State of Play: under Motley Fool basic rules there are no companies worth investing in listed on the ASX, so I’ve dug out another book, Tim Hewat’s The Intelligent Investor’s Guide to Share Buying to see what I can glean from it.
In Chapter 8, Solid Signposts for Success, Mr Hewat sets out six guidelines for selecting shares:
1. Diversify by investing in 12 shares. Interestingly the same figure I settled on – clearly great minds think alike.
2. Tend towards Big Caps first and then, if there is no value there, second-line shares. Unfortunately, the book doesn’t define what a second line share is, so I’m not sure how low to go with market capitalization.
3. Give top priority to PE ratios of 10 or below. Mr Hewat has a whole chapter on the Price-Earnings Ratio (current share price divided by earnings per share). He describes a study done by David Dreman (an investment manager) and Professor Michael Berry of the University of Virginia. They made a list of the top 60% of shares by market value listed on the New York Stock Exchange, ranked them by PE ratio and split them into quintiles (ie, shares with the top 20% of PE ratios in one group, next 20% in the next group, etc). They revised the groups each year for 25 years using the same methodology. (I’m guessing this means that at the end of each year they “sold” shares no longer in one group and then “bought” the shares that where now ranked within the group). Over the 25 years, the shares in the lowest quintile returned 17.3% pa, whereas the average for the whole group was 12.3% pa. (There is no comment on whether they took into account taxes and transaction costs).
Another fellow called Qualls did a similar thing with 100 randomly selected industrial companies listed on the (then) Sydney Stock Exchange and also found the lowest group outperformed the rest.
The chapter gives a few more examples, all with the same results. Mr Hewat settled on an absolute benchmark of 10 (note, his book was published in 1994 in the midst of a market boom). This approach saves the time taken to rank all the shares, however, a look over the tables from the weekend edition of the Australian Finance Review shows a fair proportion of them have PE ratios below 10. Also, given we now have the internet and MS Excel, the process of ranking shares by PE ratio and splitting them into quintiles should take all of five minutes, so I think I’ll use that method.
4. Price to Assets Ratio (PAR) should be 1.0 or lower. This is explained along the line of, for example, if the PAR is 0.9, it means you can buy $1 worth of the company or 90c. From this I’m assuming that the ratio is calculated by dividing the market capitalization of the company by the net assets reported on the balance sheet. My concern here is that it assumes the assets in the balance sheet are valued correctly. If I was looking at these figures today (26 January 2009) for a property company, and they were based on 30 June 2008 annual reports, I’d want to discount the properties by, say 10%. But I suppose, as with all of these things, the devil’s in the detail.
5. Satisfy yourself that Dividend Yield meets the demand for an adequate return. I have serious issues with this guideline. Aside from the fact that Mr Hewat provides no real way of determining what an “adequate return” is, the last thing I need is for companies to give me back money in the form of dividends, so I have to pay tax on it and then have to find a place to reinvest it and (unless they have a dividend reinvestment program) pay a fee to a broker to do so. Unfortunately, I think its quite fashionable for Australian companies to pay dividends. I use to the term fashionable quite deliberately, because there is no real reason to pay dividends except that investors in Australia seem to like them so you are an Australian company you are unlikely to attract investors if you don’t pay dividends. We will see when the time comes whether I can find any non-dividend paying shares for profit making companies.
6. Dividends paid without interruption for at least five years. This I see as a lazy way of checking whether the underlying performance of the company has been OK. I would prefer to look at whether the company has actually made a profit for the past five years, because, if a company is making a loss and funding dividend payments through increased borrowings, then it’s a company from which you should run a mile.
Having reviewed all that, I’m going to set a new set of criteria based on a mixture of the Motley Fool rules and the above. So, my new criteria are:
1. Daily Dollar Volume: From $100,000 to $25m;
2. PE Ratio within the lowest 20% of PE ratios for all shares;
3. Price-Assets Ratio of less than or equal to 1.0;
4. Net Profit a positive number and greater than last year;
5. Revenue of $500m or less and greater than last year;
6. Cashflow from operations: a positive number; and
7. Preferably all earnings reinvested (no dividends paid).
So lets see how we go.
