5 qualities of top stocks
Top stocks have 5 things in common: great management, strong return on equity, low debt, rising earnings and rising intrinsic value.
All great quality companies’ display similar distinguishing characteristics, and as a value investor you need to know what they are to ensure you look beyond short-term hype to more meaningful measures when deciding which stocks to buy.
According to Benjamin Graham, the founding father of value investing, the key to unearthing top stocks is being able to identify what separates them from their lower quality counterparts.
Stocks that stack up well against key criteria, argues Graham, are more likely to withstand financial storms, and because of this are more worthy of a place in your portfolio.
To help you rate the underlying quality of individual companies, Share Analysis stock research software has automated the principles of value investing. The filters embedded within Share Analysis help to highlight five essential characteristics you should always look for in a stock.
Companies that have these characteristics (also known as key indicators or performance ratios) are more likely to deliver a sustainable competitive advantage – so let’s take a look at them more closely.
1. Company management
Quality companies have good management with a proven track-record in delivering strong and sustainable earnings, cash flow and profitability from a competitive business model within a market offering potential for long-term growth. These companies also have a sound balance sheet and a strong corporate governance structure.
Media coverage, interviews, articles and company announcements, (especially during reporting season) should indicate how well a company has been managed. Similarly, the “Share Analysis Score” Evaluate screen provides a snapshot of a company’s overall wellbeing. The proof of the pudding is in how well a company stacks up when evaluated against the following performance ratios:
2. Return on equity (ROE)
A key measure of the return a company makes on the equity in the business, return on equity represents earnings (revenue minus expenses, taxes and depreciation) divided by average equity. Share Analysis prefers companies with ROE greater than 15 per cent, preferably more for an extra margin of safety. But it’s important to know how much the balance sheet needed to be geared to deliver those earnings and whether this impacts on the company’s ability to reinvest at the same ROE going forward. The following ratio explains why.
3. Net Debt to Equity
This measure lets you know what proportion of equity and debt a company is using to finance its assets, and is calculated by dividing its total liabilities by stockholders’ equity. A company that has more cash on hand than debt is much more likely to weather any financial storms. Share Analysis prefers companies with a Net Debt/Equity ratio of 40 per cent or less.
4. Earnings Per Share (EPS) growth
EPS reflects the portion of a company’s profit allocated to each outstanding share of common stock, and (EPS) growth projections are a quick way to gauge a company’s future prospects and profitability. Where available, Share Analysis provides three years of analyst forecasts, and while they are always estimates, they typically provide good insight into what the company’s future may look like. But it’s equally important to overlay EPS growth projections with regular market updates (including sector or regulatory changes, and competitor activities), plus ongoing company disclosures for a better understanding of a company’s future prospects.
Everything being equal, EPS increases are typically mirrored by a share price increase, and the more a company grows its EPS, the greater the opportunity for its earnings to be revalued upwards. The “Forecast Change in intrinsic value” and “Forecast EPS Growth” available in Share Analysis’s filter make it easy to identify businesses with the most value growth upside.
5. Intrinsic Value
Benjamin Graham claims that companies capable of growing their intrinsic value – the sum total of the business’s worth based on earnings, dividends, equity and debt – are more likely to provide increasing capital gains to your portfolio as well. Given that a company’s share price cannot overtake its underlying performance forever, intrinsic value becomes a vital metric when it comes to deciding which stocks to buy.
Share Analysis’s estimate of intrinsic value and the Safety Margin calculated for each stock can help you make this decision. Remember, while price is important, it always takes second place to quality. Buying a lower quality business with less upside for future growth at a cheaper price is less likely to grow the value of your portfolio in the long run than good underlying businesses trading at a significant discount to full value.
How to find stocks with a competitive advantage
If you don’t have a competitive advantage, don’t compete”. That’s pretty good advice from former General Electric CEO (the company’s value rose 4000 per cent during his tenure) Jack Welch.
Companies with a strong competitive advantage can share a few distinguishing characteristics: advanced technology, market dominance within sectors with high barriers to entry, scalability, great prospects for sales and profits, untapped global target markets, top management.
As a smart investor it’s your job to identify top stocks with a competitive advantage that’s sufficiently sustainable. That means it won’t ‘crash and burn’, leaving you with a potential value trap with all its best days behind it.
