Sustainable growth increase is indispensable
The basis of successful investing is always long-term profit growth. Stable earnings growth not only increases the return on your investment, but also reduces the risk of a loss. The 100 best stocks worldwide are characterized by increasing profits over a longer period of time.
Important criteria for growth increases are sales and EBIT growth over the last five years and the next three years. A healthy combination of both growth criteria distinguishes quality companies. The average annual sales growth over the last five years (CAGR) shows how valuable a company is in the long term. Profit growth in the long term comes primarily from sales growth. A company that is to become steadily more valuable must therefore generate ever greater sales. The average annual expected sales growth over the next three years (CAGR) is necessary to look at future expectations. After all, when investors buy a stock, they benefit from all of a company's future profits. We are in a constantly evolving world where new technologies are increasingly being used. Therefore, it is important to look into the future and bet on tomorrow's winners.
The average annual operating profit growth (EBIT) over the last five years (CAGR) is growing steadily for quality companies. If companies can only increase their sales but not their EBIT growth, this is a dangerous sign. To be successful in the long term, companies must also increase their operating profit. The average annual expected operating profit growth (EBIT) over the next three years (CAGR) is also a key indicator for the future. This is because the value of a share is the result of all cash flows generated in the future, discounted to the present day.
Caution with trend stocks
Yesterday commodity stocks were trending, tomorrow it will be cannabis stocks. Many investors buy what is currently trendy and follow the herd instinct. This kind of investing is more like gambling in a casino than rational investing. Of course, fashion stocks can lead to high returns, but unfortunately it can go just as quickly in the other direction. Most of the time, these trend stocks are overpriced and do not generate long-term profits.
Minimise the risk
The stock market brings with it some risks. However, investors cannot prevent market risks such as inflation, interest rates, economic growth. Therefore, it is important to reduce the risk of the investment and in doing so we look at the following criteria: Net financial debt, profit continuity and EBIT draw-down. Eulerpool filters out risky business models for investors, so that in no case investments are made in pipe failures.
For quality companies, net financial debt is less than four times the company's operating profit. This is because high debt leads to higher risks, which investors want to avoid.
Calculation of net financial debt. Net financial debt = current financial debt + non-current financial debt - cash
In order to minimize the risk of your investment, you also need to look at profit continuity. Quality companies are characterized by the fact that they have no operating losses in the long term. Companies with steady profit have a stable business model and therefore reduce the risk.
Ultimately, the EBIT drawdown is important to find quality companies. EBIT must never have fallen by more than 50% in the last five years compared to the previous record profit in the 5-year period.
Profitability is an important benchmark for measuring and analyzing success. Profitability tells investors how efficiently the capital provided is being used. Two important ratios for putting the capital employed into perspective are return on equity (ROE) and return on capital employed (ROCE).
Return on equity is considered a measure of a company's profitability and its efficiency in generating profits. Therefore, a high return on equity is of great importance. A return on equity of more than 15 percent is very good, because then a company can easily finance itself from the profits it generates. However, a company's return on equity also depends on the industry in which it operates. For example, it is common for technology companies to have an ROE of more than 15 percent; for many companies in the utility sector, it is not unusual to have an ROE of less than ten percent.
ROCE is a financial ratio that can be used to assess capital efficiency independently of the capital structure. Even though ROCE is similar to return on equity, it cannot be manipulated by debt. A company should also have a value of over 15 percent for ROCE.
Avoid too high ratings
In the end, it is important to avoid too high a valuation, because no investor wants to enter a stock at too high a price. That's why it's important to find good value, quality companies based on a low price-to-earnings (P/E) ratio. But a low P/E ratio does not distinguish a quality company by a long shot; investors must also factor in expected returns.
Top companies are characterized by an expected annual return of over ten percent. The expected return depends on the current share price development. If a company's share price rises, so does its market capitalization and thus its expected return.