Checking Fiscal Fitness
Just because the economy is gaining strength doesn’t mean that you should throw caution to the wind.
Regardless of which way the market is heading, you’ll always do best holding financially strong stocks that won’t need to raise additional cash in order to fund expansion – let me explain why.
Firms can raise cash either by selling more shares or by borrowing. Selling more shares increases the number of shares out, cutting earnings per share (EPS) – the number used to value stocks. Adding debt increases operating costs, which also shrinks EPS.
Here are four quick fiscal fitness checks. You can find the needed data on MSN Money as well as many other financial sites. I’ll check American Airlines ($AAL), Bloomin’ Brands Inc. ($BLMN), Cisco Systems Inc. ($CSCO), GoPro Inc. ($GPRO), Groupon Inc. ($GRPN), Intel Corporation ($INTC), JC Penney Company ($JCP), Sears Holdings Corp. ($SHLD) and Twitter Inc. ($TWTR) to demonstrate the process. For each of the four checks, award -1, 0, or +1 points, as described below.
The Leverage Ratio is a good overall debt measure. A ratio of one signals no debt and the higher the ratio, the higher the debt. Few firms have zero debt, so consider firms with ratios below 2.5 as low-debt, and ratios above 5.0 as high-debt. Award one point for ratios below 2.5, zero for ratios between 2.5 and 5.0, and subtract one point for ratios above 5.0. Here are the leverage values and point values for the nine stocks: American Airlines: 21.7 = -1, Bloomin Brands: 5.7 = -1, Cisco Systems: 1.8 = 1, GoPro 1.4 =1, Groupon: 2.9 =0, Intel 1.7 = 1, JC Penney: 4.6 =0, Sears Holdings: 126.4 = -1, Twitter: 1.5 =1.
Cash vs. Day-to-Day Costs
Next, determine whether a firm has enough cash in the bank to pay its day-to-day bills. We’ll use the Quick Ratio, which compares available cash to current liabilities. Ratios above one signal excess cash, while ratios below one indicate a cash shortage. Score one point for ratios equal to or greater than 1.1, zero for ratios between 0.9 and 1.1, and subtract one for ratios below 0.9. American Airlines 0.7 = -1, Bloomin Brands 0.3 = -1, Cisco Systems 3.1 = 1, GoPro 2.3 =1, Groupon 0.9 = 0, Intel 1.2 = 1, JC Penney 0.3 = -1, Sears Holdings 0.1 =-1, Twitter 10.3 =1.
Obviously, profitable firms are less risky than money losers. We’ll check that using profitability gauge Return on Assets (ROA), which compares net income to total assets. Positive values mean positive earnings and vice versa. Score one point for ROAs above 10, zero for positive values below 10.0, and subtract one point for negative ROAs. American Airlines 6.7 = 0, Bloomin Brands 4.1 = 0, Cisco Systems 8.5 = 0, GoPro 16.4 =1, Groupon -3.4 = -1, Intel 12.7 =1, JC Penney -5.8 = -1, Sears Holdings -10.6 = -1, Twitter -12.9 = -1.
Sometimes companies appear to be profitable when they actually lost money in terms of cash that flowed through their bank accounts. We can check that using operating cash flow, which is positive when cash flowed in and negative when a firm burned cash. Use the “price/cash flow ratio” and add one point for positive values and subtract one point for negative numbers. The actual values are not relevant.
American Airlines 12.8 = 1, Bloomin Brands 7.7 = 1, Cisco Systems 12.2 = 1, GoPro 50.5 =1, Groupon 6.8 = 1, Intel 7.6 =1, JC Penney -33.3 = -1, Sears Holdings -2.7 =-1, Twitter 344.8 = 1.
Adding up the fiscal fitness scores, we get: GoPro 4, Intel 4, Cisco Systems 3, Twitter 2, Groupon 0, American Airlines -1, Bloomin Brands -1, JC Penney -3, and Sears Holdings -4.
Both three and four point positive scores reflect reasonably strong financials, but that doesn’t necessarily mean that you’ll make money owning a stock. Many other factors come into play. Consider the fiscal fitness score as another tool for your stock analysis toolbox.
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