- Investment strategies
- Why invest in the stock market?
- Buy and hold or technical analysis? Why you need an investment plan
- Value investing and short selling in volatile markets
- Using technical analysis to support value investing
- Investing in the unexpected
- Franking credits, explained
- What is dividend stripping and is it a sensible strategy?
- Investing in quality IPOs
- How to invest in stocks that benefit from a moving Australian dollar
- Reasons to avoid bonds when interest rates are low
- How value investors use Skaffold
- Quality, growth and value = a winning strategy
- Know your investor type and boost your performance
- Technical + fundamental analysis = better buy and sell decisions
- Fundamental investing
- Value investing and the price earnings ratio
- Intrinsic valuation models and methodology
- Value investments or value traps?
- How to find value stocks in a bull market
- Find value investments in expanding markets
- Why capital raisings struggle to add investment value
- How to value an insurance company
- Top stocks
- 5 qualities of top stocks
- How to find stocks with a competitive advantage
- Why return on equity is the best measure of business performance
- Using cash flow to find value investments
- Finding high quality dividend stocks
- Debt is not always a dirty word
- Why Skaffold share investment software makes sense
- Using economic factors to uncover the best investment options
- How do experts find top stocks to invest in?
- Investing in global stocks
- How to invest in international shares on global stock markets
- Benefits of investing in international shares
Portfolio review checklist
Reviewing your portfolio will ensure your strategy exposes your portfolio to maximum opportunities in the months and years ahead.
In today’s constantly changing world, regular portfolio management and stock analysis is critical. A set and forget approach simply doesn’t cut it.
First consider macro economic conditions
Before rolling your sleeves up to take a closer look at your portfolio and check if you still hold top stocks, first consider the most profitable investment themes of the previous 12 months and decide if they’re likely to continue. Also think about the future directions of the local and international economy, and where the greatest opportunities for growth lie.
Paying attention to what’s happening around you, and keeping your ear to the ground, will help you spot trending investment themes, narrow down your list of investment opportunities to just the very best stocks and ensure you can manage your portfolio with confidence.
Key qualities of top stocks
Understanding what constitutes a top quality stock helps ensure you have a top quality portfolio. At Skaffold, we believe great companies display similar distinguishing characteristics. Stocks that stack up well against key criteria are more likely to withstand financial storms, and will be more worthy of a place in your portfolio.
You want to own businesses that:
• have solid balance sheets
• have good cash flow
• are consistently profitable, and
• have the ability to continue expanding.
Portfolio review checklist
It’s time to pull out each company’s latest annual report and run your ruler over the numbers (Skaffold members just need to login at Skaffold.com). If a company fails more criteria than it passes, then the future may not be very promising and that business could be a drag on your portfolio’s performance.
Here are the key performance criteria you need to check each company against:
Earnings per share are rising
Rising earnings per share are desirable, however they must not be examined in isolation from the other key business drivers such as return on equity and cash flow.
Earnings per share exceed dividends per share
While high dividend stocks are desirable, chasing dividends at the expense of good economics can be a recipe for disaster. If a company consistently pays more out in dividends than it earns, without increasing earnings per share, sooner or later the dividend will be reduced or suspended.
Normalised profits (NPAT) are rising
A company’s reported profit figure includes its regular earnings, plus one-off items that may not recur in the future, such as the sale of an asset or the windfall from a successful lawsuit. Removing abnormal and non-recurring revenues and expenses provides a more sustainable representation of the company’s ongoing profits. If normalised profits aren’t rising, this will have a negative impact on the business’s return on equity and intrinsic value, and ultimately the share price.
The company isn’t constantly undertaking capital raisings
If a company raises additional equity (capital) and then earns a return on that equity that does not exceed the previous return it was earning, then the return on the entire pool of equity is reduced. The company may be growing its absolute profit level, but if the level of profitability as measured by return on equity on each dollar of equity capital is declining, then the company is best avoided. The practice of raising equity capital in the same year as paying dividends is equally questionable. Why raise capital simply to hand some of it straight back?
