Pham-
I can tell you my basic criteria for identifying a good stock. Keep in mind that none of these rules are absolute, but I've found them to be useful guidelines.
1. The first thing I look at is the company's financial situation.
For a small company, like SMTC, I will usually discard it from consideration if the debt:equity ratio is greater than .10 (10%). Larger companies, with market caps around $1 billion, can have some debt, assuming the debt is not hurting the company.
I like a small company to have enough cash & short term investments to cover ALL liabilities. This eliminates a lot of candidates, but it assures me of excellent liquidity and financial strength.
The company must have a current ratio (current assets minus current liabilities) greater than 2.0.
2. Once I have eliminated most of the financially weak companies, I look at a company's operations and earnings performance.
The company must have a return on equity (ROE) greater than 20%.
The company must have a positive operating cash flow. This is very important, because many companies report strong earnings, despite losing money. This is legal, because companies can report sales even when accounts receivables are growing (they have booked the sale, but haven't received actual payment yet). Also, growing inventories tie up a company's cash, which is not good. Looking at operating cash flow reveals a lot about the health of a company's business.
If it's a technology company, I like to see R & D expenses exceed 8% of sales.
I like to see a trend of decreasing S G & A expenses and increasing gross margins. Ideally, the company's operating (or pretax) margins exceed 15%.
I like to see sales and earnings growth of at least 25% annually.
3. Valuation is the next thing I consider.
I form my own earnings estimates for the next year or so, and compare them with the Street consensus. I compare the expected 3 year growth rate to earnings estimates for 1 year forward, and calculate the PEG (P/E divided by expected growth rate). I usually buy stocks with a PEG lower than .67. Preferably, the PEG is below .50. For example, SMTC is trading at 20 times next year's earnings, and I expect EPS growth of at least 30% for the next 3 years. That gives it a PEG of .67. SMTC meets most or all of the previous criteria, too.
4. I also look at other things, like insider ownership, institutional ownership, earnings estimate revisions, insider buying, footnotes of the SEC files (for litigation and other high-risk contingencies). I look at executive compensation, other forms of outstanding capital stock (preferred, convertible, etc.), industry growth, the company's position in its industry, etc.
5. Although timing is very difficult, I try to evaluate the stock using numerous TA indicators. I like to see the stock in an uptrend, having increased significantly relative to other stocks.
There are numerous books on fundamental analysis, but a lot of the good ones are huge (like "Securities Analysis," by Benjamin Graham). A good beginner book for small-cap investing is called "Investing In Small-Cap Stocks," by Graja and Ungar. It's a Bloomberg book.
I hope this was helpful. Good luck.
Todd |
