With the market slowing down, it’s time to start paying attention to fundamentals, especially, financial strength. Firms strong in that department will be better equipped to deal with business slowdowns than those that aren’t.
Here are five quick tests that you could use to evaluate your stocks financial strength, which I call “fiscal fitness.” I’ll describe the tests using data from “Seeking Alpha,” but you may find the same information on other sites.
I’ll check the scores for Delta Airlines (ticker: DAL), General Motors (GM), Microsoft (MSFT), Shopify (SHOP) and Tesla (TSLA). To start, from the Seeking Alpha home page, enter a ticker symbol; click on “Financials,” and then select “Overview.” Once there, you can select the same page for other stocks by simply entering a new ticker in the top Search window.
We’ll start by checking profitability.
Profitable firms are best able to self-fund growth. Use profitability gauge Return on Assets (ROA), which compares net income to total assets. Positive values reflect positive earnings and vice versa. Score one point for ROAs above 10, and subtract one point for negative ROAs. Here are the ROA and point values for each stock:
Delta: -10% = -1; General Motors 3% = 0; Microsoft 14% = 1; Shopify 3% = 0; Tesla: 3% = 0.
Assets vs. liabilities?
Use the Current Ratio (current assets divided by current liabilities) to determine if a firm has enough current assets (cash, inventories & receivables) to pay current liabilities (payables). Ratios are above one when assets exceed liabilities, and vice-versa. Score one point for ratios above 2.0, and subtract one for ratios below 1.0.
Delta: 0.9= -1; General Motors 1.1%= 0; Microsoft 2.3% = 1; Shopify 17% = 1; Tesla: 2% = 0.
Bookkeeping rules sometimes make firms appear profitable when in fact; cash is flowing out, rather than into their bank accounts. “Net Operating Cash Flow” is the cash that flowed into, or out of, a firm’s bank accounts resulting from its basic operations. Obviously, cash flowing in is better than cash flowing out. Add one point for positive values and subtract one point for negative cash flow.
Delta: -$3 billion = -1; General Motors $16 billion = 1; Microsoft $73 billion =1; Shopify $65 million = 1; Tesla: $8 billion = 1.
Free cash flow?
Free cash flow is excess cash that a firm does not need to fund its basic operations. It could be used to cut debt, fund expansion, raise dividends, etc., all happy events for shareholders. Add one point for positive levered free cash flows, and subtract one point for negative values.
Delta: -$4 billion= -1; General Motors -$14 billion = 1; Microsoft $38 billion = 1; Shopify $491 million = 1; Tesla: $4 billion = 1.
Too much debt?
Long-Term Debt to Total Capital, a leverage measure, is the debt percentage of total capital (debt plus market capitulation). Ratios below 50% signal low debt. Award one point for ratios below 60% and subtract one point for ratios above 80%.
Delta: 86% = -1; General Motors 46% = 1; Microsoft 33% = 1; Shopify 10% = 1; Tesla: 28% = 1.
Adding up the fiscal fitness scores, we get: Delta -5, General Motors 3, Microsoft 5, Shopify 4, Tesla 3. Positive scores reflect strong financials, but many other factors come into play in determining whether you’ll make money owning a stock.
Harry Domash of Aptos publishes the Winning Investing and the Dividend Detective websites. Contact him at www.winninginvesting.com or Santa Cruz Sentinel, 324 Encinal St., Santa Cruz, CA 95060. To see previous Domash columns, visit santacruzsentinel.com/topic/Harry_Domash.