See for an example Equity Research report on Voltas by Morgan Stanley
http://www.voltas.com/corporate/reports/MorganStanley_July%2024,%202007.pdf
Showing posts with label Analytical methods. Show all posts
Showing posts with label Analytical methods. Show all posts
Monday, December 3, 2007
Tuesday, October 16, 2007
Piotroski Method
Professor Joseph Piotroski of the Graduate School of Business, Chicago, came out with a much simplified system of fundamental analysis based on the last two years' financial statements that can be used by active investors for picking value stocks with a one- or two-year horizon.
There are nine steps or tests in the model. The stock gets a point for every step/test it passes and a zero for any step it fails. Betting on stocks that score eight or nine points is recommended.
Test 1: Positive net income - Net income, the bottomline after-tax profits, is the simplest measure of profitability. Score a point if the latest year's net income is positive; otherwise, a zero.
Test 2: Positive cash flow - Cash flow is arguably a better profitability measure than net income. Cash flow measures the money that actually moved into or out of a firm's bank accounts. Add one point if the latest year's operating cash flow is positive.
Test 3: Earnings quality - Many experts compare net income to operating cash flow to detect potential accounting manipulations. Cash flow normally exceeds net income because depreciation and other non-cash expenses reduce income, but not cash flow. Award one point if the latest year's operating cash flow exceeds the current year's net income.
Test 4: Decreasing debt - Piotroski rewards companies that are reducing their debt levels. He uses 'financial leverage,' which is total debt divided by total assets, to quantify debt. Award one point if the most recent annual figure is less than the value of the preceding year.
Test 5: Increasing working capital - Working capital, the difference between current assets and current liabilities, measures the cash available to run the business.
Piotroski prefers stocks with increasing working capital. Current ratio, which is current assets divided by current liabilities, is the usual metric for measuring working capital. Award one point if the most recent annual figure exceeds the preceding year's number.
Test 6: Increase in asset turnover - Award one point if the most recent annual asset turnover (sales revenue divided by total assets) exceeds the year-ago figure.
Test 7: Growing profitability - Return on assets measures overall profitability by comparing net income to total assets (net income divided by total assets). Award one point if the most recent annual ROA exceeds the year-ago figure.
Test 8: Issuing stock - Piotroski prefers companies that did not issue more stock to raise capital or to fund acquisitions. Award one point if the most recent number of total shares outstanding is equal to, or less than, the year-ago figure.
Test 9: Competitive position - Increasing competition often forces companies to cut prices, and hence profit margins, to maintain sales. Conversely, rising profit margins signal an improving competitive position. Award one point if this year's gross profit margin exceeds the year-ago number.
Piotroski recommended the use of this method on the lowest quintile of shares on New York Stock Exchange
Piotroski's scoring system is easy to use. It was found to be effective over the period from 1976 to 1996 by Piotroski himself.
There are nine steps or tests in the model. The stock gets a point for every step/test it passes and a zero for any step it fails. Betting on stocks that score eight or nine points is recommended.
Test 1: Positive net income - Net income, the bottomline after-tax profits, is the simplest measure of profitability. Score a point if the latest year's net income is positive; otherwise, a zero.
Test 2: Positive cash flow - Cash flow is arguably a better profitability measure than net income. Cash flow measures the money that actually moved into or out of a firm's bank accounts. Add one point if the latest year's operating cash flow is positive.
Test 3: Earnings quality - Many experts compare net income to operating cash flow to detect potential accounting manipulations. Cash flow normally exceeds net income because depreciation and other non-cash expenses reduce income, but not cash flow. Award one point if the latest year's operating cash flow exceeds the current year's net income.
Test 4: Decreasing debt - Piotroski rewards companies that are reducing their debt levels. He uses 'financial leverage,' which is total debt divided by total assets, to quantify debt. Award one point if the most recent annual figure is less than the value of the preceding year.
Test 5: Increasing working capital - Working capital, the difference between current assets and current liabilities, measures the cash available to run the business.
Piotroski prefers stocks with increasing working capital. Current ratio, which is current assets divided by current liabilities, is the usual metric for measuring working capital. Award one point if the most recent annual figure exceeds the preceding year's number.
Test 6: Increase in asset turnover - Award one point if the most recent annual asset turnover (sales revenue divided by total assets) exceeds the year-ago figure.
Test 7: Growing profitability - Return on assets measures overall profitability by comparing net income to total assets (net income divided by total assets). Award one point if the most recent annual ROA exceeds the year-ago figure.
Test 8: Issuing stock - Piotroski prefers companies that did not issue more stock to raise capital or to fund acquisitions. Award one point if the most recent number of total shares outstanding is equal to, or less than, the year-ago figure.
Test 9: Competitive position - Increasing competition often forces companies to cut prices, and hence profit margins, to maintain sales. Conversely, rising profit margins signal an improving competitive position. Award one point if this year's gross profit margin exceeds the year-ago number.
Piotroski recommended the use of this method on the lowest quintile of shares on New York Stock Exchange
Piotroski's scoring system is easy to use. It was found to be effective over the period from 1976 to 1996 by Piotroski himself.
Graham-Rao Method
The model by Benjamin Graham, who is credited with systematising fundamental analysis, recommended for use by conservative investors.
Accordng to Graham's stock-selection criteria, the company must have an adequate size (Rs 100 crore sales may be taken as adequate size for Indian companies) and a strong financial condition.
To satisfy this criterion, the current assets should be at least twice that of current liabilities and the total debt-equity ratio should not be greater than 1:1.
The company should have paid dividends and earned profits for the last 10 years.
There should be a growth in earnings per share of 10 per cent per annum over the last seven years.
The current price should not exceed 20 times the average EPS in the last seven years for companies with past seven-year growth higher than 20 per cent. For companies with past growth rates between 10 and 20 percent per annum, the multiplier has to be the growth rate itself.
The current price should also not be more than 1.5 times the book value last reported.
These prescriptions by Graham require 10-year data to pick stocks. But the method is unambiguous and uses a limited number of ratios.
Investors may complain about the 10-year data requirement; but they have to keep in mind that their hard-earned money has to be protected by committing it to companies with a good past record.
Accordng to Graham's stock-selection criteria, the company must have an adequate size (Rs 100 crore sales may be taken as adequate size for Indian companies) and a strong financial condition.
To satisfy this criterion, the current assets should be at least twice that of current liabilities and the total debt-equity ratio should not be greater than 1:1.
The company should have paid dividends and earned profits for the last 10 years.
There should be a growth in earnings per share of 10 per cent per annum over the last seven years.
The current price should not exceed 20 times the average EPS in the last seven years for companies with past seven-year growth higher than 20 per cent. For companies with past growth rates between 10 and 20 percent per annum, the multiplier has to be the growth rate itself.
The current price should also not be more than 1.5 times the book value last reported.
These prescriptions by Graham require 10-year data to pick stocks. But the method is unambiguous and uses a limited number of ratios.
Investors may complain about the 10-year data requirement; but they have to keep in mind that their hard-earned money has to be protected by committing it to companies with a good past record.
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