While judging the financial health of your stocks, it is imperative to look at the holistic picture and not just a few parameters. Factors that could help you determine how well your stock is doing could be its free cash flows, bottom line performance, revenue trend, price momentum, debt levels, fluctuation in the EPS, and so on.
In fact, these parameters are not even close to the count that must be considered for the broader picture. This is where the “Financial Health” tool of InvestingPro+ comes to the rescue which does all the job of analyzing the stock and gives a score (rating) to each of them.
Let us take the example of HDFC Bank (NS:HDBK), the largest private-sector bank in India with a market capitalization of INR 12,07,901 crore.
Cash Flow Health - 1.38/5
As can be seen from the image below, the tool has analyzed all the ratios that help to make a judgment of the cash flow situation of the company such as asset turnover, cash ratio, debt/equity ratio, etc., and gave a score out of 5 to each one. The final score was calculated by taking the average of all, which was 1.38/5.
What we need to make sure is, the average does not go below 3, else that specific parameter is considered not so strong.
Growth Health - 2.72/5
Growth parameters such as EPS trend, gross profit, revenue growth, operating income, etc are taken into consideration for a health check on the growth aspect of the company. The avg. score is 2.72, which is good as it’s almost 3.
We consider a score of 3 to be the benchmark and slipping below which is a sign of caution. However, if you look at the EPS trend score, which is 5, gives us some confidence that investors earlier had.
Price Momentum - 2.41/5
If investors also blend some aspects of technicals into their fundamentally strong picks, they can do noticeably better and hence the price momentum is also included in the overall quality of the stock. Simply, it does not make sense to hold strong stocks in the portfolio if they haven’t been moving an inch for the last many months.
There’s always an opportunity cost to pay and therefore we don’t want laggards to be in the portfolio. The tool calculates the price momentum over various time frames and gives a score for every time frame, the average is then taken to arrive at the final momentum score. This metric alone can be used to pick high-momentum stocks in the portfolio, irrespective of their fundamentals, something which I do often. The time frames can also be excluded as per the liking of the investor.
Profitability Health - 3.12/5
This is an important area to focus on. Luckily, HDFC Bank has a score of over 3 here. The bottom line is extremely important for a company and this is what most shareholders are concerned about.
If you look at the parameters here, the “net income to the company” has a score of a perfect 5. Hence, investors can sit for the long term. This metric can help to stay the course.
Relative Value - 2.6/5
The last but one of the most imp. parameters is the valuation relative to the peers. No matter how good the counter is, it is imperative to buy when the valuations are comforting to not just have a higher potential for profitability but also to increase the margin of safety.
This is where HDFC is looking weak with a score of 2.31. This simply implies that there are other lucrative opportunities in the market if investors are willing to take exposure to the banking space. So investors who are waiting to buy HDFC Bank shares can wait for the ratings to improve.
Now, with some parameters good and some not-so-good, how would you decide whether HDFC Bank is a good portfolio stock or not? The answer lies in eliminating the extreme ends via averages. The final financial health score is taken as the average of the scores of all 5 above-mentioned parameters. This final figure is the “Ultimate Health Check” for your stock, which is 2 in the case of HDFC Bank. As long as this score is below 3, you can think of avoiding it.
This is how I do a quick health check of the stocks I hold in my portfolio via InvestingPro+ and stay informed about when to exit them.
Read More: 2 Undervalued Stocks with 20% Upside to Keep a Tab On
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