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Recently my analysis procedure turned up this equity (and another -- CLHL. I'm going to start a board on CLHL shortly, containing much the same info as is in this post). I thought I'd share what I found and how I got there, in case any one is interested.

I'm very interested in what people think about my results for FLXS as well as improving how I got there. The procedure is supposed to prioritize completeness first and time-efficiency second (Right off the bat, I could improve that with a screen that turns up more than 200 stocks. You'll see what I mean, below).

To start, I run 6 screens. The screens are similar, but turn up slightly different lists. So I combine them and eliminate the duplicates. At first run they turn up around 1200 issues. De-duplicating cuts that down to around 400 - 500.

Unfortunately, the screens are MSN Money Central screens (it's where I learned about screening!), so they're hard to post. Drop me an e-mail me if you'd like copies, and I'll be glad to send them to you.

A warning, though, the screens are pretty simple. I haven't taken the time to optimize my screening process. Having run through my procedure a few times now, I know the screen end of it can be better. For example, I currently use a combination of Money Central and Yahoo Finance to get data, collecting a lot manually. Running screens from both sites would probably save a lot of time.

As it is, I run 6 screens, cut out the dupes, and wind up with 400 - 500 possibilities.

FUNDAMENTAL
===========

1. The first thing I looked at (that the screens did not) was Times Interest Earned. If it's less than 1.0, I ditch the stock.

At 42.7, FLXS beats this by a large margin! Enough moola to pay its interest debt almost 43 times over. I like that.

2. Next, are the current and quick ratios similar? If the current is much bigger than the quick, then a lot of the assets on hand are inventory. Inventory degrades and is usually overvalued. Not good. If the current exceeds the quick I then check it against the industry average current ratio. A lot of the company's assets may be inventory, but that could just be an industry thing.

FLXS has a current ratio of 3.5 and a quick of 1.4. Digging a little farther, the industry average quick is also 1.4, so minus inventory, they've got the same assets everyone else does. The industry average current is 2.4. So their inventory situation bears digging into, but the company is not so drastically heavy in inventory as to disqualify it.

3. After collecting current asset, current liability and cash data from the balance sheets, I can look at working capital and cash. I do a couple of working capital and cash calculations:

a. The first, most simple question is - is it positive? FLXS has $67.6 mil in working capital, so - yes.

b. How does working capital compare to market capitalization? Is it greater than about 50%? FLXS is at 48.86%. Close enough for government work.

* * * SIDE NOTE If it's not close enough, I compare it to the industry average. If its better than the industry average, it's a keeper. I do this a lot, so lets call it the doing the industry average comparison or in acronymn land, doin' the IAC. Oh - and if anyone can point me to a convenient source of industry average numbers, I'd be greatly obliged. I've been calculating averages manually, and since any real statistical significance requires at least 30 data points it's been a pain. * * *

c. How about cash and market capitalization? Is it greater than or equal to about 10%? FLXS comes in at 9.25%. Not sterling (pun!), but enough in the money (another pun!) to keep (for now).

d. Taking inventory out of the picture, I look at working cap again. (Working cap - inventory) / market cap. I want to know if this number is similar to working cap / market cap. If it's not, then a lot of the working capital was due to inventory. Generally, I want at least half of real working capital to be due to cash. FLXS is 51.92% and that's pretty similar to 48.86%. FLXS stays in the running.

4. Now I want to see if FLXS is better than its peers at collecting its dough after a sale. I compare the FLXS Days Sales Outstanding (DSO) to an industry average. Lower is better here, so if its lower than the industry average I keep it.

At 36.14, FLXS collects its cash from a sale in a little over Net 30. That's good, so FLXS stays.

In fact, I'm willing to bend a little on DSO. Even if the rest of the industry does better, if a company's DSO is less than 40 I'll usually keep it. The thinking is that most bills don't really come due for 40 days (30 days + 10 days grace), so if a company's DSO is less than 40, it can keep ahead of its bills. And if a company does that, it has the time to fix it's problems, so I give the company the benefit of the doubt. For now.

* * * QUICK NOTE: Tell me if you think my method for calculating DSO is valid. I found DSO difficult data to collect, but I could get receivable turnover pretty easily. Theoretically, receivable turnover is the mathematical inverse of DSO, so I calculate DSO as (1/Receivable Turnover) x 365. Valid? * * *

5. Next, I take another look at Times Interest Earned. I want a company to not just be safe, but to be safer than its peers (otherwise, I should look harder at the peers, right?). So, I do another IAC and if Interest Coverage (same as Times Interest Earned) is bigger than the industry average, I keep the stock. FLXS passes this test too.

6. Now I need to look at some trends for FLXS. I like to look at the most recent 5 years.

* * * NOTE These are manual (not screen collected) calculations, too. If someone knows a place to easily compare trends, please tell me! * * *

a. Trend number 1 - Net Profit Margins. Are they trending up? If not, ditch it -- unless the last year was a real stunner (e.g. - 4% net profit margins for four years, but last year was 80%). If last year was a real stunner, maybe the company finally got a monkey off its back? Maybe not. More research would be required.

