It can be quite a lengthy process to properly research a stock. That’s why I established a few guidelines to help me identify stocks worthy of further research. In this article, I will use these guidelines to evaluate the attractiveness of True Religion Apparel, Inc. (Nasdaq: TRLG) as a candidate for potential further research. All the data I need to do that can be obtained from Google finance.
I usually look for stocks with low P/E ratios or at least reasonable P/E ratios (generally about 13-15 for blue chips, maybe a bit higher for the really good quality ones), but may accept a higher P/E ratio if the stock has good revenue and profit growth. True Religion has a P/E ratio of a bit more than 10.5 at the time of writing. That’s very good, considering True Religion has had pretty good revenue and profit growth.
Revenue and profit growth
I also look for companies that are growing profits and revenue healthily, and True Religion is doing great in those categories. True Religion grew revenue from about 140.5 million USD in the year 2006 to about 310 million USD in the year 2009. Operating income grew from about 35 million USD in 2006 to about 77.5 million USD in 2009. In percentage terms, from 2006 to 2009, True Religion had a compounded annual growth rate of about 30.2% for revenue and a compounded annual growth rate of about 30.3% for operating income.
Profit margins and return on equity
Investors should generally look for companies with high profit margins and high returns on equity. True religion had an operating profit margin of around 25% and a return on average equity of about 28% in 2009; all in all, pretty good. I looked at operating income growth and operating profit margin instead of net income growth and net profit margin, as the operating profit is the one that gives us the better picture of the company’s everyday business performance.
True Religion might have earned lower profits in the second quarter of 2010, but there will only be trouble if we base our investment decisions only on the latest quarterly reports. Investors need to look at profit growth in terms of years, and True Religion has had stellar growth over the past few years.
Companies don’t always grow straight up, they are capable of having some down years, which is OK; what matters after all is long-term growth. I believe that True Religion is still a very attractive candidate for further research, where we can try and determine, among other things, if the drop in profit is due to permanent impairment to True Religion’s business or if it is a result of the company spending more on activities like opening new stores, which will set True Religion up for greater future profits.
Low debt and good liquidity
Everyone knows that too much debt is bad, and that’s why I usually look for companies with low or at least reasonable debt levels. Liquidity is also very important, as there have been many companies that got into trouble because of a lack of liquidity. At this stage, I simply look at current assets to current liabilities to determine if a company has ample liquidity, I will take into account things like inventory turns and etc later when I look into the annual reports and conduct proper research.
At 2010/06/30, True Religion had 120 million USD in cash and short-term investments to only about 35 million USD in total liabilities, which indicates the company has good liquidity and very little debt.
If a company meets the guidelines that I have set, I would then consider digging into at least its latest annual report and its latest quarterly report, and conduct thorough research. When conducting proper research, all decisions that require information from the financial statements should be based on the financial statements in the company’s annual report, as I think that’s the best source.
In my personal opinion, I think True Religion meets the guidelines I have set. But as always, decisions to invest or to single out stocks for further research should be independent and based on your own research. If you liked this article, you might like to check out: Real Estate Real Returns and Things I think about before making investment decisions. Take care and may your portfolios generate good returns.
About the Author:
Justin Teo is a private investor and is currently studying for his degree in international business.