1. Daily Dollar Volume: From $100,000 to $25m and
2. Price-Assets Ratio of less than or equal to 1.0
I ran these two tests together, starting with the full list of all securities on the ASX having deleted all the options and other non-share securities. First I ranked the shares by PE ratio and deleted all the shares with a PE ratio of zero or less (ie all companies that had made a loss). I then calculated the daily dollar volume for each share (closing price multiplied by volume traded) and deleted those shares with a DDV below $100,000 and above $25m. There were 201 shares remaining, which I ranked them by PE ratio and kept the bottom 40.
3. Price-Assets Ratio of less than or equal to 1.0
The AFR tables have the Net Tangible Assets (NTA) for each share, which is “the total assets of a company less total liabilities and not including intangible items such as goodwill.” (Refer http://afr.com/home/tables_1.aspx#indus_lnk).
There were nine shares with negative or no NTA so I deleted all of those. Of the 31 shares remaining a further nine had a PA ratio (last sale price divided by NTA) greater than 1.0, so I’m left with 22 potential shares to comprise my portfolio.
4. Net Profit a positive number and greater than last year
I already knocked out the unprofitable companies in the first test, so its just a matter of checking whether the 22 remaining made a greater profit this year than last year. Eight had negative earnings growth, so we are down to fourteen shares.
5. Revenue of $500m or less and greater than last year
Four companies had negative sales growth, so ten remain. Of those, only five had annual revenue less than $500m:
• Macquarie Office Trust
• Mount Gibson Iron
• Nomad Building Solutions
• Macquarie Country Wide and
• Charter Hall Group (one of the final contenders under the Motley Fool criteria)
6. Cashflow from operations: a positive number
The five companies all have positive cashflow from operations.
7. Preferably all earnings reinvested (no dividends paid)
I knew this would be a bridge too far. Only Mount Gibson Iron does not pay dividends, so I will keep the five.
Does this mean I get onto CommSec tomorrow and start splashing my cash around? No. It means I have to start reading annual reports, so I’m going back to “The Motley Fool Investment Guide” to read Chapter 14 “Making Sense of Income Statements” (next post, that is).
Monday, January 26, 2009
Thursday, January 15, 2009
The Criteria in Action
State of Play: I have a long list of 583 shares listed on the Australian Stock Exchange (refer first post) from which I want to pick 12. I have a list of seven criteria (refer previous post) to bring down my long list to a short list. Here goes.
Criterion 1 - Daily Dollar Volume: From $100,000 to $25m.
I downloaded the Industrial Market daily report and the Mining and Oil Market daily report for 9 Jan 2009 from the AFR website (http://afr.com/home/tables.aspx). For the 583 shares I found the volume and closing price (using the sumif() function in Excel, not by hand) and multiplied them together to get the Daily Dollar Volume (DDV) for each share. I then sorted the list by the DDV and deleted all the shares will a DDV below $100,000 and above $25 million.
Have a guess how many shares were left. Go on. Remember I started with 583 shares.
62.
Yep 62. Only 62 shares were left. That’s 12% of the original list. I thought, there must be some mistake, so I went to the full market list and did the same thing. Of the full list of 2,310 securities that you can invest in on the ASX, fully 49% did not trade at all on 9 Jan 2009. That 1,138 securities that if I owned I could not have sold on 9 Jan 2009. (I use the word securities because the list includes options and other types of instruments, not just shares.)
A further 817 had a DDV below $100,000. Only 18 shares had a DDV of greater than $25m (I told you that figure would be high for the Australian market). So, from the full list of available securities only 294 (13% of the market) meet this criterion. This matches my results on the long list and as the aim of the game here is to get down to a short list, I’ll move on with the 68.
Criterion 2. My Relative Strength Proxy: 90 or Higher
As discussed in my last post. I don’t know where to find the relative strength of shares so I’m going to rank them by last sale price divided by the 52-week low (both as at 9 Jan 2009).
So starting with the full list of securities from the Industrial Market daily report and the Mining and Oil Market daily report, I deleted all the options and other strange securities. That left 1908 shares. I then sorted by the “return” (closing price divided by the 52-week low). The results are worth a look at.
