At the Fool, we believe that finding good shares to invest in first starts with figuring out how strong a company’s business is. And to do so, we can turn to the Rule Maker framework outlined by Motley Fool Chief Executive Officer Tom Gardner in his book Rule Breakers, Rule Makers. The Rule-Maker Framework Here’s how the framework looks like: Is the company selling low priced, everyday items? How does the business’s gross margins look like? What about its net margins? Is the company’s sales growing? What about its cash to debt ratio? Is its Foolish Flow Ratio (a gauge of how fast…
At the Fool, we believe that finding good shares to invest in first starts with figuring out how strong a company’s business is.
And to do so, we can turn to the Rule Maker framework outlined by Motley Fool Chief Executive Officer Tom Gardner in his book Rule Breakers, Rule Makers.
The Rule-Maker Framework
Here’s how the framework looks like:
- Is the company selling low priced, everyday items?
- How does the business’s gross margins look like?
- What about its net margins?
- Is the company’s sales growing?
- What about its cash to debt ratio?
- Is its Foolish Flow Ratio (a gauge of how fast the business can bring in cash) strong?
- Lastly, what’s your level of familiarity and interest with the business?
Figuring out Dairy Farm
With that, let’s run Dairy Farm International Holdings Ltd (SGX: D01) through the framework today.
Here’s how Dairy Farm fares against the Rule Maker framework (numbered in the same order as the seven criteria above):
- As a retailer, Dairy Farm provides everyday items to thousands of consumers through its stores like Giant and Guardian. From healthcare products to food and beverages, the items sold are often low priced and within reach of the general consumer.
- The gross margin for Dairy Farm in 2014 came in at 30%, higher than its smaller competitor Sheng Siong Group Ltd (SGX: OV8), which had a gross margin of 24% for the same period.
- Dairy Farm clocked in a net profit margin of 4.5% in 2014 while Sheng Siong’s net margin in the same year came in at 6.6%.
- Dairy Farm’s top-line has grown by 9.3% annually over the past five years. Sales growth had been slower in 2014 though, coming in at 6.3%.
- As of the end of 2014, Dairy Farm had $656.7 million in cash and equivalents, and $93.8 million in long-term borrowings. This gives a cash to debt ratio of 7, which is well above Tom’s desired ratio of 1.5.
- As of the end of 2014, Dairy Farm had $656.7 million in cash, $1.93 billion in current assets, and $2.57 billion in current liabilities. This gave a good Foolish Flow ratio of 0.49, meaning that Dairy Farm is able to hang onto most of the cash which flows through its coffers. Part of the reason is because Dairy Farm mostly gets paid by consumers at the check-out counters in all its stores, but is able to hold off paying its suppliers until much later.
- It is hard to judge the level of interest for each individual, but the everyday items that Dairy Farm sells would be familiar and easy to follow for most investors.
Putting a company through the Rule Maker framework can help you size up the type of opportunity at hand.
With Dairy Farm, we might see a company with a steadily growing revenue base. The nature of everyday items sold provides stable cash flows but brings with it tight net margins. Dairy Farm also excels at hanging on to the cash which flows through it, and this is seen by its strong cash to debt ratio.
As a final note, it is important understand that no one company is perfect.
With the characteristics defined above, the onus remains with the Foolish investor to decide if Dairy Farm’s current share price provides an appropriate margin of safety and whether it fits into his or her portfolio.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chin Hui Leong owns shares in Dairy Farm.