With FLXS, Net Profit Margins are lower than industry average, but they have been trending up for the past 3 years. Not the past 5. This suggests that something happened and the company is recovering from it. I'll keep it and investigate more later.

* * * NOTE I'll also keep it if net profit margins are flat, but significantly exceed the industry average. * * *

b. Trend number 2 - Sales. Are sales trending up? If not, ditch the stock. For FLXS, sales have recently begun trending up and greatly exceed the industry average. I wonder why.

* * * YET ANOTHER NOTE - I keep saying to 'ditch' the stock, but (in case you care), I don't actually do it so simply. I have a 'kill' list and a 'later' list. Failing some criteria puts a stock on the kill list -- I never look at it again. Failing others puts a stock on the 'later' list -- I'll look at it again if nothing else pans out. Equities for which I don't have enough data (or am too darn tired to collect more) wind up on the 'later' list. The later and kill lists also have a header for each step in the procedure. I put the failed stock under the header of the criterion for which it failed. This way I always know why an issue didn't make the grade and where I stopped analyzing it. * * *

c. Trends Number 3 & 4 - Debt / Equity ratio. Next I chart the trend in Return on Equity and the debt / equity ratios, preferrably over 10 years. Then I eyeball these trends (or if I'm feeling slow -- compute growth rates). I look for

i. Is debt/equity trending up faster than return on equity? If it is, the company is taking on more and more debt and getting less and less out of it. This is bad.

ii. It's even worse if at the same time the Interest Coverage is trending down. That means the company is taking on more and more debt, getting less and less out of the debt, and becoming less and less able to pay for the debt.

If I see either of these (i or ii) I ditch (move to the later list) the stock. If I see both of these I really ditch the stock (move to the kill list).

For FLXS, return on equity has been trending up solidly these past 4 years. In '00 it was much higher, then plummeted. Something happened to the company between 2000 and 2001 (or maybe to the industry) -- you can see it all over the nubmers: sudden drops in profit margin, stock price decling until 2000, etc.

But I'll take 4 years as an upward trend. Debt, on the other hand, first appears in this year, is lower than the industry average (leverage ratio of 1.6 vs. 1.8), is lower than the industry average relative to equity (debt/equity ratio of .19 vs. .25) and isn't trending anywhere. When I see things like this, I make a note to myself. In this case, to find out what prompted the company to take on debt for the first time since 1995 -- then I move on.

d. Trend number 5 - long term debt. Is it trending down? If it's not is it growing faster than return on equity? This is the same question as in c., but isolates long-term debt from total debt. For FLXS, they have no long-term debt so this is not an issue.

All the previous stuff was about fundamentals. Now I want to get a sense for how the market is valuing this company.


TECHNICAL
=========

7. The first valuation thing I do is decide which of three ratios is the most important for this business: price / book value, price / cash flow, or enterprise value per share.

a. I use price / book with financial companies like banks, consumer loan concerns, brokerages, credit card companies, mortgage investment concerns, and owners of real estate. I want about 1.7 or less.

b. Price / Cash Flow is for industries that involve tremendous up-front capital expenditures and companies that have large amortization burdens, like telecom. Here I like to see about 7 or less.

c. Enterprise value per share is for everything else. The truth is that I always look at EV / Share, even if I'm also looking at price / book. Less than 1.0 is real good. Less than 2.0 is a requirement.

FLXS is definitely an EV / Share company. Its rating is 1.67. So, while it could be better, a 1.67 doesn't disqualify the company outright.

8. Now it'stime to include growth and calcuate the PEG and YPEG. I always try to get both. If they are radically dissimilar that tells me to dig further into the growth story. For FLXS, once we put projected growth into the picture, the numbers gets rosy. PEG is at .49 and YPEG is .70

The fool ratio chart tells us anything less than .5 is a buy. Personally, I'm less inclined to trust the YPEG (especially for small companies) then I am to trust the PEG, because I believe all analyst crystal ball's get cloudy the farther out they are attempting to predict.

I'm excited by FLXS's PEG of .49

9. I also like to take a look at the price / sales ratio. In the best of all worlds, this should be less than 1.0. If it's not, I want it to have a P/E significantly lower than the price / sales. If it doesn't I ditch it.

FLXS passes this criteria too. It's price / sales is .38

10. Speaking of P/E:

a. is the stock's P/E lower than the industry average P/E? If not, I ditch the stock. FLXS's P/E is 13.9 and the industry average is 19.5. If I believe FLXS has done something that at a future date will make it valued more like its peers, this is a good sign. I'll need to check the story behind the stock to see, though.

b. I also want to know if the stock is trading lower than its own 5 year average. In this case, it's not. FLXS's P/E is at 13.9 and its 5 year average P/E is 12.1.

This could mean a couple of things: the company may be in the process of becoming worth more money; ergo the 13.9 P/E. That thinking is supported by the growth projections and the new debt.

