Harry Domash's Winning Investing



Check Fiscal Fitness First

Whether you’re a value investor or chasing hot growth stocks, your best candidates are profitable stocks with strong balance sheets. These stocks can fund growth internally without having to raise additional cash. Here’s why that’s important.

Firms needing to raise cash have two choices: They can either sell additional shares or they could borrow the needed cash. Both are bad for shareholders. Selling shares hikes the number of shares outstanding, cutting per-share earnings, which is the number used to value stocks. Adding debt increases operating costs, which also shrinks earnings.

Here are four quick tests that you could use to evaluate your stocks financial strength, which I call “fiscal fitness.”  You can find the needed data on Morningstar (www.morningstar.com) as well as other financial sites. I’ll check the scores for Home Depot (ticker HD), Broadcom (AVGO), Lulu Lemon (LULU) and Netflix (NFLX) using Morningstar to demonstrate the process. For each of the four tests, award -1, 0, or +1 points as described below. 

To start, from Morningstar’s home page, enter a ticker symbol; then scroll down past the “Financials” section, select “All Financials Data,’ and then “Key Ratios."

Too Much Debt?

Leverage Ratio is the best debt measure. A leverage ratio of one means no debt and the higher the ratio, the higher the debt. Ratios below 2.5 signal low-debt, and ratios above 5.0 correspond to high-debt. Award one point for ratios below 2.5, zero for ratios between 2.5 and 5.0, and subtract one point for ratios above 5.0. Morningstar labels the Leverage Ratio "Financial Leverage." Here are Morningstar's Financial Leverage values and our resulting point values for each of the four stocks:

Home Depot: FL = 17.7 and points = 1, Broadcom: FL = 2.5 and points = 0, Lulu Lemon: FL =1.2 and points = 1, Netflix: FL = 5.1 and  points -1.

Cash on Hand?

Use the Quick Ratio which compares available cash to current liabilities to determine if a firm has enough cash on hand to pay its current bills. Ratios are above one when cash exceeds current liabilities , and vice-versa. Score one point for ratios above 1.0, and subtract one for ratios below 1.0.

Home Depot: Quick Ratio = 0.4 and points = -1, Broadcom: QR =3.6 and points =1, Lulu Lemon: QR= 3.3 and points =1, Netflix: QR= 0.3 and points = -1.


Firms must be profitable to self-fund growth. Use profitability gauge Return on Assets (ROA), which compares net income to total assets. Positive values reflect positive earnings and vice versa. Score one point for ROAs above 10, zero for positive values below 10.0, and subtract one point for negative ROAs.

Home Depot: ROA =19.2 and points = 1, Broadcom: ROA =1 and points= 0, Lulu Lemon: ROA =18.3 and points = 1,Netflix: ROA = 3.0 and points= 0. 

Cash Flowing In or Out?

Creative bookkeeping sometimes allows firms to appear profitable when in fact; cash is flowing out, rather than into their bank accounts. Operating cash flow (OCF), is positive when cash flowed in vice-versa. Add one point for positive values and subtract one point for negative numbers.

Home Depot: OCF was positive and points= 1, Broadcom: OCF was positive and points = 1, Lulu Lemon: OCF was positive and points = 1, Netflix: OCF was negative so points = -1. 

Final Scores

Adding up the fiscal fitness scores, we get: Home Depot = 0, Broadcom  = 2, Lulu Lemon  = 4 and Netflix  = -3. Positive scores reflect reasonably strong financials, but many other factors come into play in determining whether you’ll make money owning a stock. Consider the fiscal fitness score as another tool for your stock analysis toolbox.

 published  12/18/17

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