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"Advice is what we ask for when we already know the answer but wish we didn't."

Erica Mann Jong

In the learning to fish series a wealth of key ratios are provided and one of the plays is picked as our favorite play. We list several reasons for picking this play and in doing so hope to impart some knowledge to those who are new to the field of dividend investing. A lot of ratios will be used throughout this article, and it would be best for investors to get a handle on some of these ratios as they could prove to be very handy in separating the wheat from the chaff.

Net income - it should be generally trending upward for the past three-four years. There are exceptions to this rule; for example if the net income has dropped but if operating cash flow is more than enough to meet the dividend payments and the company has a long stellar dividend history then some leeway can be provided. An example is Exelon Corp. (NYSE:EXC).

Total cash flow from operating activities - it also should be trending upward for the past three-four years.

Payout ratio - it should generally be below 100%, but a ratio below 70% is optimal. Payout ratios are not that important when it comes to MLPs/REITs as they generally pay a majority of their cash flow as distributions; in the case of REITs by law they have to pay out 90% of their cash flow as dividends. Payout ratios are calculated by dividing the dividend/distribution rate by the net income per share, and this is why the payout ratio for MLPs and REITs is often higher than 100%. The more important ratio to focus on is the cash flow per unit. If one focuses on the cash flow per unit, one will see that in most cases, it exceeds the distribution/dividend declared per unit/share.

Current ratio - should be above 1

Interest coverage ratio - any value above 1.5 is okay, but we would aim for 2.5-3.00 as our starting range. The higher the number the better.

Dividend growth rate - it should be at 5% or higher. A high yield with a low dividend growth rate is not good in the long run, but neither is a low dividend yield with a high growth rate; one needs to find an equilibrium here.

Five year dividend average= we generally aim for stocks that have a yield of 4.5% or higher. There are exceptions to this rule. Some stocks appreciate very fast, so even though the yield might be low, one can more than make up the difference through capital gains. Some examples are Jarden Corporation (NYSE:JAH) Common Stock, Potash Corporation of Saskatche (NYSE:POT), Cerner Corporation (NASDAQ:CERN), etc.

Sales - they should generally be trending upwards for the past three-four years.

Levered free cash flow - this is the icing on the cake; if a company meets most of the above requirements and also has a positive levered free cash flow, it can generally be viewed as a good long-term buy. Two examples are Leggett & Platt (NYSE:LEG) and Procter & Gamble Company (NYSE:PG).

An early warning signal that the company could be in trouble is when the total cash flow generated from operating expenses is not enough to meet the dividend payments. This information can be gleaned by looking at the cash flow statement; this is readily available at yahoo finance. In the example below we used LEG and the data was obtained from yahoo finance.

The cash flow in this case was more than enough to easily cover all the dividend payments for all the above years; in this the time period was from 2008-2010.

Many traders use other metrics and that is fine; we are just trying to provide a guideline. As you get better handle of the ratios explained below you can create your own list of criteria.

Long-term debt-to-equity ratio - is the total long-term debt divided by the total equity. The amount of long-term debt a company carries on its balances sheet is very important for it indicates the amount of money a company owes that it doesn't expect to pay off in the next year. A balance sheet that illustrates that long term debt has been decreasing for a few years is a sign that the company is doing well. When debt levels fall, and cash levels increase the balance sheet is said to be improving and vice versa. If a company has too much debt on its books, it could end up being overwhelmed with interest payments and risk having too little working capital which could in the worst case scenario lead to bankruptcy.

Operating cash flow - is generally a better metric than earnings per share because a company can show positive net earnings and still not be able to properly service its debt; the cash flow is what pays the bills.

The payout ratio - tells us what portion of the profit is being returned to investors. A pay out ratio over 100% indicates that the company is paying out more money to shareholders, then they are making; this situation cannot last forever. In general if the company has a high operating cash flow and access to capital markets, they can keep this going on for a while. As companies usually only pay the portion of the debt that is coming due and not the whole debt, this technique/trick can technically be employed to maintain the dividend for sometime. If the payout ratio continues to increase, the situation warrants close monitoring as this cannot last forever; if your tolerance for risk is a low, look for similar companies with the same or higher yields, but with lower payout ratios. Individuals searching for other ideas might find this article to be of interest 3 First-Rate Growth Plays And 2 To Take Or Leave

Current Ratio - is obtained by dividing the current assets by current liabilities. This ratio allows you to see if the company can pay its current debts without potentially jeopardizing their future earnings. Ideally the company should have a ratio of 1 or higher.

