The Golden Rules

Your intellectual investment framework –
the Golden Rules.

Stock Doctor’s Golden Rules simplify the complex task of selecting great businesses and, just as importantly, rejecting potential portfolio disasters.

Following our Golden Rules will give you an intellectual framework to use while selecting ASX stocks. Ultimately it will help you achieve long-term share market success.

The Golden Rules

1 Financial Health

Golden Rule 1 screenshot

Lincoln’s unique Financial Health model (Dr Merv Lincoln’s L-Score) is the first and most important rule in our quantitative bottomup stock picking methodology.

Analysing financial accounts and key accounting ratios, we attribute a Financial Health rating that reflects the business risk the company is exposed to and its underlying quality.

Investors can quickly identify stocks that warrant consideration and eliminate those that don’t.

2 Past Financial Performance

Past Financial Performance screenshot

Past performance is another important quality barometer when assessing an investment opportunity for either growth or income seeking investors. Therefore a further quantitative assessment is performed on key financial metrics to identify the elite opportunities.

For growth opportunities, we seek companies that generate strong profits and do so efficiently, with good margins and an ability to convert that profitability into strong cashflows.

For income opportunities, we seek companies that have had a demonstrated commitment to paying strong and sustainable dividends from historically positive cash earnings.

3 Outlook and Active Risks

Golden Rule 3 Outlook and Active Risks

To determine whether a company’s fundamental performance is sustainable, a qualitative analysis of the company’s outlook and active risks is required.

For growth opportunities, we examine the stock’s outlook and assess current active risks, and their impact on the company’s Star Growth Stock qualifiers should they become elevated. If they threaten to impact the company’s ability to grow in the future, we will remove it as a Star Growth Stock.

For income opportunities, the earnings profile of the company must be stable, to sustain an above market yield, and hopefully increase the likelihood of dividend rises into the future. Should active risks threaten the future dividend, or create possible business stress, then it will be removed as a Star Income Stock.

Other Considerations

Golden Rule 4 Share Price Sentiment

A positive market view on a company will be reflected in a positive price trend. Should the price experience a retraction then the volatility may have created an opportunity from both a growth and income perspective.

However, investors who are sensitive to price declines can use one of two indicators that Lincoln has identified (SDMAX and SD30TSR) that when used on Star Stocks improve performance slightly, whilst assisting investors to avoid catastrophic declines.

Golden Rule 5 Share Price Value

While our Star Stock selection process dictates that we are comfortable paying a premium price for a quality business, stocks can get ahead of themselves and become overvalued.

Valuations can be used as a stock management tool to help with position size (taking profits) and exit strategies (stop loss).

Using share price value as a primary trigger for buying and selling on its own is risky.

Golden Rule 6 Liquidity

Ensuring a business is liquid enough to allow for relative ease of getting in and out is important to ensure you get a reasonable price.

Further, smaller emerging businesses offer greater potential for capital gains should they achieve their dynamic growth targets, especially when compared to larger cap stable businesses with diverse revenue streams.

However, smaller businesses can be more volatile, so an investor’s tolerance to risk needs to be considered.

Golden Rule 7 Principal Activities

As a part owner of the business, a belief in what the company does is essential. Growth investors look for tomorrow’s leaders today. This could be due to a disruptive global business model, unique service/ product or strong industry tailwinds. Mature businesses on the other hand tend to be income distributors.

Further, seeing key Executives and Directors aligning their interests with shareholders by maintaining material holdings in the business is a positive, and should the founder still be involved in the company that is a bonus.

Your analysis should include what key executives are being paid relative to the performance delivered to shareholders, to ensure that their remuneration reflects the level of success investors have attained.

Golden Rule 8 Price Sensitive Announcements

Announcements that validate a business’ growth thematic and / or support a commitment and consistency around dividend distribution are preferred.

Companies with negative announcements are not preferred as it does not bode well for the future and can lead to elevated Active Risks.

Our Analysts will provide commentary on announcements for all Star Stocks.

Once you define the appropriate 9 Golden Rules relevant to you, and the thresholds you will rely on to make investment decisions, then follow these with absolute discipline to invest successfully in the share market with confidence, control and peace of mind relative to your objectives.

Proven long-term performance

^ This is the average annualised investment performance for each notional portfolio of stocks (based on actual changes in Star Stock recommendations) over the period shown taking into account capital returns, dividend income and estimated transaction costs (but not other distributions, fees, charges or tax) and using various assumptions including assumptions regarding dividend reinvestment and portfolio rebalancing after changes are made to the notional portfolio. These past performance figures are not a reliable indicator of future performance of the notional portfolio, or any stocks included in the portfolio. Investment performance of the notional portfolio over shorter periods will vary. You should not make investment decisions based on performance figures alone. For more detailed information about how these figures are calculated, including the assumptions used, click here.

All figures, information and illustrations are as at 31 March 2020 unless stated otherwise.