The highest return was 6900% for a company called Q Ltd. Their 52-week low was 0.5 cents and their closing price was 35 cents. I figured this was worth a further look, even though they did not trade on 9 Jan 2008 so they won’t be on my shortlist. Looking the company up on the ASX website (www.asx.com.au) revealed a serious downward trend in their shareprice from June 2008, when they were trading at above $2.00. This highlights just how flawed my little proxy is, but we shall press on.
188 shares or 10% of the market had a 0% “return”. This means they are at their 52-week low. It might be interesting to track this figure to see if it gives any clues about when the market is turning.
I then checked whether any of the 68 made it into the top 10% of “returns”. No. Top 20%? One – Australian Education Trust. Right. I now pronounce this whole criterion a waste of time so I’m sticking with the 68 shares from Criterion 1 and moving onto Criterion 3.
Criterion 3. Earnings and Sales Growth: 25% or Greater
For those of you paying attention, you would have noticed that I listed this last time as Criterion 5. However, you can pull these figures off Yahoo’s finance website (au.finance.yahoo.com) under Key Statistics, so I’m going with this one next.
I didn’t believe any stocks would meet this test and I was eye-ing my bookshelf to see what book I should move onto as I searched the yahoo site. However, a whole eight shares from my list of 68 had both earnings and sales growth above 25%, they are:
NAME Sales Growth Earnings Growth
AWB LIMITED 48.20% 262.90%
WOTIF.COM HOLDINGS LIMITED 41.80% 29.40%
JB HI-FI LIMITED 41.10% 59.40%
ABB GRAIN LIMITED 41.00% 532.00%
FLIGHT CENTRE LIMITED 40.20% 51.70%
INVOCARE LIMITED 36.80% 24.30%
CHARTER HALL GROUP 27.20% 35.20%
THE REJECT SHOP LIMITED 25.30% 35.10%
[Sorry about the formating, I'm afraid my blogging skills don't extend to tables.]
AWB immediately rings alarm bells. They are the crowd involved in the Iraqi oil-for-food scandal (check out Wikipedia for the full story) and litigation is on-going, they have lost the right to be the sole controller of Australian wheat exports, there is uncertainty over its share structure, its under threat of class actions and its having to pay (remaining) staff extra because they all want to leave (wouldn’t you!).
Criterion 4. Cashflow from operations: a positive number
Again, I’m not sticking to my original order, but again this is something you can look up on the Yahoo Finance website. All the shares get through on this one except AWB.
NAME Cashflow from operations
WOTIF.COM HOLDINGS LIMITED 46.28
JB HI-FI LIMITED 42.44
ABB GRAIN LIMITED 4.3
FLIGHT CENTRE LIMITED 391.93
INVOCARE LIMITED 38.6
CHARTER HALL GROUP 45.28
THE REJECT SHOP LIMITED 19.02
Criterion 5. Net Profit Margin: At Least 7%.
Strangely, this isn’t in the key statistics listed on the yahoo site, so I downloaded the latest annual reports for each company of their websites.
NAME Net Profit Margin
WOTIF.COM HOLDINGS LIMITED 3.6%
JB HI-FI LIMITED 3.6%
ABB GRAIN LIMITED 2.1%
FLIGHT CENTRE LIMITED 10.2%
INVOCARE LIMITED 12.1%
CHARTER HALL GROUP 70.0%
THE REJECT SHOP LIMITED 4.7%
As the table shows, only three companies meet the test and yes, the net profit margin for Charter Hall really is 70%. I think this has to do with it basically being a fund manager, but we can look into this further if it makes it all the way through.
Criterion 6. The company’s sales are $500m or less.
NAME Sales
FLIGHT CENTRE LIMITED $1,407m
INVOCARE LIMITED $228m
CHARTER HALL GROUP $91m
Who knew Flight Centre was such a big company? People who bother to look at these thing I suppose. However, they are too big according to the Motley Fools, so we are down to just two.
Criterion 7. Insider Holdings: 10% or more
I’m glad I was only down to two companies for this one, because it took a lot of flicking through pages on the annual report to work this one out (and even then I’m not entirely sure its correct.