The best measure of a company’s competitive advantage is whether it’s generating higher rates of return on equity than its competitors, which in turn sets it up for promising future of growth. But it’s important to understand that a company can’t consistently raise prices without losing business, without defendable points of difference.
When identifying better performing companies, find out what their defendable points of difference, aka competitive advantages, are and how exposed they are to macroeconomic, sector or company-specific dynamics.
Bad news when companies lose their competitive advantage
Investors had a crude reminder of the damage regulatory change can inflict on a niche sector when Kevin Rudd’s proposal to remove one loophole concerning novated leases for ‘work’ vehicles threatened around half of McMillan Shakespeare’s (MMS)’s total profit.
Then there’s Billabong International (BBG), whose market leadership decline in the early noughties was largely its own doing – the company failed to adapt to the changing youth market. Unsurprisingly sales plummeted, along with the company’s intrinsic value and share price.
Sectors with a lost competitive advantage
There’s no shortage of sectors that have been left flat-footed in the competitive advantage-stakes. The free-to-air television industry is a classic example. With the total TV ad market expected to shrink in the face of digital entertainment, listed TV channels collectively lack a competitive advantage from their core business model. Ten Network’s 10-year share price isn’t a pleasant sight.
More recently the ASX’s (ASX) former ‘near-monopoly’ status has been lost to regulatory reform, while the former duopoly enjoyed by Tatts (TTS) and Tabcorp (TAH) in Victoria was removed in 2012.
If these examples tell you anything, it’s that a company’s competitive advantage can’t always be sustained. That’s why it’s so important to find companies with a solid track record and future growth opportunities.
How to find companies with a durable competitive advantage
Share Analysis Score
A1, A2, B1, 2
Investment grade stocks with solid balance sheets.
Historical change in IV
> 10 per cent
Proven ability to consistently grow the value of the business.
Return on equity
> 15 per cent
Companies with higher returns should be able to deliver annual ROE above 15 per cent
Forecast change in IV
> 0 per cent
Companies with a sustainable competitive advantage should be able to continue growing the value of the business.
Qualitative research is generally available
Competitive advantage stocks checklist
When looking for stocks with a durable competitive advantage, check management’s understanding of capital allocation. How the company funds the business provides meaningful clues into how sustainable growth and superior returns might be into the future.
The greater a company’s Funding Surplus the more likely it is to avoid excessive borrowing, expand its business, pay dividends and withstand any economic downturns.
Securing your position in top stocks with a durable competitive advantage
Depending upon your investment rules and portfolio allocation strategy, you could arguably justify paying a (slight) premium for the best of these growth stocks with strong potential for growth on sales and earnings. To prevent paying an inflated premium, you should attempt to time your entry around future market corrections. Setting up a price target Share Analysis Alert will ensure you receive an email to prompt you to take action.
Why return on equity is the best measure of business performance
ROE determines the level of profitability a company earns on the equity capital it has raised and retained.
While no one tool for successful investing should ever be used in isolation, return on equity (ROE) is regarded by Share Analysis as the single best indicator of business performance, so long as debt levels are rational. As a key measure of how well a company is managing its equity, return on equity – net profit divided by (shareholder) equity – determines the level of profitability a company earns on the equity capital it has raised and retained.
Return on equity and business performance
A simpler way to look at profitability is to identify whether every $1 used in financial growth is able to convert into $1 of market value, or not. An important overlay that Share Analysis uses to best reflect ROE in the right context is a review of each company’s balance sheet gearing and how much debt was needed to deliver those earnings. It’s known as the Capital History Evaluate screen, and has a patent pending because of its unique interpretation of a company’s history of equity, debt and business performance. Share Analysis’s Capital History Evaluate screen for every ASX-listed company (and another 2,000 global stocks) will help to expose any distortion in reported earnings.
Take a look at Fortescue Metals Group (FMG). In 2012 FMG generated a return on its equity in excess of 50 per cent. This impressive performance however was achieved with the assistance of debt (red column) amounting to more than $8 billion, or more than one and a half times the equity (grey column) in the business. In 2012 Share Analysis calculated FMG ended its financial year with a net debt-equity ratio of 164 per cent. Share Analysis prefers companies whose balance sheet is geared at a net debt/equity ratio of less than 40 per cent.
