Dr Vijay Malik

The Final Checklist for Buying Stocks Criteria Value Remarks FINANCIAL ANALYSIS 1 Sales growth CAGR >15% for last 7-10 years Growth should be consistent year on year. Ignore companies where sudden spurt of sales in one year is confounding the 10 years performance. Very high growth rates of >50% are unsustainable. 2 Profitability NPM >8% Look for companies with sustained operating & net profit margins over the years 3 Tax payout >30% Tax rate should be near general corporate tax rate unless some specific tax incentives are applicable to the company. 4 Interest coverage >3 5 Debt to Equity ratio < 0.5 Look for companies with D/E ratio of as low as possible. Preferably zero debt 6 Current ratio >1.25 7 Cash flow CFO > 0 Positive CFO is necessary. It’s great if CFO meets the outflow for CFI and CFF 8 Cumulative PAT vs. CFO cPAT ~ cCFO Cumulative PAT and CFO are similar for last 10 years VALUATION ANALYSIS 1 P/E ratio < 10 Such companies provide good margin of safety 2 P/E to Growth ratio (PEG ratio) < 1 3 Earnings Yield (EY) > 10 year G-Sec yield EY should be greater than long term government bond yields or bank fixed deposit interest rates 4 P/B ratio < 1 However, I find P/B ratio irrelevant for sectors other than financial services 5 Price to Sales ratio (P/S ratio) < 1.5 James O’Shaughnessy: Buy if P/S ratio is < 1.5 and sell if >3 6 Dividend Yield (DY) > 0% Higher the better. DY of >5% is very attractive. However, do not focus a lot on DY for companies in fast growth phase BUSINESS & INDUSTRY ANALYSIS 1 Comparison with industry peers Sales growth > peers The Company must show sales growth higher than peers. If its sales growth is similar to peers, then there is no Moat 2 Increase in production capacity and sales volume Production capacity & sales volume CAGR ~ Sales CAGR Company must have shown increased market penetration by selling higher volumes of its product/service 3 Conversion of sales growth into profits Profit CAGR ~ Sales CAGR A Moat would result in increasing profits with increasing sales. Otherwise, sales growth is only a result of unnecessary expansion or aggressive marketing push, which would erode value in long term 4 Conversion of profits into cash cPAT ~ cCFO If cPAT >> cCFO, then either the profits are fictitious or the company is selling to any John Doe for higher sales without having the ability to collect money from them 5 Creation of value for shareholders from the profits retained Increase in Mcap in last 10 yrs. > Retained profits in last 10 yrs. Otherwise company is destroying wealth of shareholders MANAGEMENT ANALYSIS A) Subjective parameters 1 Background check of promoters & directors Web search There should not be any information questioning the integrity of promoters & directors 2 Management succession plans Good succession plan should be in place Salary being paid to potential successors should be in line with their experience B) Objective Parameters 3 Salary of promoters vs. net profits No salary increase with declining profits/losses promoter should not have a history of seeking increase in remuneration when the profits of the company declined in past 4 Project execution skills Green/brownfield project execution Company should have shown good project execution skills with cost and time overruns. Exclude capacity increase by mergers & acquisitions. 5 Consistent increase in dividend payments Dividend CAGR > 0 Dividends should be increasing with increase in profits of the company 6 Promoter shareholding > 51% Higher the better 7 Promoter buying the shares Insider buying ++ If promoter of a company buys its shares, investors should buy too 8 FII shareholding ~ 0% the lower the better OTHER BUSINESS PARAMETERS 1 Product diversification Pure play Company should be either a pure play (only one business segment) or related products. Pure play model ensures that the management is specialized in what they are doing. Entirely different unrelated products/services are a strict NO. An investor should rather buy stocks of different companies, if she wants such diversification. 2 Govt. influence No govt. interference in profit making No cap on profit returns or pricing of product. No compulsion to supply to certain clients. Margin of Safety MoS in Purchase Price Earnings Yield (EY) EY > 10 Yr G-Sec Yield Higher the EY than 10 Yr G-Sec Yield, the better MoS in Business Model Self Sustainable Growth Rate (SSGR) SSGR > Achieved Sales Growth Rate Higher the SSGR than achieved Sales Growth, the better Free Cash Flow (FCF) FCF/CFO >> 0 Higher the FCF as proportion of CFO, the better

by sanjiv