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To find the CRAPpiest of stocks, we need to get our hands dirty and dig our noses into the financial statements, conference calls, SEC filings and industry research. Only then can our portfolios come out smelling like roses.
What in the heck am I talking about? Four points of research:
1. Conservatively managed
The best companies are managed conservatively, and are always focused on earning high returns on capital instead of overpaying simply to grow or build an empire. By maintaining reasonable levels of debt and always having a healthy cash balance for the inevitable bumps in the road, these companies are built to last through thick and thin.
How can you tell if a company is conservatively managed? Firms that have zero or very little debt are more conservative. In general, be wary of firms that carry significantly more debt than cash on the balance sheet or whose operating earnings do not cover interest obligations more than five times
2. Revenue growth
Firms can always improve profitability through expense cutting, and stock multiples can ebb and flow, but ultimately a company must grow its sales in order to expand its bottom line sustainably. Revenue growth is catnip for money managers, and few stocks can maintain a high price/earnings multiple without it.
On the other hand, stock with good revenue growth trends could very well indicate that the market's valuation has trailed the company's growth trajectory, creating an attractive investment candidate. This is especially true if rapid sales growth is projected to continue.
3. Advantages over the competition
Competition will always be a keen risk, so look for firms that have structural competitive advantages.
4. Priced well below a reasonable fair value estimate
As a high earnings yield (basically the inverse of a low P/E) is one of the main component.
But is the valuation warranted based on the prospect of a long-term decline in revenue and profit?
Is it warranted based on horrific financial health?
Is it warranted based on competitors (or new government regulations) eating into their business?
To figure this stuff out, one needs to sit down and estimate a fair value for the business, based on reasonable estimates of future results and valuation ranges.
(C)onservatively managed, (R)evenue growth, (A)dvantages over the competition, (P)riced well below fair value.
When digging through heaps of stock opportunities, always be on the lookout for CRAP. I've got my shovel. How about you?
Edited Article of Steve Alexander
http://www.thestreet.com
What in the heck am I talking about? Four points of research:
1. Conservatively managed
The best companies are managed conservatively, and are always focused on earning high returns on capital instead of overpaying simply to grow or build an empire. By maintaining reasonable levels of debt and always having a healthy cash balance for the inevitable bumps in the road, these companies are built to last through thick and thin.
How can you tell if a company is conservatively managed? Firms that have zero or very little debt are more conservative. In general, be wary of firms that carry significantly more debt than cash on the balance sheet or whose operating earnings do not cover interest obligations more than five times
2. Revenue growth
Firms can always improve profitability through expense cutting, and stock multiples can ebb and flow, but ultimately a company must grow its sales in order to expand its bottom line sustainably. Revenue growth is catnip for money managers, and few stocks can maintain a high price/earnings multiple without it.
On the other hand, stock with good revenue growth trends could very well indicate that the market's valuation has trailed the company's growth trajectory, creating an attractive investment candidate. This is especially true if rapid sales growth is projected to continue.
3. Advantages over the competition
Competition will always be a keen risk, so look for firms that have structural competitive advantages.
4. Priced well below a reasonable fair value estimate
As a high earnings yield (basically the inverse of a low P/E) is one of the main component.
But is the valuation warranted based on the prospect of a long-term decline in revenue and profit?
Is it warranted based on horrific financial health?
Is it warranted based on competitors (or new government regulations) eating into their business?
To figure this stuff out, one needs to sit down and estimate a fair value for the business, based on reasonable estimates of future results and valuation ranges.
(C)onservatively managed, (R)evenue growth, (A)dvantages over the competition, (P)riced well below fair value.
When digging through heaps of stock opportunities, always be on the lookout for CRAP. I've got my shovel. How about you?
Edited Article of Steve Alexander
http://www.thestreet.com
