These are the most important rules every investor on the ASX should follow at all times. Use them as a framework to outperform the market.
In this article, Lincoln Indicators discusses:
- The most important investing rules that every investor on the Australian Securities Exchange (ASX) should know and follow at all times.
- Why a company’s financial health should always come first.
- The roles of management, company outlooks, share price, liquidity, company activities, and ASX news and announcements.
Even the world’s most successful share market investors need a framework to invest, and most use fundamental analysis to assess a company’s balance sheet, its profit & loss statement and cash flow.
But even if you know how to do this, one would need to analyse the financials of all 2,000 companies on the Australian Securities Exchange twice a year – a herculean, if not impossible, task in anyone’s books. The Australian share market is no place for the inexperienced, and without the best tools and education investors are taking enormous risk.
That risk can be mitigated by using a disciplined and academically-proven fundamental analysis framework that clearly identifies stocks that must be avoided as well as the financially healthy, well-managed companies that present strong potential for capital appreciation and/or income.
Lincoln Indicators has simplified the complex task of selecting great businesses and rejecting potential portfolio killers into the following 9 Golden Rules for successful share market investing.
Golden Rule 1: Financial Health
Financial Health is our first and most important golden rule.
Developed in 1982 by Lincoln founder, academic and former Olympian Dr Merv Lincoln, Lincoln’s unique Financial Health model assesses key accounting ratios relating to each company’s profitability, cashflow, liabilities and assets. It then determines a Financial Health rating commensurate with the business risk of the company so investors can quickly identify stocks that warrant further consideration and eliminate those that don’t.
To meet this criteria a stock must exhibit Strong or Satisfactory Financial Health ratings. A company must be healthy for at least two consecutive periods or more. It is not sufficient for a stock to be healthy for solely one period. (Also see, Why financial health must come first )
Golden Rule 2: Management Assessment
Management quality and leadership capabilities are important factors when assessing the ability of a company to fulfil its financial and strategic objectives.
For Growth stocks, Lincoln uses Return on Assets (ROA), Return on Equity (ROE), Earnings per Share (EPS) growth and revenue growth to asses a stock and measures these criteria based on the company’s market capitalisation and the industry it operates within. In order to suit the needs of a growth investor a company, must possess a consistent history of efficient profit growth.
|Star Growth Criteria|
|Industry & Size||Return on Assets (ROA)||Return on Equity (ROE)||Earnings per Share Growth (EPSG)||Revenue Growth|
|Small Caps (market cap below $200m)||More than 14% and on positive trend||More than 25% and on positive trend||More than 8% over the last 12 months and positive over 18 months||Must be positive over the year|
|Resources & Energy (market cap over $200m)||More than 8% and on positive trend||More than 8% over the past year|
|Financials ex. REITS (market cap over $200m)||More than 14% and on positive trend||More than 14% over the past year|
|Industrials & Materials ex. resources and inc. REITS (market cap over $200m)||More than 8% and on positive trend||More than 8% over the last 12 months and positive over 18 months||Must be positive over the year|
For Income stocks, Lincoln wants to assess management’s ability to consistently maintain stable earnings in order to fund an above market dividend yield. This will ensure the business is not overextending when returning profits to shareholders.
Golden Rule 3: Outlook/Forecast
To determine whether a company’s fundamental performance is sustainable, investors must analyse the company’s outlook and forecast performance.
For growth opportunities, we want to gauge whether a company is likely to remain as a Star Growth Stock in the future. For Star Growth Stocks and Borderline Star Growth Stocks we provide our estimates for the company’s underlying performance in the coming year.
For income opportunities, we want to ensure that their future earnings profile is stable, not only to sustain its above market yield, but also increasing the likelihood of dividend rises into the future. This is a requirement for a company to be rated as a Star Income Stock.
Golden Rule 4: Share Price Value
Star Growth, Borderline Star Growth and Star Income Stocks: These stocks are undervalued if its current price is below its Lincoln Valuation. At times the market attributes a premium to a company, particularly Star Growth Stocks, due to its strong corporate history, stability of earnings and/or its future growth prospects with the market supporting management’s ability to keep the earnings momentum going. We calculate an intrinsic value for these businesses and a stock is deemed to represent value if the current price is trading below its Lincoln Valuation.
