MEGABUCK QUICK ANALYSIS OF A STOCK
An Aid to the Stock Selection Guide (SSG)
(This analysis assists in identifying companies worthy of a complete SSG analysis)
Company Name &
** You can
click on each question number for an explanation.
Quick Analysis Explanation
Question 1: Addresses the productivity record of a company. Does company sell products that the consumer wants to buy? Look at the most recent 5 year history since in most cases this represents a business and economic cycle.
If a company has managed for 5 years in a row to increase its sales each year over the previous year, this would be the first indication that the company has worthwhile products and has managed to remain productive.
Question 2: The second question gives us a quick idea of the rate of sales growth. A basic characteristic to look for in a growth stock is growth at a rate of 15 percent per year, meaning that the company would have doubled its sales in the past five-year period ( this would be somewhat less than 15% but close enough). For large companies of $4 billion or more a sales growth rate of 10%, or doubling in 7 years would still be respectable. Thus we are looking for stocks that double in 5 – 7 years.
Question 3: Addresses the profitability record of the company. Has the company managed to be continuously profitable? Again we are looking for companies that have uninterrupted increases in EPS in the past 5 years.
Question 4: Addresses the rate of earnings growth. We are looking for a company that has at least doubled its EPS in the past 5 years, indicating a minimum of about 15% annual growth rate of profits.
Remember companies that do not a track record of 5 years are higher risk since they have no proven track record during a variety of different conditions that are experienced during normal business cycles.
Question 5 and 6: (optional): A lack of a dividend payment in a solid growth company is not necessarily negative, example: Microsoft). However, a small dividend payment that continues to increase in a solid growth company should be considered a definite positive.
Question 7 and 8: Deal with the management’s ability to extract profits from the sales of company’s products (i.e., management’s ability to operate the business). Operating income is a pre-tax number and represents the difference between income from goods sold and the cost of making and selling the goods. This is not the same as pre-tax profit used in SSG, but for most companies it represents the vast majority of total pre-tax profits). The operating margin(OM) are these pretax profits expressed as percent of sale
Question 9 and 10: Deal with management’s ability to enhance the return on company’s investments, and represents how well the management can fuel company’s internal growth using shareholders’ money.
A stable ROE of 15% is respectable and 20% is superior. Exceptional companies may boast tremendous ROE’s such as Coke, Gillette, Phillip Morris, Microsoft have ROE’s of 30%. A high stable ROE coupled with a high stable OM speaks volumes for a company’s management.
Question 11, 12 and 13: Deal with the management’s’ ability to handle long-term as well as day-to-day finances. Long term debt can be helpful in financing growing businesses. However, too high a debt can be a burden in times of a weak, inflationary economy since high interest payments on the debt could prove to be a drain on earnings. As a norm long term debt shouldn’t exceed 1/3 of the net worth of the company. ( some economists expand this to 1/3 of total capitalization). Some huge companies are prospering without carrying much or any long-term debt.
Next, the levels of current assets and
cash should be such that day-to-day financial obligations can be met
without undue stress. There are three ways to analyze this.
Question 14: Deals with the company’s future growth prospects, since we are interested mainly in companies that are likely to grow at a rate of 15% or better. Here we rely on the professional analysts’ understanding of the company, the business and the industry as a whole .
Question 15: This question is really a proxy for another question we want to ask but can’t, because it is not possible to answer it easily. That question: "Is the stock in the buy range?" However, we can "guesstimate" if the current stock price "might be" in the buy range if we were to do an SSG analysis.
In general if the current p/e is within or below the range of the past five years of average annual P/Es, then chances are that the stock price would be in the buy range on an SSG, provided that the company’s earnings are projected to grow at the same rate or higher than the past earnings growth. So if the answers to questions 4 and 14 are "yes", then a "yes" answer to question 15 would suggest that the stock might be in the buy price range. A current P/E that is higher than the highest average P/E achieved in the past five years would suggest that chances are the stock would not be in the buy range on an SSG.
If all of the previous 14 questions have strongly positive yes answers, you now have found a company with a superior sales, earnings, and dividend increases, it has grown at 15% or better, has excellent management, and good growth prospects. You have found a company that appears to be an excellent candidate for long term growth. This is a company that would merit completion of an SSG. Completing the SSG will determine an appropriate buy price range.
Question 16: Summary: If the first 4 questions come out no, you may want to look for another stock to study. If the first 4 questions come out yes, weakness in one or two other areas could be excused for an otherwise excellent corporation, i.e., "look at the whole picture".
Gradually over time, this Quick Analysis will become a mental check list when you study Value Line reports. Glancing over the sales, earnings and dividend histories, mentally checking to see if they have grown uninterrupted and if they have doubled in the past 5 years. If you are still interested in the company, then glance over the OM and the ROE history, and finally look at the long term debt and current financial position.
This is only the
beginning of the selection process. If this
initial screening is successful, we’ll want to know more about the
company. It is very useful to know the company’s products and competitors.
What is unique about this company and its products? Check out the annual
report or recent quarterly report to understand the prospects for future
growth. You should also read about what other analysts think about the
NAIC principles teach us to adhere to fundamentals like these. This will help us avoid chasing every stock that has doubled in the past 12 months or is a "sure bet to double". Instead, we can rather focus on solid long-term investment prospects.