On the other hand, the company's P/E may be likely to trend down toward it's average; especially, I think, if its business as usual at FLXS. Again, I'll need to dig into the stock's story to make a reasoned judgement.

But nothing in P/E land knocks FLXS out of the running for me. Continuing on...

11. Next I want to look at free cash flow (FCF). I've already got Enterprise Value and the most conservate analyst growth estimates, so I grab FCF (either from Yahoo Finance or I calculate it from the financials -- I haven't decided which is more accurate, yet). Then I compare:

a. EV / FCF -- I want it <= 10. FLXS is 25.73; however,with growth in the picture

b. EV / FCF / G -- I want <= 1.5. <= 1.0 and I'll get downright excited, but less than or equal to 1.5 is a must. FLXS comes in at 1.29.

This is a little confusing to me. I take it to mean that today, given how much the company is really worth, FLXS sould be generating more free cash flow. On the other hand, analysts expect them to grow in ways that will produce a more reasonable relation between the true value of the enterprise and how much genuinely available-for-use-on-anything cash it produces.

It makes me wonder (again) about this company's use of debt. Maybe they invest new cash worse than their peers, so have been afraid to try and grow the business? Maybe they've changed their minds about that, hence the new debt? Is there a new CFO or other management? A recent change in the board of directors or the regulatory environment?

Pending more digging, FLXS still interests me.

12. The stock pays a dividend of 2.4% -- that's at least a little hedge for the investing risk (not really, though, since it's less than inflation, but that's a different discussion) -- so I need to calculate the payout ratio. FLXS's is 55.5%. And since, in a growth company (REITS, Banks, and Utilities are different), I want a payout ratio of around 50% or less, this is good. It means FLXS hasn't overcommitted its free cash flow to paying a dividend. They are keeping about half of it for other purposes (growth, we hope).

Also, if I wanted this stock for it's dividend I'd be concerned about the dividend growth rate (1.46% in 5 years) and the yield growth rate (3.7% in five years).

13. Finally, in the numbers portion of the analysis I check insider ownership. According to MSN Money Central, with FLXS, insider and 5% ownership accounts for 19.8% of ownership, with 2 officers of the company owning 12.1% between them. Since I want insider ownership to be > 10% and less than 50%, this is good enough for me.

There is one last metric I usually calculate, but haven't yet. That is share dilution. I don't want to see it grow. At all. I'm willing to accept up to (but less than) about 3%, but I've been convinced that 0% is to be preferred.


QUALITATIVE
===========
As the heading suggests it's now time for the qualitative analysis. But I haven't done that yet. I'd love it if a discussion popped up regarding the qualitative side of this stock. Maybe someone out there in Fooldom can answer some of the following questions:


STUFF THE NUMBERS RAISED FLAGS OVER
===================================
1. Has something changed at the company recently?
2. What's the story with this industry? Any developments in the past year?
3. How do they value their inventory? LIFO, FIFO?
4. What's the inventory story - sales are up, are they just not clearing the stuff out? Did someone default on them recently?
5. What happened to the company (or the industry) between 2000 and 2001? That's where the numbers go wonko.
6. What's behind the recent upward trend in sales?
7. What is with this company and debt? Why no debt since 1995? Why debt now?
8. I'm not after the dividend with FLXS, but it doesn't hurt to ask why they've grown it so little. Don't shareholders deserve to benefit? Or have they just done a lousy job of growing? If the latter, what's different?
9. Why are the analysts (all 1 of them) convinced this company will grow 30.16% in '04 and 15.85% in '05? I wish there were more analysts on this. This leads to the big question:
10. What is this company doing different today that justifies belief in that growth tomorrow. This is different from why the analyst believes in growth. I want the company story: what has it started doing differently (if anything)? What new thing has happened that portends an abundant future?


THE NORMAL STUFF TO ASK AND DO
==============================
Some of this is a repeat of the above, but you'll get the gist. I like to...

1. Find out if the management team has been in place for a long time and are they seasoned?
2. Find out about the company's product(s) or service(s). Be familiar with how it is improving and what the demand for it is.
3. Read up on the company. Find books and articles on it.
4. Figure out what the company's business model is. How is it making money? How is it organized? How might the model change in the years ahead? On what assumptions is the model based?
5. Examine the company's competitive environment. What are its competitors up to? Is the company likely to fend off attacks? What advantages does the company have over the competition? Is it at any disadvantage? How is the industry changing and what challenges does it face?
6. Think about the company's risks. In SEC filings, particularly 10-K reports, the company's management will have explained some risks that they see.
7.Talk to people in the business, such as company employees, suppliers, people in stores that sell the company's products, customers of the company, people familiar with competitor companies, and so on. See how they perceive the industry and where it's headed. See what they think of the company you're studying and its future prospects.
8. Evaluate how sustainable a company's competitive advantages are
9. Learn how long has the company been in business and check if any data is missing for those years
10. Read what the accountants said about the financial reports? Qualified or Unqualified? Read the foot notes.

Just a reminder: if anyone is interested, I'm going to make substantially the same post for a different company (CLHL).

- knihi
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