Scoring System

Updates

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28-11-07: We have started to expand this section some more and started to write up some more explanations on the individual scorecard items.

31-01-07: We have renamed some of the items to make them clearer to understand and posted up this new explanation sheet to supplement the material below. company-scoring-explained-updated-31-01-07.pdf
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Introduction

Here is a pdf of our scoresheet with explanations of the rules and figures we use to rate companies. Information obtained from a company’s income statement and balance sheet is compared and scored. If a company gets a 9 or above, put it on your watchlist because it’s a good company.

Scoresheet (updated)

As you may know, there is no single metric that can tell us whether a company is good or not. Many things have to be looked at to allow a complete picture to be painted.

As you can see it is divided into 3 main categories:Profitability, Debt and Capital and Operating Efficiency.

Profitability

7 important aspects of determining how profitable a company is: Sales, Profits, Operating Cashflow, Return on Assets, Quality of Earnings and Growth of Receivables. What are they and what do they mean?

  • Sales – The measures how much a company is selling. The higher the better. But we are looking for growth. That means that the figure must rise every year.  If it has been doing that for the past 5 years then the company must be doing something right. The one thing to be careful of is that sales figures can and have been fudged. If a company decides to commit fraud, this is the simplest way to do so. It’s literally a simple thing to just go to your accounts department and fill in an invoice. Voila, you have a sale (this is where operating cashflows come into play which we will discuss later).
  • Profits - This is the bottom line. Everything that a company earns is subtracted from everything that it pays out to reach this number. Again, we are not really concerned with the actual number here. We are looking at growth, so you should be looking for this number to increase year in year out. The downside to this measure is that it can be quite volatile. Many things affect a company. Natural disasters like fires, changes in tax laws etc. all affect a company’s bottom line. Just because a company has has a hiccup one year because of something like that may not necessarily mean that it is a bad one.  Also, when fraud is committed (e.g. sales numbers are faked) this feeds into the profit number, so be careful with this number too!
  • Operating Cashflow – Cash can come into a company in a variety of ways. The usual way is when a company sells something it has made and operating cashflow measures just that. The things which this does not measure is money received as a result of getting a loan for example, or selling some shares or factory or such other asset. Those are not items which go to the core of the company’s business. Therefore this is the most useful test to determine how profitable a company really is. There are many companies in the KLCI which get their money from loans and many of them show a profit. But if they show negative operating cashflows year in year out, this is usually a sign that they have no real business to speak of. This also measures only cash which is actually received (after costs in making the goods have been subtracted). IOUs are not counted. So if a company is showing growing sale and profit but static operating cashflows, this means that for one reason or another money from selling its products just isn’t coming in through the door. Maybe it is issuing too many IOUs, or maybe its costs have gone through the roof. When compared with sales and profits, this figure can tell you many things, which is why in my opinion it is the most useful metric to look at for a company. If I had to pick only one metric, this would be it. Again, the actual figure is not important. We are looking for growth in this area, and especially growth at a rate which matches the growth in sales.
  • Return on Assets (to be updated)
  • Quality of Earnings (to be updated)
  • Growth of Receivables (to be updated)

Debt and Capital (to be updated)

Operating Efficiency (to be updated)

Conclusion

As you can see in each category are a bunch of tests which provide a score (ranging from -1 to 2 depending on the test) and there are 12 tests in all – measuring important ratios to give you an accurate summary of the health of the company.

The maximum score possible is 14, and anything scoring 9 or above is usually worth looking at in greater detail.

NB This is not a share price predictor! It is more of a benchmark to give you more insight into a company. Therefore investment decisions require taking additional factors into account. This scoring system also favours companies with strong cashflow and operating activity. They may be other companies worth buying who do not have a strong cashflow (e.g companies who are asset rich but who do not generate revenue. We hope to improve our system to these factors into account in the future.)