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 SMRT Corporation Ltd
With that, let’s run land transport giant, SMRT Corporation Ltd (SGX: S53) through the framework today. The business of SMRT can be divided into seven different segments – Train operations, Light Rail Transit (LRT) operations, Bus operations, Taxi Operations, Rental, Advertising, and Engineering and Others.
You can see below a quick rundown of how SMRT has fared against the Rule Maker framework (numbered in the same order as the seven criteria above). I’ll be using figures from SMRT’s fiscal year ended 31 March 2015 (FY2015) in this exercise:
- Millions of commuters use SMRT’s transportation network on a daily basis. On this count, SMRT easily meets Tom’s requirement as its services are used daily and are affordable for most commuters.
- We can use the operating margin as a proxy for the gross margin for SMRT. For FY2015, SMRT reported an operating margin of just 9.8%.
- For FY2015, SMRT had $91 million in net profit attributable to shareholders and that represents a net margin of 7.3%.
- SMRT’s top-line has grown annually by 6.7% since FY2010.
- As of the end of March 2015, SMRT had $156.1 million in cash and equivalents, and $812.7 million in borrowings. This gives a cash to debt ratio of 0.19 which is way below Tom’s desired figure of at least 1.5.
- As of the end of March 2015, SMRT had $156.1 million in cash and equivalents, $404.7 million in current assets, and $640 million in current liabilities. This gave a Foolish Flow ratio of around 0.4, which meets Tom’s requirement of having the figure come in at 1 or below.
- It is hard to judge the level of interest for each individual, but it is likely that the transport services that SMRT provides will be 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 SMRT, we might see a company with a steadily growing revenue base. The company though has taken on a good chunk of debt, leading to a cash to debt ratio which falls far below Tom’s criteria.
In this sense, it’s important for SMRT to maintain or grow its net margin and to keep on generating positive free cash flow in order to reap the benefits of its revenue growth and to keep financial risks at bay.
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 SMRT’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.