Hello everyone,
Since my question about your interest in such a contribution has received a very positive response, here is the promised presentation of my stock/company valuation with all the key figures used. Enjoy!
Disclaimer: This is my personal investment strategy for my own investment horizon. This strategy is not set in stone and can change at any time. I hope you can take something useful from this for your own strategy, but I do not recommend anyone to copy individual key figures or similar without doing their own research. Many key figures only make sense when viewed together with other key figures! AVG stands for "Average" in the following. CAGR stands for "Compound Annual Growth Rate". In addition, not every key figure makes sense for every type of company/sector, which is why I use some key figures and a points system that balances this out somewhat. ⚠️
I really appreciate your feedback, sit back, the post has gotten a bit longer.
In order to better understand the selection of my key figures, you first need a brief Review of my investment philosophyI look for what I consider to be the best companies, so-called compounders, with which I want to outperform the market in the long term. I do not rely on unprofitable growth speculation, do not try to chase trends and have relatively little faith in ETFs. Instead, I look for the most efficient and profitable companies with stable growth and a competitive advantage, and deliberately only invest in certain sectors. (More on this in one of my previous posts)
In contrast to the great presentation of his stock picks by @RealMichaelScott (Thanks for the hint@suscimer), my analysis does not start with the "idea" or the business model, but quite dryly with the key figures. I assign points for each phase and each key figure, which then result in a score, of which a company must achieve a certain number of points in order to move on to the next phase. This means that I only take a closer look at a company (phase #3) when the hard facts fit - otherwise, what's the point of looking at the business model first if the figures don't fit afterwards. 😉
My analysis can be divided into several phases, which I will go through after the following overview. I try to explain my approach and the meaningfulness of each key figure as simply and compactly as possible. I have also indicated my preferred data source for each key figure.
Phase #1 (Part 1 - this article)
- Margins
- Gross Margin 10Y AVG (gross margin)
- Operating Margin 5Y CAGR (EBIT margin)
- FCF Margin 5Y AVG (Free Cash Flow Margin)
- Profitability or efficiency
- Debt / Ebitda
- ROIC 5Y AVG
- WACC 5Y AVG
- ROA 10Y AVG
- ROCE 5Y AVG
- Revenue growth
- Revenue 10Y CAGR
- EPS 5Y CAGR
- FCF 5Y CAGR
- Dividends 5Y CAGR
Phase #2 (Part 2 - Coming soon)
- Moat + ESG
- Morningstar MOAT Rating
- Morningstar ESG Risk
- Compounder?
- Gurufocus Profitability Rank
- Mohanram G-Score
Phase #3 (Part 2 - Coming soon)
- Understanding the business model
- Comparison with the competition
- Subjective assessment
--> What remains after this: Inclusion in my "Investable Universe"
Phase #4 - Evaluation (Part 3 - contribution desired?)
- FCF Yield
- Valuation Framework
- Comparison of 5Y FCF CAGR with required future 5Y FCF CAGR to achieve the market P/E ratio
- GF Fair Value
- Morningstar Fair Value
Let's start with phase #1 and the main content of this article.
First, I will look at three different key figures relating to the "margin" of a company.
The Gross Margin is the percentage of sales that remains after a company's direct costs (i.e. costs for the production or sale of goods or services) have been deducted. It is calculated by dividing gross profit by sales. A gross margin of 60% means that for every dollar of revenue generated, the company keeps $0.6 and the remaining $0.4 goes to costs incurred. The gross margin is an important key figure for assessing the profitability of a company, which Terry Smith also attaches great importance to. The higher it is, the more capital a company retains for use elsewhere. I look at the average over the last 10 years in order to compensate for major fluctuations and obtain valid results. Buffett is also convinced that good companies achieve consistently higher margins, as a lasting competitive advantage leads to a high gross margin.
