My Filter Criteria to get Company for my watchlist.
- Low Debt
- - For most counter I choose, I prefer low debt (except for certain company who grow along with higher Debt-example RCE Capital, because their business is loan provider).
- - Low Debt can ensure company is healthy, most important is the company's revenue no need paid to bank as interest. Lower Debt also can ensure Company able to survive towards crisis.
- - Normally i use "Debt to Equity Ratio" indicator for this purpose, I target 0% - 50%.
- - Please take notes Interest Rate are different for different country. Example Malaysia have much higher interest rate than US, this will impact my tolerance level on Debt to Equity Ratio, in this case, I am ok for US company to have 50% debt if the company is strong growth company.
- High ROE.
- - Return on Equity refer to "How much profit can the counter generate using the Shareholder Equity". Equity = Total Assets-Total Liabilities.
- - Equity are the "money value" of the company that belong to shareholder if the company's assets are sold and after deduct all the liability/debt.
- - This indicator work more accurate on "Company Without/Very low Debt" because most of the time highest liability are Debt.
- - It indicate how strong the earning power of the Company can to double up Total Equity.
- - Let say a Company have zero Debt and ROE = 26%. This mean every 3 year, the shareholder equity can be double up. If Shareholder equity double up, share price most likely will rise.
- - To understand this concept, you can imagine you running 2 cow farm. So at first, you have 200 cow that split to 2 farm. So farm A's 100 cow every year will give birth 26% cow (ROE=26), while farm B's cow only can give birth 10% cow per year(ROE = 10). So 3 year later, farm A Cow will have around 200 cow(follow compounding rule, let say new cow also can give birth immediately) while farm B cow will only around 133 cow. So farm A is definitely more worth to invest.
- - Let bring in some Debt Concept. Same scenario, but this time, 90 cows of farm A is LOAN from other farm and need to return 3 year later. So 3 year later farm A have only 110 cows, because we need to return 90 cows to other farm. While farm B still have 133 cow. So this is why I say, ROE indicator work better with company with low/no Debt.
- Strong Cashflow.
- - Cashflow are most important resource to run a business. Procure raw material, staff hiring, research and development and etc. All kind of these important action required cash. Thus higher cash flow company are more secure (at least I think so).Recent Covid-19 did filtered away a lot company without enough cashflow to sustain their business.
- - There are 2 indicator, "Cash Ratio" tell in near future whether the company have enough cashflow to overcome the current liabilities it have. Cash Ratio = Cashflow or Cash equivalent / current liabilities
- - Another indicator is direct get the company "Cash Flow or Cash flow equivalent" from Annual Report.
- High Net Profit Margin or Gross Profit Margin.(Optional)
- - This is last indicator I look at and sometime I will ignore it.
- - Gross Profit = Revenue - Cost of Good (cost like Raw material), thus, Gross Profit Margin = % of Profit after Revenue - Cost of Good.
- - Net Profit = Revenue - Cost of Good - Indirect Cost (Rental, Income Tax, Finance auditor fees and so on)
- - These 2 indicator can tell us how strong the business is , example: Higher Gross Profit Margin show that this company might have Pricing Advantage (example, iPhone are expansive but still very popular due to the Brands. Higher Net Profit Margin show that this company might have some unique business model, example some company that have "pioneer status" in Malaysia can exempted to paid 70-100% income Tax.
- - Well, this indicator need to use wisely, sometime a company have lower NPM and GPM but these company might have higher market share compare to competitors, example Coca-Cola. The best is try to study Annual Report why GPM and NPM are high or low.
Understand what you going to buy.