I take a considerable amount of time to perform a thorough quantitative and qualitative evaluation for any stock or the company. I believe it is necessary since I am investing for long haul. How does a one month or two month matter when I am attempting to visualize for next 10 years or more. Yes, I agree delaying couple of months will make me miss the window of opportunity or as the stock investing lingo says, missing the multi-bagger.
I screen out many companies before I decide to spend long hours looking into its numbers and future direction. I keep my screening process very simple. The parameters I use for screening are as follows
Operating cash flow: A consistently positive and growing operational cash flow shows the strength of its products and demand in market place. In addition, to a certain extent, it also demonstrates management’s ability to manage the generated cash.
Debt: Ideally, I would be looking for a zero debt company. But I understand this is completely unrealistic. Businesses need debt to grow. Therefore, I am looking for a prudent debt management practices from the company. I am looking for debt to be (a) less than operating cash flow; and (b) less than net profits. I do not want management to take on debt that is higher than operating cash flow. How will they repay and/or service this debt?
Reported net profit: I am looking for consistently positive and growing trend. I am looking for profits to be (a) less than cash flow; and (b) growth trends similar to operating cash flow. How can profits be more than operating cash flow? I am looking for consistency and not occasional discrepancies. In a growth oriented economy, it is likely that in occasional years, it may not meet my criteria. But if such issues are a norm, then it is better to stay away from such a company.
Dividends: The company should be paying dividends. I should be less than 50% but greater than 10% of its earnings.
Capital usage: Every business requires capital. But what is the point of the business, when you keep pumping in capital and it does not generate higher profits over time. I am looking for prudent capital management practices as measured by ROC or ROEC or ROIC. Even though I look at this metric during pre-screening process, I do not have a very clear and strict cutoff. Here I am looking for gross or overall indicator. For example, a company consistently diluting equity, continuously accessing debt markets, no corresponding profitability changes, etc.
Margins: I am looking for (a) consistency in gross, operating, and net margin, (b) higher margin business in the market domain. Two companies operating in same market, why would you go for company with low margin business? In addition, when margins are in single digits or low double digits, there is no room for error. The company can easily slide into negative performance or it will get exposed to competition.
In my screening process, I am looking for consistency, growing trends, and ability to sustain those trends. I keep list of companies that pass these screening criteria and then decide to spend time for detailed analysis. The drawback in this screening process is that I have to do this screening manually because there are no stock screeners which capture these requirements.
cash flow, debt, dividends, metric, profit margins, ROE, ROEC, ROIC, screen process, stock prescreen