Price to free cash flow- is obtained by dividing the share price by free cash flow per share. Higher ratios are associated with more expensive companies and vice versa; lower ratios are generally more attractive. If a company generated 400 million in cash flow and then spent 100 million on capital expenditure, then its free flow is $300 million. If the share price is 100 and the free cash flow per share are $5, then company trades at 20 times-free cash flow. This ratio is also useful because it can be used as a comparison to the average within the industry; this gives you an idea of how the company you are interested in holds up to the other companies within the industry.

Interest coverage- is usually calculated by dividing the earnings before interest and taxes for a period of 1 year by the interest expenses for the same time period. This ratio informs you of a company's ability to make its interest payments on its outstanding debt. Lower interest coverage ratios indicate that there is a larger debt burden on the company and vice versa. For example if a company has an interest ratio of 11.8, this means that it covers interest expenses 11.8 times with operating profits.

Price to tangible book is- obtained by dividing share price by tangible book value per share. The ratio gives investors some idea of whether they are paying too much for what would be left over if the company were to declare bankruptcy immediately. In general stocks that trade at higher price to tangible book value could leave investors facing a great percentage per share loss than those that trade at lower ratios. The price to tangible book value is theoretically the lowest possible price the stock would trade to. Additional key metrics are addressed in this article Analyzing 5 Dividend Plays: 1 Excellent, 2 Good And 2 Middling.

Intuitive Surgical Inc (NASDAQ: ISRG) is our favorite play on this list for the following reasons:

  • It has a good levered free cash flow of $509 million.
  • It has a five-year sales growth average of 35%
  • Gross profit has surged from $751 million in 2009 to $1.27 billion in 2011.
  • A long-term debt to equity ratio of 0.00
  • It has a very strong balance sheet; Cash and Cash Equivalents have increased from $221 million in 2009 to $465 million in 2011.
  • Cash flow from operating activities has increased from $392in 2009 to $677 million in 2011.
  • Net income has increased from $233 million in 2009 to $495 million in 2011.
  • EBITDA has increased from $431in 2009 million to $756 million in 2011.
  • Cash flow per share has almost doubled from $7.30 in 2009 to $13.89 in 2011.
  • It sports a decent ROE of 21%
  • A good earning's growth rate of 24.8%
  • A strong revenue growth rate of 27.6%
  • Analyst's High estimates for EPS are $15.04 for 2012 and $17.39 for 2012.
  • Annual EPS before NRI has almost increased by 232% from $3.70 in 2007 to $12.32 in 2011.
  • It sports excellent current and quick ratios of 4.57 and 4.22 respectively.
  • A very strong total return for the last three years of 425%
  • Recurring revenues continue to grow as a proportion of total sales; they increased 30% in fiscal 2011 and accounted for 56% of total revenues during the year.
  • It operates in a niche market and has no direct competition; it acquired its only threat, Computer Motion in June 2003.
  • It issued guidance, which can be construed as positive for 2012. Total procedure count is expected to increase between 24%-26% in 2012. Revenues are expected to increase by 17%-19% in 2012. Operating income is projected to rise in the range of 39%-40%.
  • $100K invested for 10 years would have grown to $2.3 million dollars.

Intuitive Surgical Inc

Industry: Medical Instruments & Equipment

Levered Free Cash Flow: 509.35M

Growth

  1. Net income for the past three years
  2. Net Income 2009 = $233 million
  3. Net Income 2010 = $382 million
  4. Net Income 2011 = $495 million
  1. EBITDA 12/2011 = $756 million
  2. EBITDA 12/2010 = $613 million
  3. EBITDA 12/2009 = $431 million
  4. Net income Reported Quarterly = $226 million
  1. Total cash flow from operating activities
  2. 2009 = $392.2 million
  3. 2010 = $545.8 million
  4. 2011 = $677.6 million
  1. Cash Flow 12/2011 = 13.89 $/share
  2. Cash Flow 12/2010 = 10.75 $/share
  3. Cash Flow 12/2009 = 7.3 $/share
  1. Annual EPS before NRI 12/2011 = 12.32
  2. Annual EPS before NRI 12/2010 = 9.47
  3. Annual EPS before NRI 12/2009 = 6.23
  4. Annual EPS before NRI 12/2008 = 5.12
  5. Annual EPS before NRI 12/2007 = 3.7

