November 2012 Feature: the Bowser penny stock rating system

The importance and simplicity of the Bowser Rating

So much of the Bowser Game Plan relies on a company’s Bowser Rating. For example, in order to be considered for Company of the Month, a stock must be an 8 or above; or in order to be added to the Bowser Database, a company must be a 5 or above. Below is a refreshment course on how the Bowser Rating system works.

The information that we consider when rating a company can be split into three categories: general and trading information, balance sheet analysis and income statement analysis. There are 12 factors for a total of thirteen possible points (current earnings has a potential of 2 points).

General Information

One of the first things that we look at, and the most general, is the company’s principal business. What industry does the company operate in? What services/products does it provide within that industry? As long as the company does not operate within a dramatically failing industry, it gets a point for this factor.

We also consider the company’s 52-week high share price. In years past, we looked at the two-year high. What this shows is the company’s ability to move the price of the stock. If the 52-week high is 2x the current trading price or greater, the company gets a point added to its rating.

        Daily volume is another trading factor that we consider in our rating. This is how many shares trade on a daily basis. Since the companies we deal with are so small, many of them do not trade at high volumes—some only trade around 1,000 shares/day. As long as the company averages at least 600 shares/day over the past 3 months, we give it a point.

We also consider dividends while compiling our rating, but only loosely. Dividends are not for every company, especially those with net losses or miniscule earnings per share (EPS). Most companies get a point for this factor even if they do not offer a dividend for not diluting their EPS figure by dolling out extra cash that can be put back into the company.

Share structure can make or break a company, so we consider shares outstanding when rating a company. Too many shares dilute a company’s financial metrics (earnings per share, sales per share, book value, etc.).  So typically the fewer the better—although the fewer shares a company has the lower the trading volume will be. Different criteria for shares outstanding depend on the amount of the company’s sales. If the company meets the share requirement for its allotted sales, then it gets a point. See the chart below:

*Note this is different than in Making Dollars with Pennies

Balance Sheet Analysis

A company’s book value is its total assets minus its total liabilities (shareholder equity) divided by the company’s common shares outstanding. (If it has preferred shares, subtract those from the total number of shares outstanding before dividing.) Book value is a stable ratio that illustrates the strength and stability of a company’s balance sheet. If the book value is higher than the current share price, then a point is awarded to its rating.

Another balance sheet measurement is a company’s total current assets-to-liabilities ratio. To determine this figure, take the company’s total current assets and divide that number by the company’s total current liabilities—the higher the ratio the better. This number directly reflects a company’s working capital or its operating liquidity. Working capital is the difference between current assets and current liabilities. In order to receive a point in the category, the company must have a ratio of 1.8 or higher, although a ratio of 2 or higher is preferred—for every dollar in current liabilities the company has two dollars in current assets.

A company is severely limited if it carries an enormous amount of long-term debt. Debt obligations can weigh down a company because they accrue interest and eat away at the balance sheet. If long-term debt is no more than 10% of its annual sales, we do not consider it too much of a threat and consequently give the company a point for this factor.

Income Statement Analysis

Many companies that are traded publicly have annual sales of less than $5 million. A good amount of sales with an efficient business can generate a solid net income, which increases investment value. Without sufficient sales, however, even a highly profitable business cannot sustain value. Therefore, in order to receive a point for this factor, a company must have annual sales of $5 million or greater.

When dealing with small companies, growth is the key.  To factor this into our ratings, we examine a company’s current sales—the total revenues in its most recent quarter. If the revenues are higher than they were for the same quarter last year, the company gets a point for showing sales progress.

We also consider two measures of a company’s earnings. The first is its long-term earnings growth. Does the company have a positive earnings trend of at least two years? If the answer to that question is yes, the company receives a point. To measure this, we see if the most recent trailing twelve month net income is higher than the fiscal earnings results from two years ago. While the earnings might have dipped in-between, the upward trend in earnings growth is likely there and a point is given.

The second measure of earnings growth is worth two points instead of one. Current earnings are essential to rating a company because they illustrate whether net income has grown when compared to the same time period the previous year. This measurement is more up-to-date and reflects a company’s recent changes and efficiencies. If the current earnings are higher than the earnings for the same quarter the previous year (even if it is a negative figure), it receives two points.

The Bowser Report is a monthly financial newsletter that specializes in small stocks trading for $3/share or less. Our goal is to provide the individual investor with relevant information on microcap stocks. Each month, we recommend a new company, provide information on past recommendations and report news surrounding the microcap marketplace.

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