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Saturday, November 29, 2008

'Buy Alerts' Spreadsheet

With my academic background as an Industrial Engineer, it is probably not surprising that I have a strong preference for using a heavy dose of quantitative analysis in my stock selection process. In a previous post, the detailed 'Analysis Sheet' used for evaluating a potential covered calls position was presented (link).
In response to readers who have indicated that using the 'Analysis Sheet' is just too cumbersome for them, the Covered Calls Advisor has now developed a more user-friendly stock selection analysis sheet which I am hopeful is more practical for your use -- let's call it 'Buy Alerts'. This spreadsheet includes those financial ratios and metrics that this advisor has found to be most relevant as an aid in identifying good stocks to purchase. These criteria are categorized as follows:
  • Stock Advisory Services Ratings -- the two services preferred by this advisor are Schwab Equity Ratings and MarketGrader.com; but you can, of course, use whatever advisory ratings you personally prefer.

  • Solvency Ratios -- the three key financial ratios here are: (1) Total cash & cash equivalents as a percent of market capitalization, which should be > 10%; (2) Total debt as a percent of market cap should be less than 40%; and (3) Free Cash Flow as a percent of market cap should be > 10%.

  • Value Ratios -- the two metrics here are: (1) the current year Price/Earnings Ratio should be less than 15; and (2) the Price/Sales Ratio should be less than 1.5.
  • Growth Ratio -- the 'P/E Ratio Comparison' calculates next year's P/E ratio (based on analysts' estimated earnings) divided by the current P/E ratio (based on actual earnings for the most recent 12-months). This 'P/E Ratio Comparison' result should be less than 1.0.
  • Profitability Ratio -- for this financial ratio, the company's return-on-equity (ROE) should be > 25%.

A simple spreadsheet was developed to aid in recording the results for any company under consideration for investment. The spreadsheet format also enables an easy side-by-side comparison with other companies. Prior to establishing the covered calls position in Fluor earlier this week, the Covered Calls Advisor completed a 'Buy Alerts' spreadsheet for several companies in the Engineering & Construction industry, namely Fluor, Jacobs Engineering, Foster Wheeler, and McDermott. It is presented below for your review:





In reviewing this spreadsheet, you can see that Flour, Jacobs, and Foster Wheeler each ranked equally highly with 'Total Points' of 8 (out of a maximum possible total points of 9). So why was Fluor selected to add to the Covered Calls Advisor Portfolio? The answer lies in the fact that the 'Buy Alerts' should be viewed essentially as a starting point in the more comprehensive stock selection decision process. This spreadsheet should be used only as a 'first pass' tool, which determines only if a particular company is worthy of further analysis as a potential future investment. If the total points for a particular company is 7, 8, or 9, then they are a viable candidate for further analysis. Beyond the 'Buy Alerts' spreadsheet, essential further analysis would include calculating return-on-investment potential, analyzing risk factors, and assessing the quality of the company's management. Additionally, valuable insights can be gained from studying a company's website. For example, it is very worthwhile to take about one hour to listen to top management's presentation and to listen to their answers to analysts' questions during their most recent quarterly earnings conference call (archives of the most recent conference call are usually available in the Investor Relations section of their website). It is also helpful to read recent commentary about the company from various stock advisory services (Standard & Poor's, Morningstar, and Argus for example) as well as from websites such as Yahoo! Finance, Seeking Alpha, or even Wikinvest.

I hope both this 'Buy Alerts' form and the additional suggestions for doing your homework on a particular company are helpful. It may sound like a lot of work (and time commitment), but 'doing your homework' prior to making a decision to invest your money is both a wise approach and a worthwhile time investment that will greatly increase the likelihood of achieving exceptional investment returns.

Regards and Godspeed to All,

Jeff

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