Share Analysis’s Capital History Evaluate screen presents FMG’s history of equity, debt and return on equity
Debt levels will reveal a lot about the company’s ability to reinvest at the same ROE in the future. As a stock picker, it’s important for you to understand how sustainable that profitability is. Let us explain further using the following example.
Your business started the financial year with $100,000 in the bank, and ended it with $200,000. At face value you made a $100,000 profit. But during the year you borrowed $200,000 – bringing your bank balance back to zero – and raised an additional $150,000 in equity, leaving you with a cash loss of $150,000. Adding to the false impression of your business improvement and a further distortion to the ROE, you also borrowed to pay a dividend of $200,000.
Business performance and debt servicing
As a value investor, you should be looking for stocks that can deliver a return on equity above Share Analysis’s recommended 15 per cent. Identifying businesses capable of delivering a significantly greater ROE will build in a recommended margin of safety. How much of a safety margin is desirable will depend somewhat on the state of a company’s balance sheet.
Admittedly, the better the underlying cash flow, the greater a company’s capacity for balance sheet gearing. US-listed International Business Machines (IBM) is a great example.
While IBM’s balance sheet is geared at more than 115 per cent, the company has consistently produced enough cash to more than cover its debt obligations. Since 2003 Cash Flow Generated from Operations has exceeded Reported Net Profit After Taxes – a rare achievement indeed.
But assuming debt levels are modest – typically with net-debt to equity under 30 per cent – companies with higher ROE should have higher levels of profitability.
Australian companies’ profitability
Interestingly, the return on equity of the great bulk of ASX-listed businesses (Share Analysis estimates around 60 per cent) is insufficient for them to be regarded as profitable. Size is no determinant of profitability, with many large-caps ($2 billion-plus market cap), such as Alumina (AWC) and Whitehaven Coal (WHC), included amongst those with negative profitability. So assuming ROE is used as an important filter, the stocks left in your universe have already been culled to around 30 per cent of the entire Australian Stock Exchange.
If a company isn’t profitable, or forecast to be profitable, an intrinsic value cannot be estimated by Share Analysis, so a Safety Margin cannot be calculated. Based on Share Analysis’s automated ranking of profitable ASX-listed stocks, just under 20 per cent offer a positive safety margin. Companies in the mining and healthcare sectors are the worst offenders where those deemed unprofitable exceed 80 per cent.
So in a market where value-for-money is perennially hard to find, ROE serves as a useful insight into profitability, but only if it’s used in the right context. While it won’t of itself indicate what a Share Analysis Score should be, or whether shares are valued higher than the worth of a business, ROE will help cull the colossus of stocks that should not be on your radar due to insufficient profitability.
Remember, the value-for-money proposition is constantly changing along with share price movement. That’s why it’s important to regularly review the cash position of your companies. If they’ve spent more than they’ve earned, and raised capital and taken on debt, then there could be a time bomb ticking in your portfolio.
Using cash flow to find value investments
The best stocks to invest in are those that produce an ongoing funding surplus. Use cash flow to find them.
There’s no better insight into what’s left for you as a shareholder in a business, once it’s paid all its bills, than an analysis of cash flow. When it comes to assessing the investment quality of a company’s cash flow, you should be attracted to those with sufficient money in the bank to fund their operations and produce an ongoing Funding Surplus.
While every business operates to generate cash, you should exercise caution around stocks that often show a Funding Gap. This occurs when there’s insufficient cash to continue operating and the company is forced to take on debt or raise capital from shareholders.
Funding surplus or funding gap?
A Funding Surplus or Gap can be arrived at by subtracting the capital expenditure, investments and dividends paid from the company’s Cash Flow Generated from Operations.
The greater a company’s Funding Surplus the more likely it is to avoid excessive borrowing, expand its business, pay dividends and withstand any economic downturns.
The trouble is that deciphering whether a company is self-funded (generating more money than it spends) or relies on external funding – after factoring in its operations, investments and financing – isn’t always a straightforward exercise. That’s why Share Analysis’s automated software has simplified the process for you by charting up to ten years of data from a company’s Profit and Loss and Cash Flow Statement.