Return on equity (ROE) is stable or rising
Return on equity measures the profitability of a company by comparing how many dollars were required to produce the company’s profit. It is the return being generated on your equity.
Attractive businesses are able to increase profits each year without the need to raise additional capital or take on debt. These companies produce increasing profitable returns on their equity without increasing risk. You want to own businesses that can generate a return higher than you could earn from a term deposit or bond, and also allow an extra margin for the additional risk. Top stocks are consistently able to generate impressive and rising returns on their equity in excess of 15 per cent.
Debt is low and/or declining
Debt increases the risk profile of a company. It directly impacts the bottom line and requires ongoing servicing. Highly profitable companies are able to increase profits and return on equity while reducing the amount of debt on their balance sheets. Avoid companies with a net debt / equity ratio greater than 40 per cent.
Cash flow is positive
Every business operates to generate cash. The amount of cash generated in a given period is known as operating cash flow. If a company generates plenty of cash, you can be fairly confident your dividend won’t be suspended. In some cases, companies with strong cash flow are also able to use debt wisely by ensuring they retain enough cash to more than cover their interest bills.
Cash flow generated from operations exceeds net profit and is rising
Cash flow generated from operations represents the cash flows from the company’s day-to-day trading activities. Cash inflows can include sales, receipts from debtors, and any other cash revenues. Outflows include all payments related to expenses (usually including interest), payments to creditors, prepaid expenses, and any payments for expenses incurred in previous periods (such as accrued wages). Top stocks consistently generate cash flow from their operations that is higher than net profits. In business cash is king. The more the better!
Intrinsic value of the company has been rising, and is forecast to continue doing so
A company’s intrinsic value represents the value of the business based upon its fundamentals. Earnings, dividends and equity are some of the inputs into Skaffold’s intrinsic value formula. Top stocks are able to increase their intrinsic value year after year. Value investing theory is based on the premise that over the longer term share prices tend to converge with value, so if value is continuing to rise, prices should eventually do the same (provided the price hasn’t already run too far ahead).
Future growth is expected
It’s one thing to identify a great quality and high performing company. Looking in the rearview mirror however will not guarantee a thriving portfolio. Businesses are dynamic. Economic conditions change and impact business models. Consumer sentiment also changes. Companies that fail to adapt to changing conditions can be left behind.
When assessing a company’s future prospects, investigate if the business is in a period of growth. Be cautious of companies whose growth is beginning to slow or stagnate.
Other portfolio management questions
• Is the business of the company unique, or will competitors potentially steal some of its market power?
• Will the businesses benefit from government regulation?
• Have the company’s profits risen in all market conditions, or is revenue susceptible to business cycles?
Qualitative portfolio management
When you buy shares in a listed business, you’re relying on the leaders of that business to operate it with your best interests at heart (most of the time it works out). Understanding a company’s fundamentals is vital in ensuring the business model is sustainable. Monitoring the comments made by management, and their subsequent performance, will give you even greater insight into whether your managers are steering your business in the right direction.
Step 1: Collect Annual Reports and do some reading
Get your hands on as many Annual Reports as you can find and print off the Chairman’s and Managing Director’s report from each. Create two piles, one for the Chairman’s reports and the other for the Managing Director’s. Put the most recent reports at the bottom of the pile, and the oldest on top. Read the reports like you’d read a book, from cover to cover.
Step 2: Investigate
Time to do some thinking… What did management say they were going to do in 2012? By 2013, had they achieved what they set out to do?
How have their views of the business changed? And the competitive landscape? Do the reports mention any ongoing issues? Project delays, debt collection issues and a changing market place are a few things to look out for.
Is the Managing Director who wrote the report in 2010 still writing the report today, or is the company churning through senior management? Changing management styles can severely disrupt the underlying business and impact staff retention.
Finally, follow the transactions of the company’s directors. If you find a situation where you feel the business’s prospects have deteriorated and management are selling their shares, that can only reinforce your analysis. If however you believe the business has bright prospects, management’s decision to sell may be of a personal nature and while it should be investigated, may not necessarily be a reason for alarm.