FA Experts: Calling For Your Help
As many of you know, I focus primarily on technical analysis more than fundamental analysis. It’s time for me to build a strong strategy for fundamental analysis and determining what stocks are worth investing in.

What are your non negotiable financial metrics that have to exist to invest in a company?

Free cash flow positive?
Growing gross/net margin?
Growing EBITDA?
Dividend Payer?
PEG ratio?
Debt vs Asset Ratio?

Would love to hear your thoughts to help me shape my fundamental analysis framework. Thanks everyone!
Dollars and Sense's avatar
For me there are three really important things I looks for.

One is growing Revenues and Free Cash Flow. If those are headed in the right direction that's what I care about. I will figure out if those increasing revenues are sustainable later when looking through their 10k. Its also very important to have both be increasing. Some companies will have growing revenue and stagnant to falling free cash flow, this could mean the company isn't becoming more efficient i.e. bloated and might cause issues later on. The same goes in the reverse. Falling revenues plus growing free cash flow could mean they are losing their competitive advantage and are cutting parts of the business away.

Two is Debt. Total Liabilities - Cash, take that number and compare it to free cash flow. If a company has $100m in total debt - cash and only does $10m in free cash flow that could and probably will prove to be unsustainable. Usually I like to see this number around 3x it means in 3 years time a company can completely pay of its debts provided it maintains its current free cash flow levels.

Three is Total Shareholder Yield. This is the dividend + Buybacks + Debt paydown. If a company doesn't pay a dividend that's fine, but are they buying back shares and paying down debt. Maybe they do pay a dividend but don't buy back shares, great, are they paying down debt. Maybe the company is paying out dividends and buying back shares and is piling on debt to do so. The total shareholder yield has the capacity to tell you all of that.

Of course all of these number need context. That's why its really important to read through things like a 10q/10k/20-f.

Just some quick thoughts. Hope it helps in some way.
Preston | Investor Insight's avatar
@dollarsandsense This helps a lot!!

Where does stock based compensation come into play when comparing revenues and free cash flow position or does it for you?
Dollars and Sense's avatar
@investorinsight to be honest I dont pay close attention to SBC, yeah it can get out of hand and its worth noting but usually I dont pay much mind.
Ben's avatar
Welcome to the slow and boring side of investing.

I look for moats, improving margins, low capex to net income ratios, low debt interest expense to net income, andhigh ROE, And ROI.

Dividends are nice but not a necessity. Decreasing share count is nice too if done properly.

If a company is a small distributor and has enough top line growth and I believe in the story. I look at LTV/CAC, net promoter score, net revenue retention rates.
Preston | Investor Insight's avatar
@rpinvestments How do you determine moat?

Also what is LTV/CAC? and How do you locate a net promoter score for a company?
Ben's avatar
@investorinsight Moat is subjective. But it’s a thing you know when you see. ASML has a moat bc no one else can make EUV lithography. Netflix, prior to everyone else starting a streaming service, had a moat. Google has a search moat.
Life time value to customer acquisition cost. 3is good. 4 is great. It’s life time value of a customer vs marketing cost to get that customer.
Net promoter score is found with google
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Preston | Investor Insight's avatar
@rpinvestments Thank you for this info!

What is a good net promoter score?
Ben's avatar
@investorinsight any time. But put my expert in quotes. Make sure to get many views. NPS range is from -100 to + 100. +50 and above is excellent. $WRBY is 80. $TSLA 97. $LMND 70. $ZM 69. $AAPL 68.

Letting your customers advertise for you helps the margins and leads to satisfied returning customers
Preston | Investor Insight's avatar
@rpinvestments Makes sense!

$ZM looks great from an FA standpoint, but from a TA standpoint it looks real weak.
Ben's avatar
@investorinsight when you focus on FA my goal, is a 5-10 year time horizon. If you do it right, short term TA doesn’t matter. Buying google 10 years ago for 13 or 16 a share doesn’t mean as much when it’s 100 now.
Preston | Investor Insight's avatar
@rpinvestments I hear you but if I can buy Google at 60 instead of 100, it allows for even better compounding!

I quote this often: Use FA to locate your stocks and TA to determine your entries/exits.
Christian's avatar
"Don't fight the Fed", i.e. direction of interest rates because the main competition for stocks is bonds is why that is I believe, is another good fundamental factor.
Christian's avatar
Small cap stocks are more sensitive to interest rates than bigger cap stocks, e.g. Russell 2000 vs S&P 500, generally.
Preston | Investor Insight's avatar
@etfs Agreed! Small caps are great for a buy the dip post recession.
Preston | Investor Insight's avatar
@stockopine @valuabl @rihardjarc Any thoughts on this discussion that you would like to add?

I know each of you do extension fundamental research before initiating positions.
Edmund Simms's avatar
I have two criteria for building a position: First, the stock must be significantly undervalued. Second, it must either increase the expected excess return (above the risk-free rate) of my portfolio, or decrease my portfolio's risk (uncorrelated with what I own).

Within those criteria, I am flexible. I spend most of my time looking at small, crappy, evil-looking companies. They're the ones other people don't want and are most likely to be undervalued.

I'll buy any company that meets my requirements.
Preston | Investor Insight's avatar
@valuabl What constitutes an undervalued stock to you?
StockOpine's avatar
@investorinsight sure. Effectively the companies that we look for, shall display among others the following attributes:

  • Leaders in their industries or disruptors with superior business model,
  • Wide moat which will allow them to retain margins and market position
  • Strong financials

If a company possesses the above attributes and the price meets our hurdle rate, we initiate a position.

Based on the above and touching on the questions raised, free cash flow positive and growing or at least constant margins are a must. Additionally, the company should not be highly levered to minimize any surprises under turbulent times.
Preston | Investor Insight's avatar
@stockopine Thank you for this. How do you determine moat since most of that seems very subjective?
StockOpine's avatar
@investorinsight correct. That’s subjective. Few examples are, Growing market shares, higher margins than peers showing cost efficiencies, high switching costs etc.
Edmund Simms's avatar
@investorinsight To me, a stock is undervalued if the current price is less than my estimate of the intrinsic value in 90% of future scenarios.

I value the company by doing my best to forecast and discount future free cash flows. Then I do a sensitivity test of this valuation by assuming that future values will come from a distribution around my estimate. I run many simulations and build a distribution of potential intrinsic values to which I compare the price.

If 90% of the simulated values exceed the price, assuming I haven't made glaring mistakes or missed something obvious, the stock is likely undervalued.

Most will think this approach is too conservative and that I will miss out on many investments. This is true. It is conservative and I will pass on the vast majority of stocks I look at. But there are 50,000 public companies out there and I am betting on my ability to find some that meet my criteria.

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