Share Analysis’s Cash Flow for every company is updated annually, following the release of the company’s annual report. Share Analysis uses a (colour-coded) Cash Flow Evaluate screen to interpret the complexities of a company’s history of reported net profit after taxes (NPAT), cash flow generated from operations and dividends paid. What you’re left with is a clear understanding of how the cash generated by a business has been utilised and whether or not the company has required external funding to finance its activities.
Let’s look at exactly how Share Analysis’s Cash Flow Evaluate screen works, and then draw on a live example to show you how easy it is to use. The Cash Flow Evaluate screen is designed to give you a historical snapshot of a company’s overall cash flow position using two key indicators. The blue line reveals the cash flow generated from operations, the green line indicates the Funding Surplus or Gap.
CSL Limited (CSL)
CSL Limited (CSL) is a great example of a company that has consistently strong cash flow generated from operations relative to reported net profit after taxes.
Share Analysis presents CSL’s cash flow statement
You should be attracted to companies with blue and green lines that are trending upwards, like CSL’s, as they have consistently generated rising profits and improving Cash Flow Generated from Operations.
Breville Group (BRG)
As another example, here’s what Share Analysis data tells us about appliance maker Breville (BRG’s) cash position.
Share Analysis presents Breville’s cash flow statement
Between 2003 and 2012, Breville has invested $98.233 million, paid dividends of $107.706 million and paid out other financing cash flows and foreign exchange effects of $5.752 million, resulting in a Funding Surplus (green line) of $90.797 million.
BRG’s cash flow has been in surplus since 2008, and based on its 2012 full year results the company’s Funding Surplus is just over $20 million – giving it an attractive Cash Flow Ratio of 1.10.
BRG’s Funding Surplus indicates the company does not currently rely on external sources of capital to fund its business activities. Based on the strength of its low debt, healthy bank account, future ROE projections above 20 per cent, and healthy cash flow surplus, BRG is awarded an attractive Share Analysis Score of A2.
GUD Holdings (GUD)
With a Share Analysis rating of A2, BRG’s direct competitor, GUD Holdings (GUD), manager of Sunbeam appliances, is also a very attractive stock. But when you compare GUD’s Cash Flow Ratio of 0.66, it’s easy to see which one you’d rather own.
Not all big companies have good cash flow
You need to be wary of well-known large-caps with unhealthy cash positions which may still attract uninformed investors due to their size. High profile stocks with a history of large debt and poor cash flow – which contribute to poor Share Analysis Scores – include: Seven Group Holdings (SVW), James Hardie Industries (JHX), Oil Search (OSH), Leighton Holdings (LEI), Asciano (AIO), Duet Group (DUE), Tabcorp Holdings (TAH), Transurban (TCL), Brambles (BXB), Origin Energy (ORG), SP AusNet (SPN), APA Group (APA) and Sydney Airport Holdings (SYD).
Don’t overlook cash flow
A company’s cash flow is a crucial ingredient in producing sufficient money in the bank to fund operations, pay dividends and produce a funding surplus. Look for those companies that have something left over for you as a shareholder, after they have paid their bills. They are the ones that will produce lasting and growing value in your portfolio.
Finding high quality dividend stocks
Dividends can provide investment income. Find stocks that can also deliver long-term value.
With interest rates at historical lows and further cuts likely, investors chasing income shouldn’t overlook high quality listed stocks paying consistently high dividends. Australian tax laws – which refund the difference between the (30 per cent) tax a company pays (on fully franked dividends) and your own personal tax rate – contribute to the attractiveness of owning stocks paying a high dividend yield.
But focusing on dividend yield – the dividend per share as a percentage of the share price – in isolation can be a trap, especially if a company’s current earnings are unsustainable and start deteriorating. Remember that if you do rely on income from your share portfolio, high dividends don’t always equate to good investments.
Good dividends are not the same as high dividends
Dividends are the main way companies distribute earnings to shareholders, and ‘good dividends’ are those that are affordable and sustainable, without compromising a company’s growth. One of the key determinants of affordable and sustainable dividends is the quality of the underlying business and its ability to consistently grow earnings.
The primary measure of a company’s ability to pay a dividend is profitability, which can be measured through its return on equity(ROE). At face value, the 10.6 per cent dividend yield offered by Australian Pharmaceutical Industries (API) in 2011 appeared attractive. However, a quick look at its ROE at around negative 4 per cent – well below Share Analysis’s preferred minimum 15 per cent – raises serious concerns over the sustainability of this yield going forward.