Non-Star Stocks: For Lincoln covered companies such as the ASX20 you can use our Lincoln Valuation. For all others the consensus target, where available, represents the market’s view on the company. In addition, traditional price earnings (PE) and price earnings growth (PEG) ratios can be used. A PE ratio less than the industry average indicates the potential for share price appreciation. Where the PE is greater than the industry average, the PEG ratio (PE/EPS Growth) is used to determine whether earnings growth justifies the premium price. Lincoln’s benchmark is a PEG ratio of less than one. A PEG of less than 1 suggests that the premium is justified and that the stock is not yet fully valued at its current price. (Also see, Why value investing can be a risky strategy ).
Golden Rule 5: Share Price Sentiment
Once a fundamentally superior stock has been identified then it is best to focus on stocks with a positive share price trend.
Be wary of stocks whose share prices are historically volatile, underperforming its peers, sector or indices, or trending downwards. A positive trend indicates the markets appreciation for the stock, its business and the industry it is in.
To meet this rule according to our measures, we require the company to have outperformed the All Ordinaries Index over the past 12 months. This is not intended to be a buy or sell indicator for the stock. It is simply a reflection of the market’s view on the company.
However, risk tolerant investors may see the failing of this rule to be an opportunity to purchase an underperforming, fundamentally sound business that represents deep value a value investor may seek to prosper from the price/value disconnect. If the company retains its fundamental quality, investors may consider the stock or even acquire more if they currently hold it. (Also see, How to find a great growth stock on the ASX ).
Golden Rule 6: Liquidity and Size
At some point an investor will wish to sell their share investment. To ensure they are able to sell the entire holding at any time, we suggest that the average ‘daily volume traded’ figure is at least five times the exposure level.
Traditionally larger stocks tend to be less volatile and have a greater volume traded than your portfolio.
When assessing for Star Stock eligibility, a different set criteria is imposed for companies with a market capitalisation of less than $200 million to companies larger than $200 million (see Golden Rule 2 for more information on these criteria).
We will generally not analyse a stock if its average daily traded is less than $50,000 though some exceptions can be made if there is strong conviction in the company’s future.
Golden Rule 7: Principal Activities
Before investing in a company, an investor should have a basic understanding of that company’s principal activities, as well as the potential opportunities and threats that may impact future earnings of the company or its industry.
Stock Doctor combines information on every ASX listed company’s operations and principal activities with analyst comments, company director statements and extensive financial data to help you understand the business behind the stock.
Golden Rule 8: News and Announcements
Company news and announcements can immediately impact stock prices positively or negatively.
Our Analysts will provide commentary on any Star Growth Stock, Borderline Star Growth Stock or Star Income Stock. Investors should be wary about investing in companies that have had recent negative news or announcements. (Also see, Why investors should block out the market noise ).
Golden Rule 9: Follow all of the above rules!
Stock Doctor’s nine golden rules provide a clear indication of a company’s Financial Health, management quality, share price value, sentiment, liquidity, size and future prospects both from a growth and income perspective. With this proven academic framework and holistic view you can make an informed and confident assessment of each company’s long-term growth prospect.
But this last Golden Rule is essential if you are going to be a successful long term investor. Maintaining investment diligence and vigilance is paramount. Adhering to the 9 Golden Rules of investing at all times, not just when assessing new stocks to invest in, but in stress testing the companies you have already invested in, is imperative.
By confirming that all the stocks in your portfolio tick all the key investment boxes, investors are well placed to achieve their specific share market objectives.
In Stock Doctor, you can easily access all the 9 Golden Rules of investing:
- Type in any ASX stock code and instantly see a company’s Financial Health rating and its standing against the 9 Golden Rules.
- Check a stock’s management assessment based around Star Growth Criteria or Star Income Criteria, relative to its industry.
- View strategic comments on every company to ensure it is aligned with your objectives, analyse the share price against the Lincoln Valuation, and compare any company against the market.
- View the latest price sensitive company announcements to make informed investment decisions.
Our team is always here to help you manage your portfolio aligned to your objectives relative to our Golden Rules of successful investing. If you would like to discuss this article in more detail or would like more information on Stock Doctor or our Managed Investment Solutions, please contact us on 1300 676 333.