We are sharing A Tiered Growth Approach in the Educational series
for Analysing Fundamental of Stocks
Profitability & Cash Flows
– rewarding profits and cash flows.
1 — Return on assets (ROA)
above the industry median: a profitability factor that
measures the return a company is generating from its asset base.
2 — Cash flow generated ROA
above the industry median: For growth like firms, cash
flow can be more critical than earnings.
3 — Cash flow from operations
exceeds net income: This measure attempts to reward
firms who are generating cash flow, which tends to be a cleaner number compared
to a company’s earnings since earnings can be influenced by creative accounting
methods.
Business/Earnings Variability –
rewards stable earnings and sales.
4 — Variance of a firm’s return
on assets in the past five years below the sector median. This
shows that the firm’s earnings are more stable than others in the sector, which
is considered a positive.
5 — Variance of year-over-year
sales growth relative to that of its sector median. Lower
revenue variability is rewarded because it helps weed out those firms who may
have negative earnings. Revenue is also a cleaner number vs. earnings, which
can be subject to accounting tricks.
Accounting/Spending
Conservatism – rewards spending on activities that can help growth.
6-8 — R&D, Capex and
Advertising intensity (3 distinct factors) ratios are higher than the sector
median. While R&D, Capex and Advertising reduce profits in the
near-term, they have the potential to help longer term profitability. To that
end, companies that are spending money in these areas are rewarded in the
overall model.
