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Stock Analysis Gets Easier
The last thing most of us want to do is
spend our days analyzing financial statements, even though we know it
would help us pick better stocks. If you’re in that category, here’s
some good news: ProfitCents (www.profitcents.com)
will do the heavy lifting for you.
Run by Raleigh, NC-based Sageworks,
ProfitCents is a free service that, except for banks and other financial
institutions, analyzes just about any company’s financial condition.
Sageworks’ business is providing financial analysis reports to
accountants and banks, and ProfitCents applies the same analysis tools
to publicly traded stocks.
Financial Grades
ProfitCents
grades each company in five categories: liquidity, profits and
profitability, borrowing, assets, and value. Except for value, these are
the same factors that many professionals scrutinize to predict whether a
firm is likely to outperform or underperform market expectations when it
next reports its quarterly results. That’s important information because
stocks generally move up when they report quarterly results that beat
analysts’ forecasts and down if they don’t.
The grades for each category run from one
to five stars, where five is best. ProfitCents uses the most recent
financial statements filed with the Securities and Exchange Commission
(SEC).
Grades
Can Give You Edge
I ran a quick and admittedly unscientific analysis that convinced
me that ProfitCents’ analysis are worth your attention. Last Wednesday,
I listed 16 companies that reported quarterly results that morning and
had clearly outperformed or underperformed market expectations. Nine had
beat analysts’ forecasts and seven had fallen short.
For each company, I checked the
ProfitCents’ score based on each firm’s previous quarterly data (usually
September ’08) compared to the year-ago figures. I averaged the scores
for each of the five categories for each company. The scores for the
nine stocks that beat forecasts averaged 3.0 stars compared to 2.4 for
stocks that fell short. An easy modification to the “borrowing” score
that I’ll describe later brought the average score up to 3.2 for the
nine winners.
While the difference between winners and
losers (3.2 vs. 2.4) may not sound like much, in my experience, it can
give you an edge in picking the right stocks.
Here’s a rundown on the five categories.
ProfitCents gives you the option of comparing the most recently reported
fiscal year to the prior year, or the most recently reported quarter to
the prior quarter, or to the year-ago quarter. For best results, always
compare the most recently reported quarter to the year-ago quarter.
Liquidity
Evaluates the ratio of cash and items easily
converted to cash such as accounts receivables to current liabilities,
and compares the latest ratios to conditions at the end of the year-ago
quarter. Given that corporate credit is currently very tight, low
scoring stocks in this category should be approached with caution,
regardless of how they rank in the other categories.
Profits & Profit Margins
Compares gross margins and net profit margins to the year-ago quarter.
Gross margins measure profits before
accounting for overhead, marketing, research and development, interest
and taxes. Rising gross margins tell you that a firm is either reducing
production costs or raising prices. Conversely, deteriorating margins
say that either production costs are increasing and the firm can't raise
prices proportionally, or that it is cutting prices in an attempt to
maintain market share.
Net profit considers all costs. Falling net
profits may signal that administrative and marketing expenses are rising
faster than sales, signaling future that the firm is struggling to meet
sales goals.
In my checks, Profits & Profit Margins was
the most significant indicator. The nine outperforming stocks
averaged a 4.1 score vs. 2.1 for the underperformers.
Borrowing
Evaluates whether a firm is using its borrowed
funds to increase profits. That is, if debt ratios (debt/equity and
debt/assets) increase, ProfitCents wants to see a corresponding increase
in net profits. That makes sense for firms that use debt to finance
continuing operations and/or growth. But ProfitCents fails to
discriminate between those firms and cash-rich companies that carry only
incidental debt.
For instance, due to minor changes in
insignificant items, ProfitCents rated Google at only one-star for
borrowing, even though Google carries no real long-term debt. To avoid
such incongruous ratings, scroll down to the Balance Sheet Data section
and award an automatic five-star rating to stocks whose cash in the bank
exceeds total liabilities.
Assets
Assets include buildings, machinery, real estate as well as intangible
items such as goodwill. ProfitCents believes that if total assets
increase, so should profitability. Thus, it awards high scores to firms
that increased profits faster than assets vs. year-ago and vice versa.
Although the differences weren’t as pronounced as for the other
categories, firms that beat market expectations outscored firms that
didn’t (2.1 to 1.6).
Value
Compares the stock price to the value of its estimated future cash
flows; and then compares that ratio to other stocks in the same
industry. While you wouldn’t think that valuation would matter for my
short-term tests, in fact, it did. Outperforming stocks were relatively
undervalued, scoring 3.9 on average vs. 2.4 for underperforming stocks.
Not
Holy Grail
I evaluated ProfitCents’ ratings strictly for their power to
predict whether a stock is likely to exceed or fall short of current
quarter analysts’ forecasts. From that perspective, the ratings showed
promise. That said, ProfitCents’ ratings are not the Holy Grail.
Consider them another tool to add to your stock analysis toolbox.
published 2/1/09 |