For Invocare (funeral directors, by the way, odd what you find on the ASX) it appears that the directors of the company own a grand total of 1.5% of the shares. So Invocare doesn’t make the cut.
Charter Hall contained a nice list of its top twenty share holders, which consisted of 18 institutions (superannuation funds and such) and two people. The two people were directors holding 1.54% and 1.49% of the shares respectively. Its possible that if the information was there for all the directors it would amount to 10%, but I don’t think it would, besides, one share does not a portfolio make. So Charter Hall is out as well.
So what have we achieved from all this? Well we could throw in the towel and conclude that there are no companies worth investing in on the ASX or, as I said earlier, we could find another book. Coming to an end (perhaps) of one of the worst downturns on the market in history, I can’t believe that there are no companies worth investing in, so its time to turn to “The Intelligent Investor’s Guide to Share Buying” by Tim Hewat and see what he has to say about things.
Criterion 1 - Daily Dollar Volume: From $100,000 to $25m.
I downloaded the Industrial Market daily report and the Mining and Oil Market daily report for 9 Jan 2009 from the AFR website (http://afr.com/home/tables.aspx). For the 583 shares I found the volume and closing price (using the sumif() function in Excel, not by hand) and multiplied them together to get the Daily Dollar Volume (DDV) for each share. I then sorted the list by the DDV and deleted all the shares will a DDV below $100,000 and above $25 million.
Have a guess how many shares were left. Go on. Remember I started with 583 shares.
62.
Yep 62. Only 62 shares were left. That’s 12% of the original list. I thought, there must be some mistake, so I went to the full market list and did the same thing. Of the full list of 2,310 securities that you can invest in on the ASX, fully 49% did not trade at all on 9 Jan 2009. That 1,138 securities that if I owned I could not have sold on 9 Jan 2009. (I use the word securities because the list includes options and other types of instruments, not just shares.)
A further 817 had a DDV below $100,000. Only 18 shares had a DDV of greater than $25m (I told you that figure would be high for the Australian market). So, from the full list of available securities only 294 (13% of the market) meet this criterion. This matches my results on the long list and as the aim of the game here is to get down to a short list, I’ll move on with the 68.
Criterion 2. My Relative Strength Proxy: 90 or Higher
As discussed in my last post. I don’t know where to find the relative strength of shares so I’m going to rank them by last sale price divided by the 52-week low (both as at 9 Jan 2009).
So starting with the full list of securities from the Industrial Market daily report and the Mining and Oil Market daily report, I deleted all the options and other strange securities. That left 1908 shares. I then sorted by the “return” (closing price divided by the 52-week low). The results are worth a look at.
The highest return was 6900% for a company called Q Ltd. Their 52-week low was 0.5 cents and their closing price was 35 cents. I figured this was worth a further look, even though they did not trade on 9 Jan 2008 so they won’t be on my shortlist. Looking the company up on the ASX website (www.asx.com.au) revealed a serious downward trend in their shareprice from June 2008, when they were trading at above $2.00. This highlights just how flawed my little proxy is, but we shall press on.
188 shares or 10% of the market had a 0% “return”. This means they are at their 52-week low. It might be interesting to track this figure to see if it gives any clues about when the market is turning.
I then checked whether any of the 68 made it into the top 10% of “returns”. No. Top 20%? One – Australian Education Trust. Right. I now pronounce this whole criterion a waste of time so I’m sticking with the 68 shares from Criterion 1 and moving onto Criterion 3.
Criterion 3. Earnings and Sales Growth: 25% or Greater
For those of you paying attention, you would have noticed that I listed this last time as Criterion 5. However, you can pull these figures off Yahoo’s finance website (au.finance.yahoo.com) under Key Statistics, so I’m going with this one next.
I didn’t believe any stocks would meet this test and I was eye-ing my bookshelf to see what book I should move onto as I searched the yahoo site. However, a whole eight shares from my list of 68 had both earnings and sales growth above 25%, they are:
NAME Sales Growth Earnings Growth
AWB LIMITED 48.20% 262.90%
WOTIF.COM HOLDINGS LIMITED 41.80% 29.40%
JB HI-FI LIMITED 41.10% 59.40%
ABB GRAIN LIMITED 41.00% 532.00%
FLIGHT CENTRE LIMITED 40.20% 51.70%
INVOCARE LIMITED 36.80% 24.30%
CHARTER HALL GROUP 27.20% 35.20%
THE REJECT SHOP LIMITED 25.30% 35.10%
[Sorry about the formating, I'm afraid my blogging skills don't extend to tables.]