Another obvious measure of dividend sustainability is the quality of a company’s underlying earnings, and how much it’s had to borrow to generate them, so keep an eye on debt levels. For example, while Automotive Holdings Ltd’s (AHE) 2013 dividend yield of 5.4 per cent may look attractive, its net-debt to equity of 140.6 per cent and $12 million cash flow funding gap raises doubts over its sustainability.
Share Analysis’s Capital History Evaluate screen presents AHE’s history of equity, debt and return on equity.
Share Analysis’s Cash Flow Evaluate screen presents AHE’s cash flow.
Steer clear of companies offering dividends that cannot be supported through cash generated by the business. Similarly, avoid companies that only have a high dividend yield based on a falling share price due to declining fundamentals like high debt, falling profits or negative cash flow.
Sustainable dividends are key
Likewise, alarm bells should ring if any companies you own start paying out dividends that their earnings can no longer sustain. As a value investor looking for income, you should view any signals that current dividend levels are no longer affordable as a potential trigger-point to exit the stock.
Admittedly, some companies attempt to attract investors with a yield they clearly can’t afford, but this strategy is ultimately wealth destroying. That’s because once cash balances are depleted, dividends have to be funded by raising debt or issuing additional equity.
In the case of building products company CSR Limited (CSR), between 2009 and 2011 dividends exceeded Reported Net Profit After Taxes, and between 2003 and the last full year report (31 March 2013), overspending resulted in a Funding Gap of $66 million. If this wasn’t enough to raise a big flag to investors, then a three-fold deterioration in dividends per share (DPS) from $0.34 to $0.05 over the same period would.
Share Analysis’s Cash Flow Evaluate Screen compares CSR’s Reported Net Profit After Taxes and Cash Dividends Paid.
CSR’s dividends per share have been declining since 2010.
Unsurprisingly, the company’s profitability, as measured by return on equity (ROE), has averaged an underwhelming 5 per cent since 2011. And since 2006 the share price has tumbled six-fold from $12.50 to around $3.00.
Another blue chip that also can’t afford its dividend is Ten Network Holdings (TEN), which has used debt and additional equity to maintain its average yield at around 6 per cent. In 2011 TEN increased its debt by $37.5 million. The following year the company raised an additional $200 million of equity and paid out almost $115 million in dividends. In anybody’s language, getting one group of shareholders to stump-up cash so it can be given back to other shareholders is bad business.
Screening for top dividend stocks
Share Analysis online investment software has made it easy for you to unearth the top dividend stocks by applying numerous screening filters. By only focussing on profitable companies Share Analysis has immediately culled the 2000-plus ASX-listed stocks by 80 per cent.
One final Share Analysis filter, which isolates stocks forecast to positively grow their intrinsic value, with ROE greater than 15 per cent and a dividend yield of 4 per cent makes finding the best stocks to invest in as easy as child’s play.
Debt is not always a dirty word
Some businesses effectively utilise debt to accelerate growth.
Despite popular belief, debt is by no means a dirty word when it comes to running a business. Indeed some businesses effectively utilise debt to accelerate growth.
But if the managers of your businesses don’t effectively manage the level of borrowings, they can easily undermine the overall value of your share investment portfolio.
Global stock markets are littered with stocks that have imploded under the strain of too much debt relative to their earnings. If the global financial crisis (GFC) has any positive legacy, it’s the way it forced companies to redefine the value of debt and what it means to carry too much on their balance sheets. Interestingly, while the management of ‘under-geared’ companies – with little to no debt – were once accused of running ‘lazy’ balance sheets, they’re now lauded for good financial management.
Smart investors focus on debt levels. Why? Because debt has to be repaid, and creditors will always recoup their losses before shareholders.
Value investors also avoid companies offering dividends that cannot be supported through cash generated by the business.
As crazy as it sounds, prior to the GFC some companies often borrowed the funds necessary to pay their dividend. Suffice to say none remain in business today.
In spite of lessons learnt, the ASX remains littered with many large-cap blue chip companies, with the size and brand familiarity to attract uninformed investors, that have large debt levels and poor cash flow (and continue to fund dividends with debt and/or capital raisings).
