5 Numbers To Watch Before Investing Your Money

Analyze the key fundamental metrics before investing your money (with python)

The motivation behind our investment decision is often to capture a return on our idle money, build wealth, and get financial independence earlier in life. As Robert Kiyosaki told in his best-selling book “Rich dad, poor dad”, let our money work for us, instead of us working for money.

I don’t think we need to go that route to discuss why we should invest our idle money. Since you are reading this article, that means you are already convinced or at least looking for a better way to utilize your money.

People have different expectations for the return on investment. But usually, the target is to beat the broader market index like the S&P 500 (an index of the 500 largest companies listed on US stock exchanges). Unfortunately, it’s difficult to find good businesses that are reliable and have the potential to outperform the broader market, consistently. The long-term return of the S&P 500 is around 8–10%, so ideally our target should be to identify businesses that will grow more than 10% year-over-year. Disclaimer: my personal target is a minimum of 15% growth per year.

Looking into past performances gives us a good hint of how the business is likely to perform in the future. Our target is to find businesses that have solid fundamentals and good historical performances. Here are the 5 key numbers that I observe closely in a business. And I look for businesses that have grown in each of these 5 areas by more than 15% in the last 10 years.

• Revenue Growth
• EPS Growth
• Equity Growth
• Free Cash Flow Growth
• ROIC (return on invested capital)

In the previous article, we touched upon the fundamental analysis of stocks and learned to gather historical information on a stock. In this post, we’ll get more constructive and collect these 5 key figures that will help us identify businesses that are likely to grow more than 15% yearly.

Revenue or Sales Growth

This indicates how much the sale is growing year over year. Revenue is also known as the “top line” because it’s found at the top of financial reports. This is very important for “high growth” companies because this can mean that the company is capturing the market share.

EPS Growth

EPS = Earnings / Shares Outstanding

Earnings per share (EPS) simply refers to the net profit for each share. It indicates the company’s profitability and that’s why Wall Street cares about this number a lot.

Equity Growth

Equity or Shareholders Equity = Assets - Liabilities

Equity, also known as book value, is found in the balance sheet of the company’s financial statement. This basically implies the intrinsic value of a company after subtracting all the liabilities.

Free Cash Flow Growth

The last type of growth rate we’ll consider is free cash flow (FCF) growth. Free cash flow represents the cash a company generates after deducting all the capital expenses (CapEx) and operating expenses (OpEx). This considers expenses like payroll, rent, taxes, and others. If the FCF is decreasing, that is not necessarily a bad sign. It might be because the company is investing in its growth.

ROIC

Return on invested capital (ROIC) is the rate of return a business makes on its invested capital. In other words, this indicates how efficiently or poorly the company is using its cash.

Each of these 5 key factors indicates a particular area of a business, but to judge the overall business we have to consider all 5 matrices together.

We want each of these growth rates to be above 15% per year on average over the last ten years and should be moving upwards, meaning the company is not slowing down.

Microsoft’s historical growth rate analysis

Let’s have a look at my favorite stock, Microsoft (MSFT), and inspect how they have performed over the last 10 years.

Similar to the previous article, I’m going to use the python library fundamentalanalysis, which offers three of the four key growth rates (revenue, eps, and free cash flow) through an API. The library also offers the yearly equity number, we just have to calculate the growth rate from that.

Let’s do this with Python:

I removed the eps growth graph from the chart because the high range of it scaled the chart in a way that the graph was difficult to read. You can uncomment the line and try it yourself.

From the chart, it’s visible that in recent years Microsoft really has turned the business around. We see a strong growing revenue, fcf, and equity growth. It’s well above 15% and increasing constantly. That is what we look for in a business.

Microsoft’s ROIC analysis

Perhaps the most important matrix is the ROIC. For ROIC we look for more than 15% average yearly growth for the last 10 years. Let’s see how that looks:

Similar to the growth rate, ROIC is also improving in recent years. For the last 5 years, yearly ROIC has gone above our expected threshold of 15%, and the average 10-year ROIC is even above 20%. That’s really impressive.

Conclusion

This is just the beginning. Once you find fundamentally stable and growing businesses, the next thing you want to know is at what price should you buy a stock. There are several valuation models to help you with that. That’s for another day. Till then, feel free to use the code and run a fundamental analysis on your favorite companies before investing your hard-earned money into them.

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