Performance

  1. ROE = 20.77%
  2. Return on Assets = 17.96%
  3. Quarterly Earnings Growth = 24.8%
  4. Quarterly Revenue Growth = 27.6%
  1. Key Ratios
  2. Price to Sales = 11.95
  3. Price to Book = 7.81
  4. Price to Tangible Book = 8.54
  5. Price to Cash Flow = 38.14
  6. Price to Free Cash Flow = 35.3
  1. Current Ratio 09/2011 = 4.57
  2. Current Ratio 5 Year Average = 4.7
  3. Quick Ratio = 4.22
  4. Cash Ratio = 3.3
  1. Total return last 3 years = 425.48%
  2. Total return last 5 years = 374.38%

Priceline.com, Inc. (NASDAQ: PCLN)

Industry : Business Services

Levered Free Cash Flow : 974.69M

Growth

  1. Net income for the past three years
  2. Net Income 2009 = $489 million
  3. Net Income 2010 = $528 million
  4. Net Income 2011 = $1056 million
  1. EBITDA 12/2011 = $1477 million
  2. EBITDA 12/2010 = $850 million
  3. EBITDA 12/2009 = $526 million
  4. Net income Reported Quarterly = $226 million
  1. Total cash flow from operating activities
  2. 2009 = $509.67 million
  3. 2010 = $777.3 million
  4. 2011 = $1.35 billion
  1. Cash Flow 12/2011 = 24.52 $/share
  2. Cash Flow 12/2010 = 14.23 $/share
  3. Cash Flow 12/2009 = 10.23 $/share
  1. Annual EPS before NRI 12/2011 = 22.32
  2. Annual EPS before NRI 12/2010 = 12.25
  3. Annual EPS before NRI 12/2009 = 7.87
  4. Annual EPS before NRI 12/2008 = 5.09
  5. Annual EPS before NRI 12/2007 = 3.53

Performance

  1. ROE = 52.69%
  2. Return on Assets = 42.14%
  3. Quarterly Earnings Growth = 66.3%
  4. Quarterly Revenue Growth = 35.5%
  1. Key Ratios
  2. Price to Sales = 7.72
  3. Price to Book = 13.06
  4. Price to Tangible Book = 17.99
  5. Price to Cash Flow = 27.55
  6. Price to Free Cash Flow = 27.4
  1. Current Ratio 09/2011 = 2.77
  2. Current Ratio 5 Year Average = 1.87
  3. Quick Ratio = 2.77
  4. Cash Ratio = 2.53
  5. Interest Coverage 09/2011 = 36.77
  6. Total return last 3 years = 740.7%
  7. Total return last 5 years = 1206.32%

Molycorp Inc. (NYSE: MCP)

Industry : Metal Products

Levered Free Cash Flow : -202.87M

Growth

  1. Net income for the past three years
  2. Net Income 2009 = $-29 million
  3. Net Income 2010 = $-51 million
  4. Net Income 2011 = $118 million
  1. EBITDA 12/2011 = $162 million
  2. EBITDA 12/2010 = $-45 million
  3. EBITDA 12/2009 = $-25 million
  4. Net income Reported Quarterly = $226 million
  1. Total cash flow from operating activities
  2. 2009 = $-22.38 million
  3. 2010 = $-28.72 million
  4. 2011 = $42.97 million
  1. Cash Flow 12/2011 = 2 $/share
  2. Cash Flow 12/2010 = -0.49 $/share
  1. Annual EPS before NRI 12/2011 = 1.69
  2. Annual EPS before NRI 12/2010 = -0.74
  3. Annual EPS before NRI 12/2009 = -0.73

Performance

  1. ROE = 18.02%
  2. Return on Assets = 13.39%
  3. Quarterly Revenue Growth = 512.4%
  1. Key Ratios
  2. Price to Sales = 6.09
  3. Price to Book = 2.86
  4. Price to Tangible Book = 2.88
  5. Price to Cash Flow = 14.42
  6. Price to Free Cash Flow = 615.7
  1. Current Ratio 09/2011 = 3.58
  2. Current Ratio 5 Year Average = 7.53
  3. Quick Ratio = 2.95
  4. Cash Ratio = 2.56
  5. Interest Coverage 03/2012 = N/A

E-Commrc Ch-Adr (NYSE:DANG)