4 financials ratios to spot stocks with too much debt
Figuring out whether a company is self-funded or relies on external funding (a la debt) – after factoring in its operations, investments and financing – isn’t a simple exercise. Here are 4 key financial ratios you can use to understand if a business is self-funding and how it funds its dividends.
1. Net Debt to Equity ratio
Share Analysis calculates annual net debt to equity ratios for every ASX-listed company, plus up to 2,000 of the world’s largest listed stocks.
The net debt to equity ratio captures the size of a company’s debt compared to its total shareholders equity, allowing for any cash in the bank. The ratio allows investors to pressure-test the potential impact of debt on the quality and sustainability of a company’s earnings and distributions.
By taking the net debt (debt less cash balance) and dividing it by the total shareholders equity, you arrive at a net debt to equity ratio. Share Analysis prefers stocks to have a net debt to equity ratio well under 40%.
Admittedly, the better a company’s underlying cash flow, the greater it’s capacity for gearing its balance sheet. But assuming debt levels are modest – typically with net debt to equity under 30 per cent – companies with higher return on equity (ROE) should have higher levels of profitability.
2. Cash Interest Cover ratio
Value investors are attracted to stocks with sufficient earnings to adequately cover net interest expenses. Calculated by dividing operating cash flow by borrowing costs paid, the Cash Interest Cover ratio reveals how many times over a business can pay its interest bill with its cash flow. The higher the number the better!
Assuming a company can cover its net interest expenses a minimum of three times over, it will be able to continue servicing debt without overlooking its tax obligations and either distributing to shareholders via dividends or alternatively reinvesting in business growth.
There are no hard and fast rules about gearing, and what’s regarded as ‘acceptable’ interest cover will vary between companies and different industry sectors. As a case in point, capital intensive infrastructure stocks are typically more highly geared because of the very steady cash flows their assets can generate.
3. Share Analysis’s patent-pending cash flow Funding Surplus/Gap
This ratio, unique to Share Analysis stock research software, tells you instantly if a company is spending more money than it is earning.
A Funding Gap occurs when there’s insufficient cash to continue operating and the company is forced to take on debt or raise capital from shareholders. Try to steer clear of stocks in a Funding Gap.
If you don’t have a clear understanding of how the cash generated by a business has been utilised, and whether or not the company has required external funding to finance its activities, then find out before investing in it.
Share Analysis’s Funding Surplus/Gap is arrived at by subtracting the capital expenditure, investments and dividends paid from the company’s cash flow generated from its operations. The greater a company’s funding surplus the more likely it is to avoid excessive borrowing, expand its business, pay dividends and withstand any economic headwinds.
4. Debt and return on equity
Companies able to produce rising profits without the need for debt or dilutive shareholder capital raisings are more attractive. They produce increasingly profitable returns on equity without increasing risk.
Share Analysis’s Capital History screen lets you quickly assess profitability and determine if you’re comfortable with the level of risk. It shows a company’s relationship with its owners and lenders.
Why Share Analysis share investment software makes sense
Share Analysis’s share research software can help you make sense of all the available market information and invest in the right stocks.
Investing can be a daunting task. In today’s world we have a wealth of information and share investment software packages at our fingertips, but sifting through that information and focusing on what really matters is where the challenge lies.
Whether you’re managing your SMSF to prepare for your retirement or trying to build a nest egg for the present, you want to catch the best opportunities and avoid disasters.
How do you find the best stocks to invest in?
There are thousands of stocks listed on hundreds of stock exchanges all around the world.
Every investor develops methods to narrow down the universe of investment opportunities to a group of just the best stocks. Often we use rules of thumb. We may eliminate entire markets or sectors based on a premise like ‘I don’t like resource stocks’, or ‘I don’t understand technology businesses.’ Other investors determine their universe based on advice from a tip sheet, share investment software, adviser or other source.
All of these methods for finding stocks to invest in are legitimate, but they are not scientific and are likely to result in a lot of good investment opportunities being overlooked.
Share Analysis was built to circumvent this problem. Within 4 or 5 mouse clicks Share Analysis members can narrow the entire universe of stocks down to a group of 5 to 20 of the very best stocks to invest in.
Most importantly, this is not a simple filter that relies purely on historical data. Share Analysis looks forward and presents forecast data including forecast intrinsic values – over the next three years. This gives you a powerful advantage.