AWB immediately rings alarm bells. They are the crowd involved in the Iraqi oil-for-food scandal (check out Wikipedia for the full story) and litigation is on-going, they have lost the right to be the sole controller of Australian wheat exports, there is uncertainty over its share structure, its under threat of class actions and its having to pay (remaining) staff extra because they all want to leave (wouldn’t you!).
Criterion 4. Cashflow from operations: a positive number
Again, I’m not sticking to my original order, but again this is something you can look up on the Yahoo Finance website. All the shares get through on this one except AWB.
NAME Cashflow from operations
WOTIF.COM HOLDINGS LIMITED 46.28
JB HI-FI LIMITED 42.44
ABB GRAIN LIMITED 4.3
FLIGHT CENTRE LIMITED 391.93
INVOCARE LIMITED 38.6
CHARTER HALL GROUP 45.28
THE REJECT SHOP LIMITED 19.02
Criterion 5. Net Profit Margin: At Least 7%.
Strangely, this isn’t in the key statistics listed on the yahoo site, so I downloaded the latest annual reports for each company of their websites.
NAME Net Profit Margin
WOTIF.COM HOLDINGS LIMITED 3.6%
JB HI-FI LIMITED 3.6%
ABB GRAIN LIMITED 2.1%
FLIGHT CENTRE LIMITED 10.2%
INVOCARE LIMITED 12.1%
CHARTER HALL GROUP 70.0%
THE REJECT SHOP LIMITED 4.7%
As the table shows, only three companies meet the test and yes, the net profit margin for Charter Hall really is 70%. I think this has to do with it basically being a fund manager, but we can look into this further if it makes it all the way through.
Criterion 6. The company’s sales are $500m or less.
NAME Sales
FLIGHT CENTRE LIMITED $1,407m
INVOCARE LIMITED $228m
CHARTER HALL GROUP $91m
Who knew Flight Centre was such a big company? People who bother to look at these thing I suppose. However, they are too big according to the Motley Fools, so we are down to just two.
Criterion 7. Insider Holdings: 10% or more
I’m glad I was only down to two companies for this one, because it took a lot of flicking through pages on the annual report to work this one out (and even then I’m not entirely sure its correct.
For Invocare (funeral directors, by the way, odd what you find on the ASX) it appears that the directors of the company own a grand total of 1.5% of the shares. So Invocare doesn’t make the cut.
Charter Hall contained a nice list of its top twenty share holders, which consisted of 18 institutions (superannuation funds and such) and two people. The two people were directors holding 1.54% and 1.49% of the shares respectively. Its possible that if the information was there for all the directors it would amount to 10%, but I don’t think it would, besides, one share does not a portfolio make. So Charter Hall is out as well.
So what have we achieved from all this? Well we could throw in the towel and conclude that there are no companies worth investing in on the ASX or, as I said earlier, we could find another book. Coming to an end (perhaps) of one of the worst downturns on the market in history, I can’t believe that there are no companies worth investing in, so its time to turn to “The Intelligent Investor’s Guide to Share Buying” by Tim Hewat and see what he has to say about things.
Saturday, January 10, 2009
Selection Criteria
So, the state of play is: I have a list of 583 shares from which I want to pick 12. I’m hoping Chapter 13 of “The Motley Fool Investment Guide” will get me down to a short list from which I can pick the 12 . The chapter presents a list of eight criteria that are geared towards finding growing small-cap companies. The criteria are:
1. The company’s sales are $500m or less.
In the US this is considered a small company. The rational for investing in small companies is that there are more likely to grow than large companies. I’m pretty sure that would not be a small company in Australia, but I don’t know what threshold to use, so I will leave if at $500m for now.
2. Daily Dollar Volume: From $1m to $25m.
This is the value of trades done each day. Volume is usually quoted in number of shares, so I will estimate this by multiplying the number of shares by the closing price. Again, I don’t know whether this range is too high for Australian markets.
