A. Monopoly Factor – Generally a firm will not earn a full +1.0 score unless they have a dominant share of the core business they compete in. For example, Google would get a +1.0 given its high share (over 65 percent) of the online search business, and its huge lead over Microsoft and Yahoo. Companies can often merit a +0.5 if they show clear dominance in their field while still competing with many players.
Companies such as, Cisco Systems (CSCO), Deere (DE), Electronic Arts (ERTS), Federal Express (FDX), Fluor (FLR), Goldman Sachs (GS), Nucor (NUE), Schlumberger (SLB), and Transocean (RIG) show such dominance in their fields. The goal of the Monopoly Method is to find companies with at least a +0.5.
B. Revenue Growth – This is one of the most important considerations for a stock’s out-performance. The cleanest of reported financial metrics—it is hard to fake revenue growth without committing outright fraud—revenue growth offers a reflection of both the end market opportunity and a company’s ability to differentiate itself versus its peers. As a result, our process thus doubles the score associated with revenues. Look at three metrics to come to a value between -1.0 and +1.0: first is absolute growth, second is growth relative to its own history (look for acceleration), and third, growth relative to its peers.
C. Margin Growth – Similar to revenue growth, it’s imperative to focus on margins relative to history and relative to the rest of the industry. To score a +0.5 or +1.0 on this metric, companies’ margins should be higher than their peers and increasing. Likewise with revenue growth, this variable receives double weighting in our process due to its importance to stock price movement.
D. Financial Visibility – Visibility relates to the likely probability of a company hitting its earnings guidance. For example, a cable company that has a base of subscribers paying monthly rates has a higher likelihood of making its projections than a company that has to move product, even if that company is Apple or General Electric. This is where data such as book-to-bill, backlog, and pipeline development come into consideration For example, if Cisco Systems has a positive book-to-bill in a quarter (higher sales booked versus reported), then you can have more confidence in their next quarter, perhaps leading to a score of +0.5.
E. Historical Track Record - How well has the company done with respect to their guidance? Have they met, exceeded, or missed a portion of their estimates over the past two years? If they have met all their estimates over the past two years, it’s a +1.0. If they’ve missed once, perhaps a +0.5. Anything worse than that is a zero at best, but more likely a negative.
F. Balance Sheet Strength – As discussed earlier, balance sheet structure differs by industry. The presence of debt, in other words, is not a bad thing in and of itself. A weaker balance sheet than the competition, however, is not something you’re looking for, unless it’s on the obvious road to improvement. Other factors to consider include inventory levels, backlog, and receivables balances.
G. Management Quality - How experienced is this management team? How long have they been in charge? Has the stock performed well under their tenure? Have they met their forecasts accurately? These all point to the credibility, experience, and insight management teams need to have to be successful and more importantly, worthy of your investment dollars.
H. Company Catalyst - This is the only function that is scored from -2.0 to 2.0. Catalysts could be:
- An expected financial earnings beat or miss, or
- A new significant contract, or client, or
- An acquisition or some other significant positive or negative event, or
- A significant technical point on the pricing chart.
In general, if you expect a catalyst within three months, the score is higher, as much as 2.0 if you believe it will have a big impact on the stock. Time periods of six to twelve months score roughly 1.0 and beyond that period, a zero. If you don’t expect something significant to happen in the short-term, the catalyst—and therefore the score—is zero. While few among us can accurately predict the future, those who occasionally do enjoy far superior investment returns than those who don’t.
I. Stock Price Target – The best investors use a combination of upside hope and downside possibility when timing their investment decisions. In other words, what’s the downside risk versus the upside reward possibility? At some point, you’ve got to put a number on it, even if we can all agree that predictions are rarely worth the paper they are printed on.
The formula for this metric is:
(Price Target – Current price) / (Current Price – Downside Price)
For example, if you believe a stock could trade from $20 to $30 over the next year but perhaps go as low as $15, your score would be ($30-$20)/($20-$15) = 10/5 = 2. You should be in search of companies that give 3x to 4x type price target scores, meaning that you see the possibility of 3 to 4 times more upside than downside.
J. Technical Strength – The price chart of a stock tells a story that is important to factor into your investment decision. Much can be gained by focusing on the moving average, relative strength, and other indicators discussed earlier. Scoring should be based on how well a stock chart is performing relative to your chosen technical indicators.
K. Wall Street Expectations/Sentiment – This metric measures the excitement level for a company and tries to quantify it. It is the hardest to measure in a quantitative way. It is also a contrarian’s measurement, meaning when that expectations are high, you score negative, and when they are low, you score positive. The higher the expectations, or the more a stock runs up in anticipation of an earnings report, the lower the score—as prices move up, the return versus risk tradeoff is diminished. Sites like www.whispernumbers.com can provide context and insight into expectations.