How We Rate Companies as Buys or Sells

The following is a summary of the categories that we currently use (as of June 22, 2002) to rate companies. This is subject to future refinement.

Strong Buy – The Price earnings ratio is less than 20. The return on equity is at least 15%. The historic five year growth in earnings per share is at least 15% and earnings per share are still growing at at least 15%. The company does not produce a commodity product with high fixed costs (which leads to excessive price competition). Debt levels are not excessive. There is little chance of a permanent loss of capital. Based on a reasonable forecast of earnings growth, the shares are trading at 75% or less of intrinsic value calculated at a 9% required rate of return.

Speculative Strong Buy – Most but not all of the above criteria are met, the risk level is higher and may be significant.

Buy – The Price earnings ratio is less than 20. The return on equity is at least 10%. The historic five year growth in earnings per share is at least 10% and earnings per share are still growing at at least 10%. The company does not produce a commodity product with high fixed costs (which leads to excessive price competition). Debt levels are not excessive. There is little chance of a permanent loss of capital. Based on a reasonable forecast of earnings growth, the shares are trading at 90% or less of intrinsic value calculated at a 9% required rate of return.

Speculative Buy – Most but not all of the above Buy criteria are met, the risk level is higher.

Weak Buy – Essentially a hold with a bit of a bias to the buy side.

Weak Sell – Essentially a hold with a bias to the sell side.

Sell – We think it is over-valued

Strong Sell – The analysis, based on fundamentals, indicates the stock is very over-valued. We think there is a strong risk that the stock could fall significantly.

Investors should realize that stock prices will often move in the opposite direction to the one our analysis indicates. Stocks are inherently risky and unpredictable.

However, we think that there is considerable merit in applying fundamental analysis as a screen. We hope and believe that we will be right more often than we are wrong.

This Site is dedicated to the idea that it is possible, through fundamental analysis, to identify certain stocks as being under-valued and others as being over-valued.

Most equity investors would agree that this is possible. But, there are many people who would argue that the market is “efficient” and that it is impossible to consistently pick winners and losers.

We rely mostly on published financial and operating information for each company. We thoroughly analyze the current sales and earning and the established growth trends. We examine liquidity and book value ratios. We look at the strength of the balance sheet. We look for any concerns regarding the reported earnings.

We also try to examine the outlook for companies by considering the general outlook for the industry that each company operates in. We do not have access to insider information.

Our screening process clearly favors stocks that have already demonstrated profitability and sales.

A company with no earnings but with tremendous growth in revenue might still pass muster with us (as a speculative pick). But a company that has essentially no sales is not going to pass our screen.

Our philosophy is that, on average companies that have established consistently high profitability but which are available at low prices are good bets.

The fact is, that our methods will fail to see the potential in certain start-up companies, particularly if they have not yet even established any sales. This would be true of many drug research companies, electronics research companies and junior mining companies. We consider these companies to be a bit like lottery tickets. Some of them will be big winners. Some people might even be able to pick the winners. We can’t. So we will stick to looking for companies that can be analyzed on the basis of proven sales, earnings, growth and other financial data.

When we analyze a company, we show you the data that we have used and explain how we reached our conclusions. You can then use your own judgment to see if you agree.

DISCLAIMER: The information presented is not a recommendation to buy or sell any security. The author is not a registered investment advisor and the information presented is not to be considered investment advice. The reader should consult a registered investment advisor or registered dealer prior to making any investment decision. The author may at times have a security position in the companies presented.

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Shawn Allen, CMA, MBA, P.Eng.