Quality and Fundamentals (Part 2)

In Part 1, I presented the critique of my EOG stock study and my rebuttal aided by Google AI. Today I want to go into further detail about “good fundamentals.”

My rebuttal basically argues that “up, straight, and parallel” makes for a quality stock and one worthy of study and potential investment. While discussed in many BetterInvesting® (BI) presentations, “up, straight, and parallel” does not really tell the whole story for BI.

At this juncture, I want to shout out a shameless plug for the BetterInvesting® South Florida Chapter “Learn to Earn” series. This is an online webinar taking place roughly five times per year between September and April. Registration is free for everyone and may be seen here.

In the January Learn to Earn webinar, Dr. Randall Buss succinctly defined a BI high-quality growth stock—otherwise known as a stock with good fundamentals. Here are the six criteria:

1.       Sales growth > 9% per year in a straight line
2.       Pretax profit growth > 10% per year in a straight line
3.       EPS growth > 10% per year in a straight line
4.       Pretax profit good to excellent relative to peers with nonnegative growth
5.       ROE > 15% per year
6.       Debt-to-Capital < 33% per year

Based on the above, I actually am not screening for “good fundmentals” when choosing what stocks to study. I look at the first three criteria without regard to magnitude. I look at the last three criteria for qualitative context but not for any concrete decision making. I personally believe Interest Coverage is more important than Debt-to-Capital and I look at M* and VL Financial Health, Capital Allocation, and Financial Strength ratings. I like to see companies that lead peer and industry averages but lack therein would not make for an instant cut.

What does make for an instant cut is lack of “up, straight, and parallel.” This amounts to failure of visual inspection.

I think what really matters here is largely unknown because we don’t have enough data to conclusively determine much less know what the future will hold. Investing the BI way, we want stocks that will realize 100% returns in five years (e.g. double in price if no dividend is paid).

Does a stock need to be high-quality growth to double in five years? I will continue next time with a long-standing debate in finance between growth and value stocks that calls into question whether high-quality growth is what we should even be looking for in the first place.

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