This criterion is about liquidity, ie how easily you can buy and sell a share. Given its Christmas at the moment, an extraordinary number of companies are not trading at all. I don’t want to be left holding something I can’t sell if I need to, but given I don’t have much to invest I will set a lower threshold of $100,000 (still many times more than any trade I would be doing).
3. Minimum Share Price of $7.
In the US, the share price for one share can be thousands of dollars. In Australia, the average share price is $1.66 (I calculated this by excluding options etc from the “Weekly Round Up – Sector by Sector” table for 9 January 2008. This table is available on the AFR website http://afr.com/home/tables.aspx). The Motley Fools cut out at $7 because shares priced this low in the US are generally illiquid. I’m inclined to think this is double counting. The Daily Dollar Volume is an accurate measure of liquidity and this is some strange proxy, so I’m not going to try and set a minimum share price for Australian shares.
4. Net Profit Margin: At Least 7%.
This is a measure of quality. It is the bottom line of the profit and loss statement (ie “Net Profit”) divided by the top line (ie “Sales” or “Revenue”). The Fools reckon 7% is a high number which indicates that the company is “soundly beating its competition or (Fool’s Choice) has no competition at all”. I have no idea whether this is a good figure for Australian companies, so in the absence of any available evidence, I’m just going to take the 7% at face value.
5. Relative Strength: 90 or Higher.
Relative strength is a rating of how a share has performed relative to all the other shares. The range goes from 1 to 99. A relative strength of 90 indicates that the share has outperformed (is that a real word?) 90% of all the other shares. The idea here is that shares will have a high relative strength because they “(1) are doing something right and (2) have the market taking notice.”
Relative Strength is not a figure you often see quoted in Australia. The only place I have seen it is at the end of news articles on www.businessspectator.com.au. This is not at all helpful if I’m looking up a share that hasn’t had any articles written about it.
Annoyingly, the book does not explain how to calculate Relative Strenghth, but as a proxy, I’m going to do my own calculation using the “Weekly Round Up – Sector by Sector” table. I’m going to rank the shares by closing price on 9 Jan 2008 and divide by the 52-week low. Anything that is not in the top 10% will get the heave-ho.
This is not perfect because it will mean that every share's return is calculated on a different time period. A company that has taken 12 months to achieve a return of 10% will be rated the same as a company that has taken 1 day to achieve a return of 10%, but we will just have to bear this in mind for now.
6. Earnings and Sales Growth: 25% or Greater.
So again we are looking at the top line and the bottom line of the profit and loss statement. This time to see whether the change in both is an increase of 25% from the year before. 25% sounds a lot to me, particularly with the way the economy is going, but I’ll stick with it for now.
7. Insider Holdings: 10% or more.
The idea here is that if the people managing the company also own the company, they will be very interested in making sure it does well. Sounds reasonable to me, but 10%? Again, I don't know if this is reasonable or not, so I'll just take it on face value.
8. Cashflow from operations: a positive number.
This figures appears on a company’s cashflow statement. Having it positive means that the company is being paid more from its customers then it is paying its suppliers and staff. This sounds like profit, doesn’t it? However, I’m reminded of a quip I heard about Centro “its business was great, but its debt was greater”. So, while its not a guarantee of a solid company, I still think it’s a good criterion.
So, to sum up, here are the criteria I’m going to use to get my long list down to a short list:
1. Daily Dollar Volume: From $100,000 to $25m.
2. My Relative Strength Proxy: 90 or Higher
3. Net Profit Margin: At Least 7%.
4. Cashflow from operations: a positive number
5. Earnings and Sales Growth: 25% or Greater
6. Insider Holdings: 10% or more
7. The company’s sales are $500m or less.
I’ve rearranged the order a bit, as the first two will cut out the most shares. The remainder requires downloading annual reports and I've put those I'm more sure about first.
Next post, I’ll put all this all into action.
1. The company’s sales are $500m or less.
In the US this is considered a small company. The rational for investing in small companies is that there are more likely to grow than large companies. I’m pretty sure that would not be a small company in Australia, but I don’t know what threshold to use, so I will leave if at $500m for now.