Levered Free Cash Flow = N/A

Basic Key ratios

Market Cap ($mil) = 604

Growth

  1. Net Income ($mil) 12/2011 = -36
  2. Net Income ($mil) 12/2010 = 5
  3. Net Income ($mil) 12/2009 = 3
  4. 12months Net Income this Quarterly/ 12months Net Income 4Q's ago = -1759
  5. Quarterly Net Income this Quarterly/ same Quarter year ago = -1019.44
  1. EBITDA ($mil) 12/2010 = 6
  2. Net Income Reported Quarterlytr ($mil) = -21
  3. Annual Net Income this Yr/ Net Income last Yr = -878.97
  4. Cash Flow ($/share) 12/2010 = 0.42
  1. Sales ($mil) 12/2011 = 575
  2. Sales ($mil) 12/2010 = 346
  3. Sales ($mil) 12/2009 = 218
  1. Annual EPS before NRI 12/2010 = 0.02
  2. Annual EPS before NRI 12/2011 = -0.46

Performance

  1. Percentage Change Price 52 Weeks Relative to S&P 500 = -63.74
  2. Next 3-5 Year Estimate EPS Growth rate = 60
  3. EPS Growth Quarterly(1)/Q(-3) = -114
  4. Return on Investment 06/2011 = -17.66
  1. Current Ratio 06/2011 = 1.5
  2. Quick Ratio = 0.75
  3. Cash Ratio = 0.72

Valuation

  1. Book Value Quarterly = 2.32
  2. Price/ Book = 3.29
  3. Price/ Cash Flow = 18.13
  4. Price/ Sales = 1.07

Notes

It falls under the category of "average"

Akamai Tech (NASDAQ:AKAM)

Levered Free Cash Flow = 259.33M

Basic Key ratios

  1. Percentage Held by Insiders = 3.8
  2. Market Cap ($mil) = 6643
  3. Number of Institutional Sellers 12 Weeks = 1

Growth

  1. Net Income ($mil) 12/2011 = 201
  2. Net Income ($mil) 12/2010 = 171
  3. Net Income ($mil) 12/2009 = 146
  4. 12months Net Income this Quarterly/ 12months Net Income 4Q's ago = 17.34
  5. Quarterly Net Income this Quarterly/ same Quarter year ago = 14.42
  1. EBITDA ($mil) 12/2011 = 475
  2. EBITDA ($mil) 12/2010 = 408
  3. EBITDA ($mil) 12/2009 = 363
  4. Net Income Reported Quarterlytr ($mil) = 60
  5. Annual Net Income this Yr/ Net Income last Yr = 17.33
  6. Cash Flow ($/share) 12/2011 = 2.16
  7. Cash Flow ($/share) 12/2010 = 1.85
  8. Cash Flow ($/share) 12/2009 = 2.2
  1. Sales ($mil) 12/2011 = 1159
  2. Sales ($mil) 12/2010 = 1024
  3. Sales ($mil) 12/2009 = 860
  1. Annual EPS before NRI 12/2007 = 1.07
  2. Annual EPS before NRI 12/2008 = 1.34
  3. Annual EPS before NRI 12/2009 = 1.35
  4. Annual EPS before NRI 12/2010 = 1.01
  5. Annual EPS before NRI 12/2011 = 1.17

Performance

  1. Percentage Change Price 52 Weeks Relative to S&P 500 = -5.96
  2. Next 3-5 Year Estimate EPS Growth rate = 13.58
  3. EPS Growth Quarterly(1)/Q(-3) = -116.67
  4. ROE 5 Year Average 06/2011 = 13.58
  5. Return on Investment 06/2011 = 10.05
  6. Debt/Total Cap 5 Year Average 06/2011 = 6.73
  1. Current Ratio 06/2011 = 7.56
  2. Current Ratio 5 Year Average = 5.68
  3. Quick Ratio = 7.56
  4. Cash Ratio = 6.14

Valuation

  1. Book Value Quarterly = 12.02
  2. Price/ Book = 3.11
  3. Price/ Cash Flow = 17.33
  4. Price/ Sales = 5.73
  5. EV/EBITDA 12 Mo = 12.2

Conclusion

As the markets are extremely overbought, it would be prudent and wise for long-term investors to wait for a decent pullback before committing large sums of money to this market. Patience is warranted as markets tend to overshoot to the upside and downside nowadays

EPS, EPS surprise, broker recommendations, and price and consensus charts sourced from zacks.com. Earning's estimates and growth rate charts sourced from dailyfinance.com. Free cash flow yield, income from cont operations, and revenue growth sourced from Ycharts.com.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: This list of stocks is meant to serve as a starting point. Please do not treat this as a buying list. It is imperative that you do your due diligence and then determine if any of the above plays meet with your risk tolerance levels. The Latin maxim caveat emptor applies-let the buyer beware

Source: 5 Growth Plays; 4 Impressive And 1 Middle Of The Road