The higher the gross margin, the better. In my valuation I would like to see at least 50% gross margin (1 point), preferably >60% (2 points) with >70% (3 points) being the maximum possible score for this metric. [Good source for gross margin: https://www.gurufocus.com/term/grossmargin/ADBE/Gross-Margin-Percentage/Adobe]
For the second key figure, the operating margin, better known as the EBIT margin or return on sales
(operating margin) I do not look at the average over the last 10 years, but at the growth over the last 5 years in order to be able to make a statement as to whether the company has been able to increase its efficiency and convert sales into profits more effectively. If a company loses its competitive edge, the gross margin and EBIT margin usually fall well before sales decline - which means that a "value trap" can be avoided if these are closely monitored. A widening margin, on the other hand, is always a good sign for the company's development. The operating margin measures how much profit a company makes on one dollar of sales after paying all variable production costs such as wages and raw materials (before paying interest and taxes) and thus provides information about the efficiency of profit generation. It is calculated by dividing the operating result (EBIT) by turnover.
A 5Y CAGR > 0 is therefore a good sign in my model and gives 2 points, negative margin growth gives between 1.5 and 3.5 points, depending on the level. [Good source for EBIT margin growth: https://www.gurufocus.com/term/operatingmargin/ADBE/Operating-Margin-Percentage/Adobe]
Free cash flow, i.e. the amount available to a company after it has paid all its expenses and made its long-term capital investments, is very important in my general view of shares. In my opinion, there is nothing more important.
Therefore, the FCF margin (free cash flow margin) should not be missing in my model. It compares the free cash flow with the turnover of a company (operating cash flow - CAPEX divided by turnover). In general, an FCF margin of 10-15% can be seen as a rough boundary between a capital-efficient and a capital-intensive company. Of course, this does not mean that all companies with low FCF margins are bad, but I prefer companies with high FCF margins, as the low capital intensity makes it easier to scale a company.
In my model, an FCF margin >10% gives two points, >15% three points and >20% four points. A margin <10% a deduction of one point. [Good source for the FCF margin: https://www.gurufocus.com/term/FCFmargin/ADBE/FCF-Margin-Percentage/Adobe]
Now we come to the section "Profitability and efficiency"
As I wanted to classify the key figure debt / EBITDA in one of the three categories, I have put it here, although it provides little information on efficiency. Nevertheless, in my opinion, it is essential to look at debt. I use the current Debt-to-EBITDA ratio. It measures a company's ability to pay its debts. A high ratio means that a company is spending more time paying off its debts. According to Joel Tilinghast, a ratio of more than 4 is considered scary. I generally take an even more critical view of debt.
Therefore, in my view, a debt / EBITDA > 3 results in a deduction of one point, between 2 and 3 there is one point, between 1 and 2 two points and less than 1 three points. [Good source for debt-to-EBITDA: https://www.gurufocus.com/term/debt2ebitda/ADBE/Debt-to-EBITDA/Adobe]
The ROIC (return on invested capital) assesses the efficiency of a company in allocating capital and provides information on how well a company uses its capital to generate profits by reinvesting it. It is calculated by dividing the net profit after tax (NOPAT) by the invested capital. However, it only makes sense to look at ROIC if the weighted average cost of capital (WACC) is compared with the weighted average cost of capital (WACC). A company creates value when its ROIC exceeds its WACC. An ROIC of 50% means that if a company reinvests $1 in one year, it will earn $1.5 in the following year. So I look at the difference between the 5Y AVG ROIC and the 5Y AVG WACC of a company.
The higher this difference is, the more likely it is that the company will achieve sustainable long-term value creation.
A ROIC-WACC > 15% gives 3.5 points, >10% 2.5 points, greater than 5% 1.5 points, greater than 0% 0.5 points.
[Good data source for ROIC 5Y AVG: https://www.financecharts.com/stocks/ADBE/value/roic, for WACC 5Y AVG (calculate quotient yourself): https://www.gurufocus.com/term/wacc/ADBE/WACC-Percentage]
The ROCE (return on capital employed) is the next underestimated key figure with similar significance. In order to save a little paperwork, I will insert a great explanation in the article by @RealMichaelScott . (https://getqu.in/mNKUXj/wLIvk0/)
For me, ROCE is a killer criterion. Companies with a 5Y Average <15 kommen nicht in mein Depot. Ein ROCE >=15 give 1.5 points, but a ROCE of at least 20 (3 points) is preferred, even better >25 (3.5 points).
