Author Dave Van Knapp
EXCERPT FROM CHAPTER C-1: A SENSIBLE APPROACH TO
PICKING COMPANIES
The Goal: Finding Candidates for Investment
The first step in Sensible Stock Investing is picking companies as
candidates for investment.
Among the goals of the company-picking stage are the following:
As it turns out, all these goals can be fulfilled.
We want to be on the lookout for factors that tend to be predictive of the
fortunes of companies. Therefore, to meet the goals just stated, we’ll devise
a sensible, systematic rating system that utilizes the most reliable predictive
factors in companies’ business success. The scoring system will elevate the
most investment-worthy companies while downgrading those with the least
attractive prospects.
We will develop the Sensible Stock Investing scoring system in the
following chapters, ending with a handy summary in Chapter C-11. Then,
to illustrate it in actual use, Appendix I, Form 1 contains a completed Easy-
Rate scoring sheet for a well-known stock. The approach is completely
transparent. You will see exactly how the scores were compiled. There are
no “proprietary formulas” in Sensible Stock Investing. This allows you to
judge for yourself how sensible they are.
Getting Started with the Easy-Rate™ System
Our system awards “points” for the positive characteristics of companies.
With just a couple exceptions, there are no negative points in the system; a
company cannot have a total score below zero. Rather, the system builds
up from zero. You will come to see that companies that score anywhere
near zero are of no interest to us. A low total score means that the
company has failed too many of our tests.
In developing the points system, no effort has been made to have the
points total 50 or 100 or any other round number. Rather, the idea is to
assign the right number of points to each rating factor to properly
“weight” it against the other factors. So the total number of available
points is simply the sum of the maximum points possible for each
individual factor. Another way of looking at this is that the system is open-
ended. Thus, if you wish, you can add, delete, or reweight factors, without
having to worry about unbalancing an artificial 50-point or 100-point
system. As you see how the factors and points are developed, the benefits
and flexibility of this open-ended approach will become apparent.
In rating companies under the Easy-Rate system, points are awarded in
three general categories:
Adding the three categories, the total points available to a company is 63.
As of this writing (early 2006), the best companies’ scores are around 40.
So you can see that our system is tough on the companies, as it must be.
To be successful investors, we have to separate the contenders from the
pretenders, and weak tests won’t get the job done.
PICKING COMPANIES
The Goal: Finding Candidates for Investment
The first step in Sensible Stock Investing is picking companies as
candidates for investment.
Among the goals of the company-picking stage are the following:
- To have a disciplined approach in order to avoid hype and emotional
elements. - To identify companies whose business prospects are most favorable.
- To have it work: to actually identify “better” companies.
- To be fun and involve as little tedium as possible.
- To be not costly in time and money. This is particularly important for
the individual investor.
As it turns out, all these goals can be fulfilled.
We want to be on the lookout for factors that tend to be predictive of the
fortunes of companies. Therefore, to meet the goals just stated, we’ll devise
a sensible, systematic rating system that utilizes the most reliable predictive
factors in companies’ business success. The scoring system will elevate the
most investment-worthy companies while downgrading those with the least
attractive prospects.
We will develop the Sensible Stock Investing scoring system in the
following chapters, ending with a handy summary in Chapter C-11. Then,
to illustrate it in actual use, Appendix I, Form 1 contains a completed Easy-
Rate scoring sheet for a well-known stock. The approach is completely
transparent. You will see exactly how the scores were compiled. There are
no “proprietary formulas” in Sensible Stock Investing. This allows you to
judge for yourself how sensible they are.
Getting Started with the Easy-Rate™ System
Our system awards “points” for the positive characteristics of companies.
With just a couple exceptions, there are no negative points in the system; a
company cannot have a total score below zero. Rather, the system builds
up from zero. You will come to see that companies that score anywhere
near zero are of no interest to us. A low total score means that the
company has failed too many of our tests.
In developing the points system, no effort has been made to have the
points total 50 or 100 or any other round number. Rather, the idea is to
assign the right number of points to each rating factor to properly
“weight” it against the other factors. So the total number of available
points is simply the sum of the maximum points possible for each
individual factor. Another way of looking at this is that the system is open-
ended. Thus, if you wish, you can add, delete, or reweight factors, without
having to worry about unbalancing an artificial 50-point or 100-point
system. As you see how the factors and points are developed, the benefits
and flexibility of this open-ended approach will become apparent.
In rating companies under the Easy-Rate system, points are awarded in
three general categories:
- The Story. This is a narrative summary which articulates why the
company might make a good investment. The Story, which has both
objective and subjective elements, covers the company’s business
history and future prospects, focusing on whether it is a dominator
(or an also-ran) in its industry, whether it has a good business model,
whether it has sustainable competitive advantages, and whether it is in
a promising line of business. Up to 10 points are available for the
company’s Story. - Financial characteristics and strength. Here, we focus on the
company’s numbers. We look for companies that have both a history
of creating value and apparently good prospects for continuing to do
so. This is obviously an important line of inquiry; therefore up to 48
points are available to companies with great financial profiles. - Bonus points. These are extra points based on analyst
recommendations and how much the company is admired. Points
available: 5.
Adding the three categories, the total points available to a company is 63.
As of this writing (early 2006), the best companies’ scores are around 40.
So you can see that our system is tough on the companies, as it must be.
To be successful investors, we have to separate the contenders from the
pretenders, and weak tests won’t get the job done.
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