In an article published by Fairfax media today, a division director at Macquarie Securities, Jason Todd, shared the results of a screening test he used to identify stocks with sustainable, reliable and growing earnings over the next few years.
He screened for:
- Positive revenue and profit growth out to 2018
- Profit growth of at least 5% per annum for the next two years
- Return On Equity (ROE) above 10%
- Excluded stocks that have a high ROE due to debt or rising revenues
- Excluded stocks with net debt of more than two times Earnings Before Interest, Tax, Depreciation, and Amortisation (EBITDA)
- Stocks must generate free cash flow over the next two years
It’s a fairly exhaustive list, but it generated a surprising amount of good businesses including gold miners Northern Star Resources Ltd (ASX: NST), EVOLUTION FPO (ASX: EVN), Myob Group Ltd (ASX: MYO), Fisher & Paykel Healthcare Corp Ltd (ASX: FPH), Cochlear Limited (ASX: COH), James Hardie Industries plc (ASX: JHX), Link Administration Holdings Ltd (ASX: LNK), and Domino’s Pizza Enterprises Ltd. (ASX: DMP).
It looks like a great list, but would-be buyers need to remember that it was generated through screening tools (with the criteria listed above) and not all stocks that fit the criteria are necessarily a buy right now.
Some stocks like Domino’s, Fisher & Paykel, and Cochlear need a closer look before buying, given that they are all trading north of 30 times earnings – double the ASX average. There might not be a margin of safety available at these prices.
Other stocks like Myob, Northern Star, and Evolution face either competitive threats, or the value of the commodities they produce (gold) is outside their control, which might make them unsuitable for investors.
Motley Fool contributor Sean O'Neill owns shares of G8 Education Limited and Retail Food Group Limited. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.
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