60 times earnings can still be a poor investment, a point Charlie Munger made about the “Nifty-Fifty” era (see the Munger 200-week moving average guide). That is why StockOverlap runs them as two separate scans with separate inputs, and only cares about stocks that pass both.
The quality criteria (12 points)
The quality scan only looks at stocks trading within ±5% of their 200-week moving average, a price-discipline gate explained in the 200-week moving average guide. Each candidate is then scored on eight factors. Multi-year measures use up to the seven most recent fiscal years of reported financials.
| Factor | Full credit | Partial credit | Max |
|---|---|---|---|
| Return on equity, worst recent year | ≥ 15% | ≥ 12%: 1 · ≥ 8%: 0.5 | 2 |
| EPS growth (compound annual) | ≥ 10% | ≥ 5%: 1 · above 0%: 0.5 | 2 |
| EPS trend consistency (R² of a straight-line fit) | ≥ 0.85 | ≥ 0.60: 0.5 | 1 |
| Gross-margin stability (coefficient of variation, lower is better) | ≤ 0.05 | ≤ 0.10: 1 · ≤ 0.20: 0.5 | 2 |
| P/E relative to sector median | At or below the median | Up to 1.3× the median: 0.5 | 1 |
| Debt-to-equity | ≤ 0.50 | ≤ 1.00: 1 · ≤ 2.00: 0.5 | 2 |
| Insider buying vs selling (net = buys − sells, as a share of all insider share volume) | Net buying of +25% or more (buys at least 62.5% of the volume) | Net −15% to +25%: 0.75 · net −40% to −15%: 0.25 · no reported trades: 0.5 | 1 |
| Last two earnings surprises | Both beat estimates | One beat, one in line: 0.75 · one beat, one miss: 0.5 · both in line: 0.25 · no data: 0.5 | 1 |
Why the worst year of ROE rather than the average? Because an average can hide one bad year behind several good ones. If even the weakest recent year clears 15%, the returns are probably not a fluke. Why R² on earnings? A company whose EPS rose 10% a year in a straight line is a different animal from one that went sideways for five years and then jumped. The R² measures how close to a straight line the path was.
Quality knockouts
Before any scoring, a stock is dropped entirely if any of these is true:
- Return on equity was zero or negative in any recent year.
- Earnings per share have shrunk by more than 2% a year on a compound basis.
- Debt-to-equity is above 2.0.
- More than 20% of the float is sold short.
- Over 90% of recent insider trading volume is selling.
- Both of the last two quarters missed earnings estimates by more than 10%.
Missing data is not treated as a knockout, but it also earns no credit on the main quality factors. Grades: a total of 10 or more with every factor above zero is A+, 8 or more is A, 6 or more is B+. Anything below 6 is dropped, so every stock on the quality list has cleared a real bar.
The value criteria (12 points)
The value scan runs across the whole universe, independently of the 200-week average. It only considers stocks that are not in the top 12% of their 52-week price range, trade at $5 or more and have a gross margin of at least 8%. It scores four pillars of up to 3 points each.
| Pillar and factor | Full credit | Partial credit | Max |
|---|---|---|---|
| Momentum: revenue growth, year over year | ≥ 15% | ≥ 8%: 1.5 · ≥ 3%: 1 · ≥ 0%: 0.5 | 2 |
| Momentum: total asset growth, year over year | ≥ 10% | ≥ 3%: 0.5 | 1 |
| Valuation: free cash flow yield (FCF ÷ market value) | ≥ 6% | ≥ 3.5%: 1.5 · ≥ 2%: 1 | 2 |
| Valuation: earnings yield (1 ÷ P/E) | ≥ 6.67% (P/E ≤ 15) | ≥ 4% (P/E ≤ 25): 0.5 | 1 |
| Price: position in the 52-week range (0% = at the low) | Bottom 30% | ≤ 50%: 1 · ≤ 65%: 0.5 | 2 |
| Price: 52-week range width ((high − low) ÷ low) | ≤ 40% | ≤ 65%: 0.5 | 1 |
| Sentiment: short interest, % of float | ≤ 4% | ≤ 10%: 1 · ≤ 18%: 0.5 | 1.5 |
| Sentiment: institutional ownership | ≥ 65% | ≥ 45%: 0.5 | 1 |
| Sentiment: analysts not already euphoric | Average rating 2.2 or weaker on a 1 (strong buy) to 5 (sell) scale | — | 0.5 |
Free cash flow is the trailing figure reported by Yahoo Finance. When that figure is missing, the scan uses operating cash flow instead. Operating cash flow is measured before capital spending, so for capital-intensive companies that fallback overstates the yield. The sentiment pillar deliberately rewards a little scepticism: a stock every analyst already rates a strong buy has less room for opinion to improve.
Value knockouts
- Revenue falling by more than 5% year over year.
- Gross margin below 8%, a sign of little pricing power.
- Debt above 80% of total assets.
- Earnings per share shrinking by more than 20% a year.
Missing data earns zero on each value factor. Grades: 9 or more with all four pillars above zero is A+, 7 or more is A, 5 or more is B+, and anything below 5 is dropped.
Combining the two scans
A stock that appears on both lists in the same daily run gets a combined score out of 24. To become a Dual Pick it needs:
- a combined score of at least 15 out of 24 (18 or more earns A+), and
- enough upside to the consensus analyst price target. The live Dual Picks list in the terminal requires at least 30%; the public track record logs every otherwise-qualifying overlap name from 25% upside, so it is slightly broader than the live list.
