Whoah, don't take my advice on anything Dave...well, maybe except this. Ya gotta do your own thorough fundamental DD for every company in which you place a bet on their success. When I realized that, I began to put together a list of things to look for to judge the financial viability and growth of a company.
So, I've put together the following form which you can feel free to use. It is synthesized from various sources. To the right of the entries, I have boxes to put in the figures and dates for each financial statement I am interested in. If I want to see how well a company has done over the years, I'll just do the annual reports...quarterlies give better definition to the shorter terms.
Of course, the ratios are compared over time to see if they are growing or shrinking. Compare the information gathered with industry standards and it's a good starting point to see how your investment may fare.
The list is subjective but with all of the objectivity I can muster. One of my criteria was to use easily accessible information. Feel free to individualize it or give emphasis to whatever makes sense for a certain company.
If you're not comfortable around financial statements, may I suggest dog-earing a copy of Barron's "Keys to Reading an Annual Statement". It's pocket sized. The Canadian Securities Course through CSI also does a good job but it's tough sledding getting their assignments done and pointing out their bureaucratic stupidity to them, but that's another story.
So, that said, below is the form I've come up with. I mainly get the information from SEDAR sedar.com (That one is set for Black Hawk because I find it easier to get in from a company than from their homepage, just click Company Profiles.)
I just print out the financials, grab the calculator, fill the form in and stick it in the company's folder along with its other information. BTW, ROT means Rule of Thumb...something that will work about 80% of the time is my definition.
Here's my version of looking at ratios:
ESSENTIAL FUNDAMENTAL INDICATORS
Fundamental analysis comes down to using indicators (ratios derived thorough formulas) to define the company’s liquidity, quality of earnings, profitability, value, and solvency.
So, we need to use at least one ratio for each of these. The best ratios to use are those with easy access, strong components, have a rule of thumb, can give confirmation to each other, and that avoid colinearity of input as much as possible to get the widest view of the company.
LIQUIDITY:
1. Current ratio = current assets / current liabilities
measures accumulation of funds. How well liabilities can be covered by assets. ROT 2:1
2. Quick Ratio (the acid test) = (current assets -
inventories) / current liabilities
More stringent than current ratio, it measures how well liabilities are covered by cash (and
quick assets). ROT 1:1
3. Debt/ Equity Ratio = total debt / shareholders’ equity
ROT = total debt should not be more than 1/2 of shareholders’ equity.
measures risk involved in borrowing, higher risk is shown by a higher ratio. ROT 1:2
4. Fixed charge coverage = EBIT / (interest expense + lease payment).
Measures the burden of interest payments and leases on the earnings of a company. ROT is
generally safe at over 2:1.
QUALITY OF EARNINGS: High quality earnings are sustainable and are accompanied by cash inflows.
5. Overall Cash Flow Ratio = Cash Flow from Operations /
( Financing Cash Outflows + Investing Cash Flows).
Gives the ratio of earnings from direct company operations to those brought in through
financing and investing.
6. Cash return on sales = Cash Flow from Operations / Sales
Compares the company’s ability to generate profit on sales with its ability to generate cash
flow from sales.
PROFITABILITY:
7. Return on assets = net income / total assets
To measure management’s success in employing assets profitably.
8. Return on Equity = net income / owner’s equity
To measure management’s success in maximizing the return on investment.
9. Return on sales = net income / sales
To evaluate the profit generated on sales.
VALUE:
10. Price/ earnings ratio = stock’s current price
/ earnings per common share
indicates the value investors place on the stock, i.e., demand for the stock.
SOLVENCY:
11. Debt to total assets = debt / total assets.
Indicates if debt load is too large.
I hope this helps, Dave. Fundamentals are just a part of what can make a good investment, but I feel they are an essential part. It can save you some unhappy surprises.
Management is, of course, a big one too. When I was out walking my wolf/dog, I met a guy who drives a gravel truck who said he was going to put all of his money into a company just across the river that builds sandwich type concrete slabs to use in building and to use as roads in the North. It sounded like a good idea so I checked them out. It turned out that one of the owners had been busted with a quarter of a million bucks worth of heroin on a street corner in Surrey and another was being deported for stealing and selling military secrets. It makes ya wonder what kind of business they were really in. It was the only time I ever gave any advice on not buying a stock.
Gotta get back to work...
On Donner and Dasher and Black Hawk and Dennison...
Happy Trails,
Lenny |
