Compounding Quality Pieter Slegers
Valuation Ratio
1. FREE CASH FLOW YIELD (FCF
YIELD)
Free Cash Flow Yield measures how much
Free Cash Flow a company generates
compared to its market capitalization.
FCF Yield =
Free Cash Flow
Market Capitalization
Interpretation
A high FCF yield indicates the company is
trading at cheap valuation levels.
Try to find companies where the current FCF
Yield is higher than the average FCF Yield over
the past 5 years.
Compounding
Quality
Valuation Ratio
2. PRICE-TO-EARNINGS (PE)
RATIO
The PE (Price-to-Earnings) Ratio compares a
company’s stock price to its earnings (profits)
per share.
PE Ratio =
Share Price
Earnings per share
Interpretation
A lower PE might mean the stock is cheap,
while a high P/E might suggest people expect
growth in the future.
Look for companies where the current PE
Ratio is lower than the average PE Ratio over
the past 5 years.
Compounding
Quality
Dividend Ratio
3. DIVIDEND YIELD
Dividend Yield is the percentage of a
company’s stock price that it pays out to
shareholders as dividends each year.
Dividend Yield =
Annaul Dividend per share
Price per share
Interpretation
The higher the Dividend Yield, the more the
company pays out to shareholders.
PS: Do you want to learn about dividend
investing? Please check out Compounding
Dividends
Compounding
Quality
Profitability Ratio
4. FREE CASH FLOW MARGIN (FCF
MARGIN)
The Free Cash Flow Margin is the percentage
of a company’s sales that turns into Free Cash
Flow (money left after all expenses and
investments).
FCF = Operating Cash Flow - Capital Expenditures
FCF Margin = FCF / Revenue
Interpretation
The higher the FCF margin, the higher the
profitability.
Look for companies with a FCF Margin over
10%.
Compounding
Quality
Profitability Ratio
5. GROSS MARGIN
The Gross Margin shows how much money is
left after paying for the cost of making a
product (like materials and labor).
Gross Margin =
Gross Profit
Gross Revenue
Interpretation
A higher Gross Margin means the company
keeps more money from each sale to cover
other expenses and make a profit.
A high and consistent Gross Margin is a great
indication of pricing power.
I usually look for companies with a Gross
Margin over 40%.
Compounding
Quality
Capital Allocation
6. RETURN ON INVESTED CAPITAL
(ROIC)
The ROIC (Return on Invested Capital) gives
an indication about how efficiently the
company allocates its capital. If the ROIC is
15%, the business generates $15 in profit per
$100 of invested capital.
ROIC =
Net Operating Profit After Tax (NOPAT)
Invested Capital
Interpretation
A high ROIC indicates the company is
allocating capital efficiently.
I prefer a ROIC higher than 15%.
Compounding
Quality
Capital Allocation
7. RETURN ON EQUITY (ROE)
ROE (Return on Equity) shows how well a
company turns the money from its
shareholders (equity) into profits.
ROE =
Net Income
Average Total Equity
Interpretation
A high ROE means the company is good at
rewarding its owners (shareholders).
Companies with a ROE higher than 20% can be
seen as great businesses.
Compounding
Quality
Capital Intensity
8. CAPEX/CASH FROM
OPERATIONS
The CAPEX/Cash From Operations gives an
indication about the capital intensity of a
company.
The ratio shows how much of the Operational
Cash Flow is used for Capital Expenditures
(CAPEX)
Capex to Cash
Flow Ratio
=
Capital Expenditure
Operating Cash Flow
Interpretation
The less capital a company needs for its
regular business activities, the more money it
has for things such as paying down debt and
dividends.
I prefer this metric to be lower than 25%.
Compounding
Quality
Balance Sheet Ratios
9. NET DEBT/FREE CASH FLOW
(FCF)
Wondering how many years it would take for a
company to pay off its debt entirely? The Net
Debt/Free Cash Flow calculates this.
Net Debt/Free
=
Cash Flow (FCF)
Net Debt
Free Cash Flow
Interpretation
A lower number means the company can
handle its debts easily, which makes it less
likely to run into trouble.
I look for companies with a Net Debt/Free
Cash Flow below 4x.
This means the company should be able to
pay off its debt in less than four years when
they decide to use all free cash flow to pay
down debt.
Compounding
Quality
Balance Sheet Ratios
10. DEBT/EQUITY RATIO
The Debt/Equity Ratio compares how much
money a company borrows (debt) to how
much money its owners have invested
(equity).
Total Debt
Debt to Equity =
Ratio
Total Shareholders Equity
Interpretation
It shows how a company is financed.
A lower ratio often indicates the company
uses less leverage.
I prefer a Debt/Equity Ratio lower than 80%.
Compounding
Quality
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Pieter Slegers
Compounding Quality