Appraising The Stock Market: Part 2

Over the past week I’ve been doing some number crunching in an effort to find some good stock market investments (you can read here Part 1 of “Appraising The Stock Market”). This means I’ve selected another cliched image for the blog! Also, and more importantly, even though I am only an amateur investor I do kind of feel that with a bit of number work, and a dollop of common sense, it is possible to make sensible investment decisions that won’t come back to bite me on the bottom.

As I detailed in Part 1, I spent some time applying a bit of logic to the FTSE 100 Index and split it into sectors that made sense to me, before then trying to estimate – in very broad terms – how those sectors might fare in the near future, bearing in mind we’re on the cusp of recession.

The next step was to dig a bit deeper into the sectors of interest and see what the analysis spits out at me… So here goes nothing…

Rationale For My Fundamentals Analysis Approach

My guiding principal is that I want to be investing in companies that make money. It might sound like an obvious thing to say, but we know that some companies don’t make a penny yet still cost a lot to invest in. This is because market capitalisation of companies is based on future value, of course, and so share prices in some companies can be high, even if not a penny has been made in profit thus far.

That kind of investment is not for me though as it represents too much risk. I want some proven cash generation. As such, I’ve chosen to focus on fundamentals around earning and efficiency:

  • EPS (Earnings Per Share)
  • ROCE (Return On Capital Employed)
  • Revenue increase from 2018 > 2019
  • Increase In Cash

Each measure on its own has its plus points and negatives, but used together I believe they can give me a fairly accurate broad picture of where a company is at now, which itself is the springboard for a deeper dive – namely, Discounted Cashflow Analysis. But more on that another time.

What Does My Analysis Tell Me?

Here is an example of data I looked at for the Banking Sector:

So, it is worth clarifying that this is only a small sample. And yes, this data only scratches the surface. However, at first glance Lloyds Banking Group leap out as a company that might be of interest. The share price has dropped by 48% in the past 12 months, more than some peers, yet it appears – at first glance – to have a bit more momentum than sector rivals. Lloyds have increased their cash position of lat e, too, which I find reassuring. I have also represented this increase as a percentage of 2019 revenue to see how much of the annual revenue growth has ended up as cash. 6% is on the high side, by my reckoning.

The downside to investing in Lloyds is that banks were ordered to cancel dividends in the short-term by the Bank of England, but that won’t last forever. It might not belong in a ‘sexy’ sector, but Lloyds Banking Group is definitely of interest to me (currently trading at around 30p).

Two More Companies I Like The Look Of

I’m also potentially sweet on two other companies. First up is Hikma Pharmaceuticals. My biggest worry here would be that I’ve already missed the boat, as the share price has improved 57% over the past 12 months. However, if the aim is to invest over the long-term in solid, well-run businesses that generate cash then this looks a decent investment. Here are the numbers:

This makes for impressive reading. Hikma Pharmaceuticals (trading around 2,502 as I type) has gone on my shortlist.

Finally, for now, I also think ITV might be worth a look:

The ITV share price has plunged 26% in the past year, with the Covid-19 crisis not helping in that regard. However, before Covid-19 they managed to increase revenue in a competitive operating environment, while also managing to increase cash by more than their increase in annual revenue. This to me suggests ITV is a well-run business (which is backed up by ROCE, which looks strong compared to leading peers). ITV is trading at around 81p at the moment – it might well be worth a dabble.

Some Conclusions

The three companies above are only potential investments for now, but I feel like I’ve got a sound basis for moving forward with some even more detailed analysis. Of course, what my sector analysis also tells me is that I don’t need to concentrate only on the FTSE 100 – there could well be some similar firms lurking in the FTSE 250, or AIM, that could be of investment interest.

More research is needed!