Analyst targets are opinions and change often. StockOverlap's own methodology notes that in backtesting a 30% threshold and a looser 25% one produced similar results, so the upside gate mainly narrows the list rather than improving the odds. Treat it as one filter among many. The full pipeline, including how picks are closed, is in how StockOverlap picks stocks.
How the criteria guard against value traps
A value trap usually shows up in the numbers as one or more of: falling revenue, shrinking or erratic earnings, eroding margins, rising debt, or heavy insider selling. Each of those is either a knockout or a scoring penalty in at least one of the two scans:
| Warning sign | Where it is penalised |
|---|---|
| Revenue in decline | Value knockout below −5% a year; no momentum points below 0% |
| Earnings shrinking or erratic | Quality knockout below −2% a year; low EPS growth and R² scores |
| Margins eroding or unstable | Quality gross-margin stability score; value knockout below 8% gross margin |
| Too much debt | Quality knockout above 2.0 debt-to-equity; value knockout above 80% debt-to-assets |
| Insiders heading for the exit | Quality knockout above 90% selling; lower insider score |
| Crowded bearish bets | Quality knockout above 20% short interest; value short-interest score |
| Recent earnings disappointments | Quality knockout after two misses of more than 10%; surprise score |
No screen catches everything. The financial data lags the business, and some problems (a lost contract, a lawsuit, new competition) do not show up in any ratio until later. That is why StockOverlap also re-scores every open pick after each daily scan, even once it no longer passes the entry filters, and closes it by rule, for example when its combined score falls materially from its peak. The exact rules are in how StockOverlap picks stocks.
Checklist: using these criteria on your own screener
You can approximate a lot of this with a free screener. A reasonable starting set:
- Market value above $500 million and share price above $5, to stay in liquid names.
- Return on equity above 15% and debt-to-equity below 0.5 to 1.0.
- Positive five-year EPS growth and positive revenue growth.
- P/E below its sector average, or a free cash flow yield above roughly 3.5% to 6%.
- Price in the lower half of its 52-week range, or near its 200-week moving average.
The parts that are hard to reproduce on free tools are the multi-year ones: the worst single year of ROE, the consistency of the earnings path and the stability of gross margins. Those need several years of reported financials. If your screener only offers trailing-twelve-month figures, check the last five to seven annual reports by hand for anything that makes the list.
What any screener cannot tell you
- Why the price fell. A screen sees the drop, not the reason. Read the news and the filings.
- Whether the moat is intact. Past margins and returns describe the past.
- Data quality. Third-party data can be delayed, restated or missing. See the methodology page for how StockOverlap handles gaps.
- Your situation. Position size, time horizon and taxes are yours to decide.
Results so far
Criteria are only half the story; the other half is what happened to the stocks that passed them. These figures are computed live from the public record of every Dual Pick (the same data as the track record page):
Hypothetical results of a rules-based screen, not actual trades. Exit rules have changed over time.
Small sample over a short period. Returns are price-only from frozen entry prices to the exit price (closed) or the latest price (open), and exclude dividends, fees, slippage and taxes. SPY is measured over each closed pick's own holding period. Past performance does not guarantee future results. Full list on the track record.
Frequently asked questions
What makes a stock both high quality and undervalued?
Quality describes the business: high and consistent returns on equity, steadily growing earnings, stable gross margins and modest debt. Undervalued describes the price: a healthy free cash flow yield or earnings yield, and a share price sitting in the lower part of its recent range. A stock needs to pass both tests independently. Cheapness alone is not evidence of quality.
What is a value trap?
A value trap is a stock that looks cheap on ratios like P/E or price-to-book because the business is shrinking or its earnings are about to fall. The low price turns out to be justified. Requiring evidence of quality, such as consistent profitability and stable margins, alongside cheapness is a common way to filter out many of them, though no screen catches every one.
What is a good free cash flow yield?
There is no universal cut-off, and it depends on growth and interest rates. StockOverlap's value scan gives full credit at a free cash flow yield of 6% or more of market value, partial credit from 3.5% and from 2%, and none below that. When free cash flow is not available it uses operating cash flow instead, which overstates the yield for capital-intensive companies.
Can I build this screen on Finviz or another free screener?
You can approximate it. Most screeners let you filter on return on equity, debt-to-equity, P/E, free cash flow, distance from the 52-week low and analyst targets. Multi-year measures such as the worst year of ROE, EPS trend consistency or gross-margin stability usually need data from filings and are harder to reproduce on free tools.
How often is StockOverlap's screen updated?
The scan runs once each trading day after the US market close. Prices for the 200-week average and 52-week range are refreshed every run, while fundamentals are cached for about four days because they only change when companies report.
Is a stock that passes the screen a buy recommendation?
No. A screen is a starting point for research, not a recommendation. Nothing on StockOverlap is investment advice, and past results do not guarantee future results.
The daily Dual Picks list, full scan output, scores and exit signals are in the StockOverlap terminal.Closed picks, wins and losses, are listed on the public track record.
- The Munger 200-week moving average strategyWhere the famous 200-week moving average quote comes from, what the indicator measures, when it misleads, and how StockOverlap uses it as an entry filter.
- How StockOverlap picks stocksThe full pipeline from universe to Dual Pick: two scans, the overlap, the gates, frozen entry prices and the rules that close a pick.
- Quality stocks near 52-week lows: a checklistA plain 52-week-low list compared with a quality-first screen, using what Buffett and Munger actually wrote, plus a value-trap checklist.
- Methodology and data sourcesData sources, update frequency, frozen prices and known limitations.