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However, for this post, I will explain in detail about the methodology of The Ultimate Scorecard – one of the scorecard database on the Fundamental Scorecard website. This will be useful to those who do not understand the criteria within the scorecard or are not familiar with the numbers.
Having created the Value StockScorecard – the very 1st version – in March 2015, I realize I have yet to write in words about my scorecard methodology.
Before I start, let me repeat that The Ultimate Scorecard is created based on value investing concepts and contrarian investing methods.
So here are the thoughts that created The Ultimate Scorecard:
1. Cash Is King! You Cannot Deny It.
In the recent market downturn, did you wish that you should have more cash on hand?
This is the same for the companies. During a crisis, companies with CASH can acquire others, give dividend, do share buy-back and grow while its competitors can only tighten their belts.
Furthermore, companies with CASH can even try to ask their suppliers for a bigger discount when they make upfront payment to their suppliers. In this way, their inventory cost will also become lower which will potentially lead to a higher net profit in future.
Companies that are able to produce FREE CASH FLOW on a regular basis will also tend to benefit. With predictable cashflow, the companies will be able to make the future decisions earlier.
2. Gearing Is Bad. Period.
If you pay your bills on time, you will not need to worry about payment if your cash suddenly dries up.
During a crisis, companies with LOW GEARING (low trade payables or debts) will not need to worry about finding CASH to pay its suppliers or creditors, while companies with high gearing may need to dig deeper to source for additional cash to make the necessary payments.
This was explicitly illustrated during the recent oil and gas crisis where companies (Swissco, Swiber, Ezra, Ezion, etc) with high gearing went into judicial management, while those with lower gearing survived the downturn and came out stronger.
3. Dividend Are Great. But Not Too Much!
I like companies that give out DIVIDEND because they helped to keep your mind focused! This is especially true when you are a value investor and have to wait very long, sometimes years, for the value of the counter to be realized.
At times when you want to “give up” on a counter, DIVIDEND will act as a comforter to keep you focus on your initial decision on why you purchased that company.
Nevertheless, it is important that companies should not give out all its net profit as dividend. They should still keep some cash to support its growth and operations!
4. Companies Have To Make Profit. Hopefully In Cash!
Although I do not really look at net profit, but I still believe a company have to be able to generate a profit. If it is not possible, why make the effort to continue to do business?
In addition, all of the profit should thrive to be CASH EARNED. Because there are possibilities of non-cash item, such as revaluation of investment properties, reported within net profit.
Thus, if the net profit is not able to convert fully to cash, it is just like diluted sugar cane – slightly sweet, and able to quench your thirst, but just not nice enough for you to buy another cup.
Since you bought into the company, you will want to make sure its management, whom are being paid extraordinary salary, are doing a good job. But how do you gauge them?
The simplest way is RETURN ON EQUITY. Their KPI should be judged by the amount of net profit they make.
6. You own Part of The Company.
This is something I am learning as well.
When you buy a share, you should view it as you own part of the company. In addition, you should only own the best out of the best. So as retail investors, we should thrive to buy GREAT COMPANIES AT FAIR PRICES!
Concentrate your efforts because your funds are limited. No point looking at any cheap Tom, Dick or Harry, because there will always be Tom, Dick and Harry around. But there is only 1 unique “You”.
After reading the thoughts behind The Ultimate Scorecard, you will realize that the scorecard has a focus on Cash. But you may still wonder how will this Ultimate Scorecard help me in selecting a company to invest in?
Quantitatively, The Ultimate Scorecard's 15 criteria can be breakdown according to:
The 1st 5 Criteria are focused on Balance Sheet.
Next 3 Criteria are focused on Dividend.
Next 4 Criteria are focused on Free Cash Flow.
Next 2 Criteria are focused on Revenue and Earnings.
Final Criteria is focused on Management Capability.
Therefore, in the event a company passed The Ultimate Scorecard with a score of at least 8 points, the company must be performing fundamentally well (or undervalued) in at least 2 categories.
This also meant that a company that passed the Ultimate Scorecard must have some form of margin of safety. In the event of a market downturn, the margin of safety will be able to buffer the fall in the share price for that company, minimizing the drop in its share price.
In addition, if you purchase a company based on fundamentally sound principles, it will also recover back faster than other companies.
Notwithstanding the above, you maybe still thinking, "Will this be enough?"
The Ultimate Scorecard has gone through simple backtesting of 20 randomly selected counters over the period of 2015 to 2017. Over the same period of time, STI was a “U” shape.
Generally, the testing has concluded that the Ultimate Scorecard accuracy on determining that a counter is undervalued range from 60% (during a downtrend) to 80% (during an uptrend).
This meant that if The Ultimate Scorecard state that the counter is undervalued, the chance of you making a gain as small as 0.001/making minimal losses are from 60% to 80%.
In my opinion, this only satisfy the quantitative portion of investing. The other 20% to 40% should be analyze from a qualitative approach. This will have to come from an investor's understanding of the business. After all, since you intend to own a part of the business, you must also understand the business.
I hope this post explain clearly the thoughts and the usefulness of the Ultimate Scorecard. It may not produce a 100% accurate decision. But I personally believe, especially for newbies, that this is a start to learn to invest fundamentally. For the investing veterans, this could become another source of finding undervalued companies.
Once you make a fundamental decision, daily changes in share price should not affect you IF THE FUNDAMENTAL OF THE COMPANY DID NOT CHANGE. Even in a market downturn, you will be less affected if you continued to believe in the fundamentals of the company.
Before I end, here is a screenshot of a subscriber whom has benefited from using the scorecard since the “olden” days:
If you are interested to sign up on The Ultimate Scorecard, do click here!
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