At the Fool, we believe that in order to find good shares to invest in, one has to start 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…
At the Fool, we believe that in order to find good shares to invest in, one has to start 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 Hour Glass
With that, let’s run Hour Glass Ltd (SGX: AGS) through the framework today.
Hour Glass is primarily in the luxury watch retail business. It has 38 boutique outlets in nine key cities in the Asia Pacific region and its closest rival may be the locally-listed Cortina Holdings Limited (SGX: C41). At Hour Glass’s closing price of $0.74 last Friday, its shares have a trailing dividend yield of close to 2.7%.
Here’s how Hour Glass fares against the Rule Maker framework (numbered in the same order as the seven criteria above):
- As a retailer of luxury watches, the purchases that happen at Hour Glass’s boutiques are expected to be infrequent. And by the definition of “luxury,” its watches may be out of reach of most consumers.
- The gross margin for Hour Glass in the first nine months of the financial year ended 31 March 2015 (FY2015) came in at 22.5%. Gross profit in this case, is defined as total revenue minus cost of goods sold.
- For the net margin figure, Hour Glass managed to clock in a respectable 7.1% for the first nine months of FY2015.
- Hour Glass’ topline growth has been steady as well, growing by 41.4% in total between FY2010 and FY2014.
- As of the end of 2014, Hour Glass had $75.2 million in cash and equivalents, and $76.9 million in borrowings. This gives a cash to debt ratio of 0.98, which is below Tom’s desired figure of at least 1.5.
- As of the end of 2014, Hour Glass had $75.2 million in cash, $422.7 million in current assets, and $120.5 million in current liabilities. This gave an undesirable Foolish Flow ratio of 2.9. In the case of Hour Glass, inventory – at S$326.2 million – had accounted for a significant portion of its current assets.
- The interest level may differ by individual for Hour Glass, but it is possible that most investors would find its business of selling luxury watches fairly straight forward to understand.
Putting a company through the Rule Maker framework can help you size up the type of opportunity at hand.
With Hour Glass, we might see a company with a steadily growing revenue base and respectable net profit margins. But, the business of Hour Glass may require it to hold large amounts of inventory on its balance sheet. Furthermore, the firm’s cash to debt ratio is not quite up to Tom’s desired standards at the moment.
Managing its operations, including finding the right product mix for its discerning customers, may prove to be the key factor which determines whether Hour Glass can continue to grow its topline. We should also keep in mind the impact of the recent surprise move in the Swiss franc (most luxury watches hail from Switzerland), which remains to be seen.
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 Hour Glass’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 doesn’t own shares in any companies mentioned.