It is important for investors to use a range of fundamental factors in their selection process to help provide a complete picture of a stock’s value and underlying financial strength. Michael Thomsett’s feature article in this month’s issue (starting on page 7) illustrates the use of four fundamental indicators that work together to measure the attractiveness of a stock while providing a study of the recent company results and working capital.

As a test of revenue strength, the First Cut seeks out exchange-listed stocks that have been able to consistently increase their annual revenue over each of the last five years. Optimally, earnings should be growing even faster than revenues. To measure earnings strength, the First Cut filter requires a current net profit margin (net income divided by revenues) higher than the average net profit margin over the last five years. The table below also highlights the median net profit margin of the corresponding industry in which a company competes. The company’s figure should be above the industry norm.

Thomsett prefers to avoid companies with extremely high or low price-earnings ratios, so the First Cut looks for stocks with a ratio between 10 and 25 times trailing earnings per share (TTM). It is helpful to examine the price-earnings ratio over time, so the table below highlights the current price-earnings ratio and the average price-earnings ratio over the last five years.

The First Cut screened for minimum dividend growth by requiring at least three increases in the annual dividend over the last six years. Many of the passing stocks also turned out to have an above-average dividend yield.

The final First Cut filter looked for a minimum level of financial strength. Thomsett favors the use of the long-term-debt-to-capital ratio (long-term debt divided by the sum of long-term debt and equity). Each stock passing the First Cut was required to have a lower long-term-debt-to-capital ratio than its five-year average ratio. The 30 stocks passing the First Cut are presented in the table below ranked by their price-earnings ratio.

—John Bajkowski, President of AAII

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