[Good data source for ROCE 5Y AVG (calculate quotient yourself): https://www.gurufocus.com/term/ROCE/ADBE/ROCE-Percentage/Adobe]
The final indicator for assessing the company's efficiency is the ROA (Return on Assets) or the return on assets. As the name suggests, it looks at profitability in relation to total assets and therefore assesses whether a company is using its assets efficiently to generate a profit. A higher ROA means that a company can manage its balance sheet more efficiently and productively. A low ROA is an indication of a poor business model or a highly competitive industry. ROA is the overall view above the two lower ROIC and ROCE and a bit double-doubled :D But double is better - once included I didn't want to remove it, ROC is better. In contrast to ROCE and ROIC, the 10Y AVG is considered in order to take a longer time horizon into account.
For this reason, the ROA 10Y AVG itself only gives 1.5 points at > 20%, 1 point at > 15% and 0.5 points at > 10%. If the current ROA is greater than the 10Y AVG ROA, an extra 2 points are awarded here, as this indicates that the company is currently in good shape.
[Data source ROA 10Y AVG (Med): https://www.gurufocus.com/term/ROA/ADBE/ROA-Percentage/Adobe]
The last part of phase 1 deals with "Growth" (growth).
The 10Y CAGR of sales (revenue) should hopefully be familiar to everyone and needs no further explanation. It must be positive and as high as possible, why should we invest in a company that is losing revenue? A 10Y CAGR > 15% gives 2.5 points, > 12% 2 points, > 8% 1 point and > 5% 0.5 points. [Data source Revenue 5Y CAGR: https://www.financecharts.com/stocks/ADBE/summary/revenue-ttm-cagr]
The second important and well-known key figure is the 5Y EPS CAGR. The average growth in earnings over the last 5 years should also be positive. A value >15% gives 2.5 points, >12% 2 points, >8% 1.5 points and 5% 0.5 points.
[Data source EPS 5Y CAGR: https://www.financecharts.com/stocks/ADBE/income-statement/eps-diluted-cagr]
A somewhat less used metric in the evaluation of a company's growth is the 5Y FCF CAGRi.e. the 5-year average free cash flow growth. Since I believe that FCF is the most important characteristic of a company and the stock price follows FCF/share over the long term, FCF growth is an important part of valuation.
The higher the FCF growth, the better. Growth >18% gives 3.5 points, >15% 3 points, >12% 2.5 points and >8% 1.5 points.
Now all that is missing is the 5Y CAGR of the dividend. However, I do not look at the amount of dividend growth, but only at the fact that the FCF 5Y CAGR is greater than the Dividend 5Y CAGR, as in my opinion a dividend should be paid out of the free cash flow. As you can see from my investment philosophy, a dividend is absolutely not a must criterion for me, but it is "nice to have". If the company does not pay a dividend, that is also not a problem for me. If the 5Y FCF CAGR > the 5Y dividend CAGR, another 1.5 points are added.
[Data source FCF 5Y CAGR: https://www.financecharts.com/stocks/ADBE/growth/free-cash-flow-cagr]
Result:
At the end of phase #1 I now have an initial score, which consists of the sum of the points achieved and can reach a maximum of 35. The points from "Margin" and "Profitability / Efficiency" are added together to give a "Quality" score.
Phase #2 is reached by all those shares whose Phase 1 score is >= 18, whose Quality score is at least 13 and whose Growth score is at least 2 (no negative growth).
Phew, that was a lot of input. Since I realized during the writing process, which took much longer than I had originally planned🥵, that I would go beyond the scope if I put phases 2-4 here, I will put them in separate posts - only if you want me to, of course 🙂
As an outlook on phase #3 I can warmly recommend points 1) and 2) of the aforementioned post by @RealMichaelScott https://getqu.in/mNKUXj/fvH5yO/ warmly recommend.
Thanks for your feedback, I hope you enjoyed the post!
❤
(Please excuse me if I sometimes mixed up the ROA or the like, I've been traveling a lot in English for the last half year. :D)
The Simpson GIF especially for @Simpson
sources (besides those mentioned in the text):
https://www.investopedia.com/terms/g/grossmargin.asp
https://www.investopedia.com/terms/o/operatingmargin.asp
https://einvestingforbeginners.com/fcf-margin-formula-roic/
https://www.investopedia.com/terms/r/returnoninvestmentcapital.asp
No investment advice
