How to Get the Right stock?
3.2.1 Analyze Financial Track Record of a Company
A company is worth investing in, if it is profitable, and is capable of increasing its profitability at a good consistent rate.
To grow its profits, a company must be able to grow its Net Sales year after year. The company can achieve it by increasing capacity in existing infrastructure; & by expanding its business in the long run.
Any kind of expansion will need funds, and company can arrange it by
- Reinvesting a part of its profits in the business
- Issuing new shares, &
- Borrowing money from banks
Company should utilise its capital efficiently. An investor / shareholder can check it by monitoring the Return on Total Invested Capital.
A good Company should borrow only so much money that it can repay without any serious difficulty. The Debt to net Profit ratio tells us how many years a company will take to repay its debt. If it's very high we need to investigate closely.
Thus, we have 5 necessary and sufficient financial factors that speak about a company's performance.
|Financial Factor||Measure of|
|1||Net Sales||Revenue generated from sales of products and services|
|2||ROCE||Efficiency of using money, shareholders' and borrowed|
|3||EPS||Profit per share|
|4||BVPS||Reinvestment done to increase its capacity|
|5||Net Op. Cash Flow||Cash generated from operation|
|6||Debt/Net Profit Ratio||Number of years a company can take to repay its debt|
To know a company's real strength, we need to study the company's performance through a full economic cycle, thro' good and bad times. So, we need to evaluate a company on above factors for a period of 10 years.
The 10 YEAR X-RAY designed by MoneyWorks4me will help to assess a company's financial track record with ease. Click on the link to know more.
This is how the 10 YEAR X-RAY of a company on MoneyWorks4me looks-
Let us understand how MoneyWorks4Me has come up with the colour coding for the following-
|Financial Factor||Assessment of Colour Coding|
|Year-On-Year growth rates of Net Sales, EPS, Net Op. Cash Flow and BVPS||In the last ten years, Inflation in India has been growing at a CAGR of around 6%. So, we put our lower limit as twice that at 12% as good consistent growth and code it green as reflected in the 10 YEAR X-RAY.
If the growth rate is 8-12% which just covers the inflation the company is considered somewhat good and is coded orange.
A growth rate below 8% is considered not good and is coded red.
|ROCE||We must maintain a return on total investment more than that on other investment options. In India, return on a 10-year fixed deposit is 8-10%; so we keep our benchmark for very good ROCE as a minimum 12% every year for 10 years and code it as green as reflected in the 10 YEAR X-RAY.
If it is 8-12% which is similar to returns obtained with other Investment options; the company is considered somewhat good and is coded orange.
ROCE below 8% is considered not good and is coded red.
|Debt/Net Profit ratio||A good company should borrow only so much money that it can repay without any serious difficulty. We think a company should pay all its debt within 3 years. Hence, we keep our benchmark for very good Debt/Net profit between 0-3 for the current year and code it as green. The ratio greater than 3 or less than 0 have been coded as orange; indicating that we need to study the company further.|