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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