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I’ve been in the markets for over 10yrs, and made many early mistakes. But I see so much rubbish ramped on Twitter, without justification for why it’ll reach the moon, so here’s my method to quickly evaluate and spot profitable, quality, fair-valued companies.
It starts with Revenue (also turnover or sales) – I’m looking for stable and ideally growing Revenue. It’s an important start, but tells you little in isolation. I could set up a shop selling £10 notes for a fiver and have lots of sales, but no profit…
Market Cap – the number of shares x share price. But MCap takes no account of debt, or cash in bank, which can be significant, so I look at Enterprise Value (MCap + debt – cash), and want to see EV lower than Mcap suggesting cash outsizes debt.
Share count – A company with lower EV than MCap has more cash than debt, so shouldn’t struggle to service that debt. I want to see what’s been happening to the share count as this should be stable, and in fact maybe reducing if the Company are buying/cancelling shares.
So far we know nothing about the Company profitability, or whether the price offers value. We only know whether it sells stuff, its debt vs cash level, and whether that cash has come from share dilution to existing shareholders…
Many ‘tips’ on Twitter turn out to be pre-Revenue companies, and may eventually turn out to be profitable but that could be years away. A read of the recent RNSs will advise how the Co are investing/depleting raised funds. Such companies need cash injection until profitable.
Profit – there are various profit measures, and EPS (earnings per share) figures can be highly skewed, so start looking at how much free cash flow is being generated (cash produced through operations after expenditure), and how cash balance is trending.
Efficiency ratios like ROCE & Operating Margin will show you companies who are able to convert much of their sales revenue into profit and (jn turn) cashflow. Some Companies declare a lot of profit, but have huge capital expenditures to maintain assets. Not much will ever be FCF.
I use stock screeners extensively to narrow the list of available stocks down to a manageable number of interesting shares (eg. <20) that match my criteria. These then get inspected, RNS’s read etc, and any warning signs noted – Which sector, where do they operate etc
A good way to make money is to avoid losses, so I look for companies who have cash on the balance sheet which represents a high percentage of the share price. If they have been generating FCF, then forecast out how long the remaining MCap will take to be covered by cash gen
This is similar to the PE ratio, but that is flawed in many ways because Price (P) is real-time, but earnings (E) are based on last reported accounts, so aren’t matched in time, leading to value traps. Also, Price (P) is based on MCap which overlooks debt obligations.
The SP can stay misaligned to cash generation for some time, but eventually, Co’s who have lots of spare cash have a few obvious routes – declare or raise dividends, make acquisitions, buyback (cancel) shares, or continue to generate a bigger cash balance which acts as a buffer.
If you do 1 thing before investing in any share, calculate how much net cash (cash minus debt) the Company holds as a percentage of its MCap/your investment. This is your investment safety buffer.
And ideally, calculate how long it will take the Company, based on most recent cash growth, to generate net cash equivalent to the remainder of the MCap. In other words, how long from now (and todays SP) would it take to reach EV of zero (Mcap + debt – cash = 0).
I hope this helps. Feel free to point out any mistakes. I know there are many other ways to evaluate/value shares and totally different methods of analysis – this is just what works for me, and may help others. Good luck!
