I have compiled a table of investment ratio multiples that I often use when looking for investment opportunities. The table includes the ratio, the multiple I aim at and what I look for, allowing for easy reflection of my investing approach.
While my personal investment style focuses on GARP (Growth At Reasonable Prices), I still adhere to certain “rules of thumb” for value plays. For example, even if a certain valuation ratio such as Price-to-Earnings presents an undervalued or overvalued play, I still want the Gross Margin to remain higher or the Dividend Payout to be low.
The ratios multiples can be split into two components: a way to compare the value of a business to other opportunities and the market, and the types of metrics we want the underlying business to have. However, adaptability is key in investing – never stay rigid to one style or method. Even the greatest investors in the world do not turn down an opportunity simply because it does not fit within their “Investment Style”.
The ratio multiples below are a guide of what I typically look for, but I do not remain fixed to them when a great opportunity presents itself outside of them. Some ratio multiples are not present as I may not frequently use them and therefore have not had a consistent track record for saying “This is what I look for”.
Ratio Multiples Chart
| The Investment Ratio: | What I look for? |
|---|---|
| Return on Equity | ROE >15% consistently over 3+ years ensuring the equity component is not fueled with any debt. |
| Return on Capital | ROC >20% consistently over 3+ years ensuring the capital allocation is aligned with long-term shareholder value. I also look to see if it is made up of a lot of Goodwill and if it is how valid is it? |
| Return on Assets | ROA >10% consistently over 3+ years paying close attention to the importance of the assets and their role in revenue generation. |
| Gross Margin | GM >50% consistently positive and rising over 3-5+ years. Looking for signs of a competitve edge. |
| Operating Leverage | OL >2-5 I want a high operating leverage. This naturally leads me toward high-growth or early-stage companies. I look at the potential of the flow-through to the bottom line as a company scales. |
| Operating Margin | OM >25% consistently positive and rising over 3-5+ years. Looking for signs of a competitve edge. |
| Current Ratio | CR >2.5x consistently able to meet all short-term obligations and continue to self-fund expansion. Observing the inventory changes accounts payable and receivables. |
| Cash Flow Ratio | CFR >2.5x consistently able to meet all short-term obligations using cash flow. Able to fund growth without taking on debt or diluting. |
| Price-to-Sales | P/S <5x looking for companies that have the consistent margins and growth prospects to back up the higher than 1 P/S. |
| Price-to-Earnings | P/E >20 looking for growth, if a company has a high P/E I want to see EPS growing at the same rate. |
| P/E-to-Growth | PEG 1x looking for companies that are not overvalued. If the P/E is 30 I expect growth to be in the same vicinity. |
| Price-to-Cashflow | P/CF <10x looking for companies that are not overvalued. If the P/CF is high the growth prospects, earnings and TAM must all align. |
| Earnings Per Share | EPS Growth Rate >20% consistently increasing and positive. Looking for clear signs of sustainable growth over 3-5 years. |
| Debt-To-Equity | D/E <0.5 typically 0 is preferred. I like companies with little to no debt, especially in the smaller end of the market. |
| Inventory Turnover | ITR >5-10x consistently high turnover, focusing on effective inventory management and the supply chain, demand and pricing power. |
| Dividend-Payout | DP <20% The companies I am looking for often don’t pay dividends as they reinvest into growth. I prefer NO dividends so the company can self-fund without debt and dilution. |
As a part of my quantitative fundamental analysis, I use these ratios along with other financial metrics. By evaluating the financial statements and considering other key components alongside the aforementioned numbers, I am able to stay focused on a certain segment of the market. Regardless of the metric or multiple used, consistency, sustainability, and evidence over consecutive years are crucial.
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