Prosperity

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Prosperity

The Prosperity model is a growth oriented analysis that is based on the assumption that the lower a company's stock price is relative to its sales, the more attractive its stock is — presuming the company is also growing its earnings and has a strong balance sheet with little debt.

The Prosperity model primarily relies on analysis of Price-to-Sales ratios (PSR) in order to identify attractive stocks.

The model also recognizes that appropriate levels for price-to-sales ratios and other fundamental analysis metrics (such as the "Price-to-Research" ratio for technology and medical companies) will vary depending on the size of the company and the industry in which it operates: the model has been designed to take these variations into account.

This analysis style is well-suited for investors who want to own conservatively financed, well-growing companies that have been overlooked—hopefully temporarily—by the rest of Wall Street.

Analysis / Calculation

As with many of ValueGain's fundamental analysis types, the Prosperity model is divided into two stages.

First Stage

To pass the first stage, a company must have high returns that can be predicted with a high degree of certainty.

Some of the criteria in the first stage of analysis include the following.

Price / Sales per Share Ratio (PSR)

The price to sales ratio is one of the most important ratios for determining whether a stock is overvalued or undervalued in relation to its peers. The price to sales ratio is calculated by dividing the share price by sales.

Prosperity looks aggressively for stocks with a PSR of less than 1.5 although the model will still hold the stock until it has a PSR of 3.

A PASS rating means that a stock has a PSR of at least 3.

A FAIL rating is given to stocks with a PSR of greater than 3.

Total Debt / Equity Ratio (D/E)

Companies like this are usually net borrowers of money.

The Debt-to-Equity ratio measures how much debt the company has compared to shareholders equity. The debt to equity ratio is important in gauging a company's financial stability. The ratio is calculated by taking total debt and dividing it by shareholders equity.

If debt to equity is too high then the company may run into financial difficulty. If it is too low, it may indicate that the company is foregoing possible opportunities to create more return to shareholders.

The Prosperity model looks for a debt to equity ratio below 40% as the model assumes this means less risk.

A PASS rating reflects a debt to equity ratio less than 40%.

A FAIL rating means that the stock has too much debt to comply with the model's criteria.

Price / Research Ratio (PR)

Some industries such as the medical or technology sector should be looked at differently because of their need for research and development.

The price to research ratio (PRR) measures the research and development spend in comparison to the size of the company. It is calculated by dividing the market capitalization by the research and development spend over the past 12 months.

Prosperity says that a PRR below 5 is rare and should be purchased, a PRR between 5-10 also represents a bargain but a PRR up to 15 is acceptable.

A PASS reflects a PRR of 15 or less.

A FAIL represents a stock that fails Prosperity's requirement for spending on research and development.

The PRR criterion is only relevant for medical and technology companies.

Second Stage

There are four major parts to the Second Stage analysis.

Price / Sales Ratio (PSR) - Super Stocks

The Price-to-Sales ratio is one of the most important ratios for determining whether a stock is over-valued or under-valued in relation to its peers. The price-to-sales ratio is calculated by dividing the share price by sales.

Prosperity looks aggressively for stocks with PSR of 0.75 or less.

To PASS the criteria for a “super stock”, a stock must have a PSR of 0.75 or less.

A FAIL rating reflects a stock with a PSR greater than 0.75.

Inflation Adjusted Long-term EPS Growth Rate

The EPS Growth Rate is the rate at which the company is growing its earnings from year to year. To pass Prosperity's criteria for a “super stock”, a company must have an inflation adjusted long term EPS growth rate of at least 15%.

A PASS reflects a company that has had an inflation adjusted EPS growth rate of 15% or more over the last 5 years.

A FAIL indicates that the company has not been able to grow earnings by 15% or more, after an adjustment for inflation has been made.

Free Flow Cash per Share

Earnings can fluctuate because of variables such as spending on research and development or a change in the accounting method. Hence, cash flow is often viewed as a more accurate representation of how healthy the company is. After all, cash represents what the company has to spend. Free cash flow per share is how much cash the company has left over after it has paid all expenses.

Prosperity requires a company to have positive free cash flow to qualify as a “super stock”. If the company has negative free cash flow, then it must have enough cash to cover 3 years of negative free cash flow.

A PASS reflects that a company has positive free cash flow.

A FAIL is a company with negative free cash flow.

Note - A company with negative free cash flow may still qualify as a “super stock” but you will need to check to see whether it has enough cash to cover 3 years of negative free cash flow.

5 Year Average Net Profit Margin

The net profit margin is a representation of how well the company does at controlling costs. The higher the margin, the better the company is at converting revenue into profit. It is calculated by dividing the total net income for the year by sales for the year.

To qualify as a Prosperity “super stock”, a company must have an average net profit margin which is 5% or greater over 5 years.

A PASS reflects a company with an average net profit margin 5% or greater over 5 years.

A FAIL means that a company's average net profit margin was not high enough to qualify as a Prosperity “super stock”.

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