When researching a company it pays to set up a guide to evaluate the merits of a potential investment. The six-point inspection below represents an example of how an investor can navigate their investigative process.
1.) What does the company do?
Let's look at FTD Companies (NASDAQ: FTD) which sells floral arrangements and gifts to retail florists, consumers, and other businesses that need gift and floral solutions. The company was founded in 1910 under the original name of Florists' Telegraph Delivery Association which conveyed its original business model of florists around the country taking and giving distant orders. The florist receiving the order delivers the products locally eliminating the need for distance transportation, lowering freight costs and increasing freshness. The FTD logo is displayed in 40,000 locations worldwide.
Looking at FTD Companies' fundamentals, its revenue increased 7% since 2011. However, its net income and free cash flow decreased 19% and 36% respectively. The top line increase came from across the board increases from its consumer, florist, and international segments. Transaction related costs due to the spin off from United Online (NASDAQ: UNTD) contributed to the decline in net income and free cash flow during that time.
So far this year, FTD Companies' revenue only increased 1% while net income decreased 3%. The florist and consumer segment served as a drag on revenue and contributed to net income retraction. Most of the expansion in overall revenue came from its international segment. On the plus side, FTD Companies saw its free cash flow increase 48% due to a decrease in capital expenditures.
On FTD Companies' most recent balance sheet, its $63.5 million in cash represents a healthy 20% of stockholders' equity. However, long-term debt clocked in at 71% of stockholders' equity. Long-term debt creates interest which chokes out profitability and cash flow. I recommend that investors look for companies with long-term debt to equity ratios of 50% or less. However, operating income exceeded interest expense by 10 times. The rule of thumb for safety here resides at five times or more.
3.) Report of independent registered public accounting firm
Pay attention to the letter from a company's external auditors to its board of directors. Generally they issue an "unqualified" opinion indicating that the financial statements are fairly represented. They also give indication over the effectiveness of internal controls over financial reporting.
It's relevant to note that FTD Companies states up front in its latest 10-K that it falls under the Emerging Growth Company reporting requirements. As part of the Jumpstart Our Business Startups Act certain small companies don't have to provide attestation on internal controls on financial reporting or comply with any new financial accounting standards until the rules becomes applicable to comparable private companies based on the law. With that said, FTD Companies' auditing letter from its external auditor indicates that the financial statements were represented fairly. However, it provided no guidance on its internal control over financial reporting.
4.) Management-employee ownership
Look for companies where the senior executives and employees retain an ownership interest. Managers who own stock in the company they run will take better care of the fundamentals. In essence, their interests are aligned with shareholders in general. FTD Companies' proxy statement reveals that current directors and executives only own roughly 1.3% of the company, meaning that no extra incentive is provided on that front.
5.) Types of risks
Assess risks such as political risks, competitive positioning, and stock price valuation. FTD Companies primarily operates in the United States, Canada, United Kingdom, and the Republic of Ireland. However, it maintains some presence in floral shops in 150 countries. This means it possesses some political risk exposure as some countries may decide to steal the logo or disrupt its customer base via war.
FTD Companies' reliance on its worldwide floral network gives the company a profitability advantage over its publicly-traded competitor 1-800-Flowers.com (NASDAQ: FLWS). 1-800-Flowers.com relies on a combination of a network of florists as well as its own store and distribution infrastructure which invokes overhead costs. According to Morningstar, FTD Companies' operating margin registered at 5.4% vs. 3.5% for 1-800-Flowers.com in 2013.
Valuation metrics indicate that FTD Companies resides in the overvalued range. FTD Companies trades at a P/E ratio of 52 vs. 18 for the S&P 500 according to Morningstar. Earnings yield clocks in at 1.9% versus 5.5% for the S&P 500. This company's price quotation may suffer more than your average publicly-traded business if the stock market corrects.
6.) Forward analysis
Flowers and feel good gifts represent a luxury that people can do without in hard times. This means that this company's fundamental performance correlates closely to the economy. FTD Companies rests on a pretty good cash cushion to help it survive an economic downturn. However, investors may want to wait for a market correction before jumping in.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.