Introducing The Investing Engineer PH’s Value Screen Scorecard
After reading and learning a lot of Value Investing strategies and tips from numerous books, blogs and tutorial courses, I decided to combine all the knowledge I learned to make a Value Screen Scorecard which I’ll be using in my personal investments and in this blog.
The reason for this scorecard is to quickly identify the companies that may be worth investigating at. Not only will it help you find good undervalued stocks, it will also help you to quickly screen out low quality and overvalued stocks.
In this post, I’ll briefly discuss the financial metrics I used to give you an idea how it works and how you can apply it in your investing decisions.
So let’s begin!
The Investing Engineer PH’s Value Screen Scorecard
The scorecard consists of financial metrics I handpicked from different Value Investing books, courses and from famous investors like Ben Graham and Warren Buffett. From there, I modeled a proprietary scoring and ranking system.
The scorecard is divided into 5 parts and sums up to 100 points. The 5 parts and the scoring mechanics are as follows
- Profitability & Growth – 30 points
- Financial Health – 25 points
- Quality – 20 points
- Dividend Assessment – 10 points
- Valuation – 15 points
The Profitability & Growth measures the company’s profits and its ability to grow. This is important since a company that consistently grows its profits will be able to create value to shareholders.
Profitability & Growth: Total of 30 points
This consists of;
- Market Capitalization (2 points) – Small Cap stocks are very volatile and thus have a high risk that’s why traders love them. Sometimes, you can make up to 50% returns in a day in just one trade. However, I avoid small cap stocks and only invest in Mid and Large Cap.
- Profit Margins (8 points) – I like companies with very high margins because it’s a sign that a company has some form of competitive advantage working on its favor. Margins differ by sector but as general rule, Gross Profit Margin should be 40% or higher and both Operating Profit Margin and Net Profit Margin should be 20% or greater.
- Net Income Growth (2 points) – Should have 5 years of consistent growth.
- Revenue Growth (2 points) – Should have 5 years of consistent growth.
- Cash & Cash Equivalents Growth (2 points) – Should have 5 years of consistent growth.
- Operating Cash Flow Growth (2 points) – Should be stable and have 5 years of consistent growth.
- Earnings Per Share Growth (4 points) – Should have 5 years of consistent growth and long-term growth rate should be 10% or greater.
- Return On Equity (6 points) – Good companies generate high returns on equity. 12% or greater is what I like to look for.
- Return On Invested Capital (2 points) – Just like ROE, I like companies that generate high returns on invested capital. 12% or greater is also what we need to look for.
The Financial Health scores a company based on the ability to meet its short-term and long-term obligations by assessing specific balance sheet metrics concerning its cash, debts, inventories, payable and receivables.
Financial Health: Total of 25 points
This consists of;
- Debt Settlement Capacity (9 points) – DSC is a collection of financial metrics to identify a company’s ability to pay long-term debts. This includes Current Ratio (1.50 or greater), Debt To Equity Ratio (less than 0.50), Interest Coverage Ratio (15 or greater), Working Capital To Total Debt Ratio (0.20 or higher) and comparison of FCF to Long-Term Debt (3xFCF should be greater than long-term debt).
- Cash To Current Assets (4 points) – Adequate supply of cash allows a company to settle debts, buy inventory or purchase investments. Too much cash on the other hand is a sign of management’s ineffectiveness in utilizing those excess cash. By comparing it to the Current Assets, I can determine how much cash is represented by the Current Assets. I like companies with a ratio equal or less than 0.40 but not greater than 0.60.
- Inventory To Current Assets (4 points) – Inventory should be sufficient but too much could lead to higher storage costs and risks of loss and unsold inventories. (Criteria same as Cash To Current Assets).
- Accounts Receivable To Current Assets (4 points) – Accounts Receivable not collected may turn into bad debts and may contribute to the loss of profits over the long-term (Criteria same as Cash To Current Assets).
- Accounts Payable To Current Assets (4 points) – A company should have payable liabilities that are manageable because if it can’t pay off short-term obligations, it may have to sell assets or worse declare bankruptcy (Criteria same as Cash To Current Assets).
Quality: Total of 20 points
This consists of;
- Piotroski F-Score (10 points) – This helps me differentiate high quality to low quality companies. It also gives me clear signs of a turnaround company.
- Altman Z-Score (10 points) – This is a bankruptcy prediction model. It helps me spot low quality companies and turnarounds.
Dividend Assessment checks to see if the stock also qualifies as a dividend stock. Besides capital appreciation, dividends also play a huge role in the compounding effect so this should also be considered in looking for a good stock.
Dividend Assessment: Total of 10 points
This consists of;
- Dividend Yield (5 points) – Should be at least 4%.
- Dividend Payout Ratio (5 points) – Dividends should be sustainable in relation to a company’s earnings. One rule I follow is to find stocks with a DPR of at least 20% but not greater than 60%.
Valuations will tell us if a stock is undervalued or not based on PEGY Ratio.
Valuations: Total of 15 points
This consist of;
- PEGY Ratio (15 points) – PEGY Ratio is almost the same as the PEG Ratio. The only difference is that we add the Dividend Yield to the EPS Growth Rate. I look for stocks with PEGY Ratios of less than 1.
How Are The Scores Ranked
The scores are ranked as follows;
- Rank 1 (100 to 81 points): I would buy a stock if it’s ranked #1 because stocks in this rank are more likely undervalued and the underlying business behind it is of high growth and excellent quality. Stocks that fall in this rank are excellent investments
- Rank 2 (80 to 61 points): Still a good stock to buy. It might have some form of weakness in its profitability, growth, financial health or other factors. Or it might just be overvalued. Stocks that fall in this rank are good investments.
- Rank 3 (60 to 41 points): I would place stocks in this rank at my watch list to study even further and to monitor the performance. I might also buy stocks in this rank if the Valuations say that it’s undervalued. Stocks that fall in this rank are mostly average investments.
- Rank 4 (40 to 21 points): I’ll avoid stocks in this rank as of now. Stocks that fall in this rank should be carefully analyzed to know where the weak areas are. These companies are usually overvalued, have weak balance sheets but has stable and strong profits or whichever the case may be. They might also qualify as turnaround companies so this warrants more investigation.
- Rank 5 (20 to 0 points): Totally avoid for now.
Keep in mind that valuations is more on understanding the reasons behind the results and not something to be followed blindly. So I encourage you to carefully look at the underlying reasons of a stock’s strong and weak points.
I believe that the financial metrics used in this scorecard are vital in understanding a company on an investor’s point of view.
So what do you think? I want to hear your thoughts. Kindly share them on the comments section below.
P.S. I’ve initially laid out the scoring mechanics but the detailed scoring (when to get a minus or a lower score) is proprietary as of now. This scoring criteria would be tested personally by me using my own money to validate the strategy in real world scenario.