Another value investing tool

The basic concept is to compare current year's financial performance signals against last year's signals. There are total 7 variable to measure these performance-related factors, each variable stand for one mark if a firm can score 7 marks it means the firm have a strong fundamentals:

(1) Profitability (3 variables)

ROA = net income before extraordinary items / beginning of the year total assets
If current year's ROA is better than prior year's score one mark, zero otherwise.

CFO - cash flow from operations
If current year's CFO less prior year's CFO is positive score one mark, zero otherwise.

Accrual = current year's CFO - net income before extraordinary items
Accrual > 0 score one mark, zero otherwise.

(2) Leverage & liquidity (2 variables)

Two of the seven financial signals are designed to measure changes in capital structure and the firm's ability to meet future debt service obligations. An increase in leverage or a deterioration of liquidity is a bad signal about financial risk.

Financial leverage = total long-term debt / beginning of the year total assets
An decrease in financial leverage as a positive sign and score one mark, zero otherwise.

Liquidity - measures the historical change in the firm's current ratio between the current and prior year, where an improvement in liquidity score one mark, zero otherwise.
(current ratio = current assets / current liability)

(3) Operating efficiency (2 variable)

The remaining two signals are designed to measure changes in the efficiency of the firm's operations.

Gross Margin - If the firm's current gross margin is better than last year score one mark, zero otherwise.

Turnover ratio = total sales / beginning of the year total asset
If current year turnover ration is better than last year score one mark, zero otherwise.
An improvement in asset turnover signifies greater productivity from the asset base.

Now I use Almost Family Inc. (AFAM) as a example to illustrate my concept:

                  2009        2010

ROA       14.27%    15.63%        --- 1 mark

CFO         27M        32M            ---  1 mark

Accrual = 32M - 29M = 3M > 0  --- 1 mark

            

                   2009         2010

Leverage     0.499       0.439           --- 1 mark      

Liquidity      2.57          3.18             --- 1mark

                              2009           2010

Gross Margin       53.48M      53.97M    --- 1 mark

Turnover ratio       1.73            1.75      --- 1 mark

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Total score 7 marks