Warren Buffett once said, “The speed with which business success is recognised is irrelevant, provided the intrinsic value of a company is rising at a satisfactory rate.”
Save time, use Share Analysis share investment software
By utilising technology such as Share Analysis, rather than manually sifting through hundreds of annual reports, value investors can quickly weed out the rubbish and focus on the few top stocks that meet their personally defined set of sensible and rational criteria.
Share Analysis was built to provide complete coverage for every stock listed on every stock exchange around the world.
Share Analysis share investment software is fully automated, which ensures its breadth and depth of stock research and analysis is not limited by the physical capacity of a team of analysts. Nor is it influenced by their biases or affected by their errors.
This automation not only enables complete coverage of every listed stock, it also means that during periods of market inefficiency, such as bi-annual reporting seasons when analysts are struggling to keep up with the hundreds of companies reporting each week, investors can rely on modern technology to sift through the updated information quickly and accurately and quickly pounce on new investment opportunities.
Instead of digging through mountains of useless fundamental data, more time can be spent understanding those companies that have risen to the top. Share Analysis uses a vast array of financial information to analyse a company and then present the findings in an easy-to-digest and visually engaging format. While Share Analysis is simple to use and understand, the processes that take the data and present it are anything but simple.
The conclusions that Share Analysis draws about a business are presented succinctly, and in such a way that investors can quickly assess the risks associated with the output.
At the end of the day, any tool, newsletter, or analyst that provides an opinion about a stock is providing an opinion about the future. The future is inherently uncertain so it is important to interpret the opinion in that light.
The best investments are also those whose futures are less likely to be subject to unexpected shocks. Those companies with a long-term demonstrated track record of success and with stable economics have a much better chance of surviving and taking advantage of those shocks.
Wouldn’t you prefer to know well ahead of time that a company is at significant risk of catastrophe? When Gunns (GNS) collapsed in 2012, investors lost $1.4 billion. Losses were also accrued by long term shareholders at Elders, Hastie Group and Becton. In each case, Share Analysis warned investors many years before that the quality of these companies was simply not investment grade.
The chart below shows that as far back as 2005 Gunns was below investment grade, and by 2008 had become a high risk situation.
Use the past as a guide for the future
One guide to the future opportunities for a business is most certainly the past. Do you really believe that the economics of running an airline in the next few years is going to be materially different to the last ten, or that the billions that have been lost by international air carriers over the last decade will turn magically into a purple patch?
If a business has sound economics and is well run, then there can be a reasonable expectation of continuance. The opposite is also true. But the past is only ever a guide and there are many reasons why the future may not resemble the past.
Research the company’s future opportunities
Share Analysis uses professional and rated consensus analyst forecasts as one of the inputs to its intrinsic value and other metrics and ratios. In the case of some Australian companies, up to 30 institutional analysts from banks and stock broking companies are forecasting the earnings per share aggregated and available in Share Analysis.
A range of estimates is also provided so as to show the level of agreement in the analyst community, as well as the number of analysts covering each stock.
Share Analysis calculates an intrinsic value range
The final piece to the puzzle is the safety margin – the difference between a company’s intrinsic value and current share price.
Intrinsic value calculations are only ever an estimate, so it makes sense to apply a safety margin to the intrinsic valuation to allow for uncertainty.
Value investors aim to invest in high quality companies that are growing their intrinsic value and trading at a price below that intrinsic value estimate. Warren Buffett famously said that in the long run share prices tend to follow value. Buy a growth stock at a positive safety margin and your share portfolio should perform quite well.
While not every investment will be a winner, and not every opportunity will be caught, by avoiding the time bombs and finding the otherwise hidden investment opportunities, overall your portfolio should prosper.
Share Analysis’s powerful filter and in-depth yet intuitive stock research does all the laborious stock analysis for you. Your job as an investor is to simply focus on understanding the best investment opportunities and acquiring shares in those businesses at an attractive safety margin.
Using economic factors to uncover the best investment options
Understand the implications of economic factors so you can focus on the best investment options.
Every company listed on the stock market, and ultimately your portfolio’s performance, is impacted by a wide variety of economic factors. As an informed investor it’s your job to understand the implications for future business performance on the stocks you own or investment opportunities you may wish to buy.