2. Daily Dollar Volume: From $1m to $25m.
This is the value of trades done each day. Volume is usually quoted in number of shares, so I will estimate this by multiplying the number of shares by the closing price. Again, I don’t know whether this range is too high for Australian markets.
This criterion is about liquidity, ie how easily you can buy and sell a share. Given its Christmas at the moment, an extraordinary number of companies are not trading at all. I don’t want to be left holding something I can’t sell if I need to, but given I don’t have much to invest I will set a lower threshold of $100,000 (still many times more than any trade I would be doing).
3. Minimum Share Price of $7.
In the US, the share price for one share can be thousands of dollars. In Australia, the average share price is $1.66 (I calculated this by excluding options etc from the “Weekly Round Up – Sector by Sector” table for 9 January 2008. This table is available on the AFR website http://afr.com/home/tables.aspx). The Motley Fools cut out at $7 because shares priced this low in the US are generally illiquid. I’m inclined to think this is double counting. The Daily Dollar Volume is an accurate measure of liquidity and this is some strange proxy, so I’m not going to try and set a minimum share price for Australian shares.
4. Net Profit Margin: At Least 7%.
This is a measure of quality. It is the bottom line of the profit and loss statement (ie “Net Profit”) divided by the top line (ie “Sales” or “Revenue”). The Fools reckon 7% is a high number which indicates that the company is “soundly beating its competition or (Fool’s Choice) has no competition at all”. I have no idea whether this is a good figure for Australian companies, so in the absence of any available evidence, I’m just going to take the 7% at face value.
5. Relative Strength: 90 or Higher.
Relative strength is a rating of how a share has performed relative to all the other shares. The range goes from 1 to 99. A relative strength of 90 indicates that the share has outperformed (is that a real word?) 90% of all the other shares. The idea here is that shares will have a high relative strength because they “(1) are doing something right and (2) have the market taking notice.”
Relative Strength is not a figure you often see quoted in Australia. The only place I have seen it is at the end of news articles on www.businessspectator.com.au. This is not at all helpful if I’m looking up a share that hasn’t had any articles written about it.
Annoyingly, the book does not explain how to calculate Relative Strenghth, but as a proxy, I’m going to do my own calculation using the “Weekly Round Up – Sector by Sector” table. I’m going to rank the shares by closing price on 9 Jan 2008 and divide by the 52-week low. Anything that is not in the top 10% will get the heave-ho.
This is not perfect because it will mean that every share's return is calculated on a different time period. A company that has taken 12 months to achieve a return of 10% will be rated the same as a company that has taken 1 day to achieve a return of 10%, but we will just have to bear this in mind for now.
6. Earnings and Sales Growth: 25% or Greater.
So again we are looking at the top line and the bottom line of the profit and loss statement. This time to see whether the change in both is an increase of 25% from the year before. 25% sounds a lot to me, particularly with the way the economy is going, but I’ll stick with it for now.
7. Insider Holdings: 10% or more.
The idea here is that if the people managing the company also own the company, they will be very interested in making sure it does well. Sounds reasonable to me, but 10%? Again, I don't know if this is reasonable or not, so I'll just take it on face value.
8. Cashflow from operations: a positive number.
This figures appears on a company’s cashflow statement. Having it positive means that the company is being paid more from its customers then it is paying its suppliers and staff. This sounds like profit, doesn’t it? However, I’m reminded of a quip I heard about Centro “its business was great, but its debt was greater”. So, while its not a guarantee of a solid company, I still think it’s a good criterion.
So, to sum up, here are the criteria I’m going to use to get my long list down to a short list:
1. Daily Dollar Volume: From $100,000 to $25m.
2. My Relative Strength Proxy: 90 or Higher
3. Net Profit Margin: At Least 7%.
4. Cashflow from operations: a positive number
5. Earnings and Sales Growth: 25% or Greater
6. Insider Holdings: 10% or more
7. The company’s sales are $500m or less.
I’ve rearranged the order a bit, as the first two will cut out the most shares. The remainder requires downloading annual reports and I've put those I'm more sure about first.
Next post, I’ll put all this all into action.
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