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 Ezion
With that, let’s run Ezion (SGX: 5ME) through the framework today.
Ezion is an oil and gas support services provider. The company owns a fleet of offshore assets that include multi-purpose self-propelled jack-up rigs and heavy-haul vessels. It also provides services such as well-servicing and maintenance, amongst others.
We will use the firm’s financials for the year ended 31 December 2014 in this exercise.
Here’s a quick rundown on how Ezion has fared against the Rule Maker framework (numbered in the same order as the seven criteria above):
- As a services provider, Ezion thrives on leasing agreements with its customers. These wouldn’t be low cost agreements that customers will do on a daily basis and would thus run contrary to Tom’s criteria.
- For 2014, the gross margin for Ezion came in at 50.7%.
- For 2014’s net margin, Ezion clocked in an astronomical 57.9%, higher than even its gross margin. But before you rub your hands with glee, the net profit for the year had included a sizable one-off gain from the sale of a subsidiary.
- Ezion’s top-line has expanded at a phenomenal compound annual rate of nearly 35% over the last four years.
- As of the end of 2014, Ezion had $372 million in cash and equivalents, and $1.5 billion in borrowings. This gives a cash to debt ratio of just 0.25 times, which is way below Tom’s desired figure of at least 1.5.
- As of the end of 2014, Ezion had $372 million in cash, $659 million in current assets, and $427 million in current liabilities. This gave a Foolish Flow ratio of 0.67, meeting Tom’s requirements of having a figure less than 1.
- The size and the scale of services that Ezion undertakes may require a strong technical background on the part of the investor in order to have full understanding of their competitive advantages.
Putting a company through the Rule Maker framework can help you size up the type of opportunity at hand.
With Ezion, we have a company with a rapidly growing revenue base. The lumpy nature of its business may affect its future sales growth though. As I noted, Ezion’s sales fell 4.6% year on year during the first quarter of 2015.
The firm’s net margin also looks healthy at first glance. But as Foolish investors, we should look at a longer term track record in order to determine the right level for Ezion’s net margins.
Also, despite the positive Foolish Flow ratio, Ezion has not managed to consistently generate free cash flow over the years. Furthermore, its low cash to debt ratio reflects the heavy weight of debt on its balance sheet. It’d thus be important for Foolish investors get a better idea regarding the operational chops of the company.
As a final note, it is important to understand that no one company is perfect.
With the characteristics defined above, the onus remains with the Foolish investor to decide if Ezion’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.