Domestic economic indicators can provide you with useful insights into what sectors and stocks stand to benefit (or lose) from economic activity beyond their control. Remember, ‘domestic factors’ dominate analysts’ consensus earnings forecasts.
By adding other high level economic factors to your stock research process, you’ll get a good idea of where the broader economy is heading and what it has in store for share markets.
Investment decisions are affected by sector changes
It’s equally important to understand how changes within a sector can significantly impact individual companies.
Before rolling your sleeves up to take a closer look at your portfolioand check if you still hold top stocks, first consider the most profitable investment themes of the previous 12 months and decide if they’re likely to continue. Also think about the future directions of the local and international economy, and where the greatest opportunities for growth lie.
Paying attention to what’s happening around you, and keeping your ear to the ground, will help you spot trending investment themes, narrow down your list of investment opportunities to just the very best stocks and ensure you can manage your portfolio with confidence.
Once you understand the impact of economic factors, and the negative correlation between asset classes, you’ll also recognise the need to regularly review the asset allocations within your overall portfolio as market conditions change.
How do experts find top stocks to invest in?
They investigate the business, future growth opportunities and always estimate intrinsic value.
So you’ve found a top quality business. It has a sound balance sheet, good cash flow and a consistent history of delivering value to shareholders. And its share price is trading at a discount to Share Analysis’s intrinsic valuation estimate. The decision to buy is easy, right? Not quite.
A top stock today may not be so great in one, two, three or five years’ time. So what research do you need to do then to make sure you build a portfolio of businesses that will stand the test of time?
Here are some expert tips…
Investigate future growth opportunities
Investigate the company’s future growth opportunities and confirm that the future intrinsic valuations estimated by Share Analysis, which are driven by consensus analyst forecasts, are likely to materialise. To find these answers, you’ll need to roll up your sleeves and do some digging.
Review the company’s website (you’ll find a link in Share Analysis on the Sumary Evaluate screen). Read its recent results announcements, with particular focus on the section titled ‘Outlook’, to understand management’s view on the future of their business.
ASX rulings require companies to release earnings and profit guidance when such guidance can be seen to impact share prices. Check the ASX Announcements regularly and pay particular attention to the price sensitive ones (they’re highlighted with a red !).
Talk to the brokers and analysts that cover the stock. Sometimes you can find their contact details on the company’s website. If the information isn’t freely available, ring the company’s CFO or investors relations and ask. If you use a full service broker, ask them to share their research with you.
One of the single most important external factors you need to consider is the market in which the business operates. Is it expanding, stabilising or contracting?
Only top companies that operate in expanding industries are worthy of a place in your portfolio.
Why? It’s much easier to grow a business in an environment where the market is growing rapidly, rather than fighting for market share or compromising margins just to make a buck.
The online space in 2012 was a great example of an expanding market. Businesses such as realestate.com.au (REA) and Webjet (WEB) did extremely well when other markets, such as retail and construction, suffered.
Investigate intrinsic value
Once you’re satisfied the future earnings, profits and intrinsic value of a top stock is likely to materialise, you want to buy shares when the price is trading at a discount to what the business is actually worth – its intrinsic value.
Share Analysis Line charts in Share Analysis stock research software illustrate a company’s intrinsic value (grey/orange line) and share price (green chart), and the safety margin.
Working with future intrinsic valuations is one of the toughest parts of investing. A business may look cheap, but if fast changes in the market catch out company management, a falling share price can be almost guaranteed.
Share Analysis’s A1 – C5 Scores are based on the most recent financial reports published by a company. For the majority of ASX-listed business, their Share Analysis Scores update in February and again in August, when the full year reporting season kicks into full swing.
It’s important to note that Share Analysis’s future valuations are derived largely from earnings, dividends, equity and profit forecasts from consensus analysts who, like many of us, can be slow to factor in some new information.
That’s why Share Analysis produces a range of valuation estimates. When you notice a wide gap between Share Analysis’s bullish and bearish intrinsic valuations, take a closer look. Review the Earnings and Dividends Evaluate screen to see how many consensus analysts are contributing forecasts to Share Analysis, and look at the range of those forecast estimates. If only two analysts are covering a business, and their EPS estimates range from $1.00 to $3.00, you need to ask: What is the likely future outlook for this business? There is probably a fair bit of uncertainty regarding the outlook for the industry or the company or both.