After reducing the quantity of potential Investments, based upon Assets to Market Cap, it's time to begin running some quantitative analysis to discover which are, "Great Companies". It should be fairly unanimous among Investors', Great Companies are measured by Retained Earnings. It would be absurd to argue against Revenue Growth being exciting too. But it would be, apparently, ridiculous to elevate the importance of Revenue Growth above that of Net Earnings (Revenue Retention). For myself, I feel Revenue declines accompanied with greater Net Earnings to still be a positive indicator.
A policy of consideration while filtering further is subjective to individual pursuit. Mine are twofold. I'll explain later. For now, the focus is on discovering Great Companies:
2. Growth of Net Earnings Greater than Liabilities - The Vector Indicator.
Here is the basis and rationality establishing an understanding of future, "Vector". The displacement or reduction of Liabilities can be illusive and deceiving. Regardless of Liability growth or decline Investors' must realize it is imperative for Net Earnings (The Bottom Line, as reported) to be increasing more than Liabilities. A positive, "Vector," should not be anticipated without that being seen.
Discovering the potential direction of Vector may be assessed a couple ways. The most obvious is seek, "Margin Growth," over focused and strategic time segments. Another is to calculate, in entirety through various time segments, the Net Earnings and Liabilities momentum. Again, I agree with Graham's suggested timeframes: Recent Decade (10 Years), Recent/Past (Within the decade): 5Y, 3Y, and One Year. Although I do look at Margin Growth too, I still prefer calculating momentum of Net Earnings and Liabilities. It should be obvious to an Investor declining Liabilities and Increasing Net Earnings would be most favorable an likely to produce an upward Vector. Although that may exist for a period, it is highly unlikely to be maintained or constant through each measured timeframe.
My Calculated timeframes, to perceive direction of Vector, are outlined as follows:
| -------------------- 10 Year Calculation % -------------------- |
| ------ Recent 5Y % -------- || -------- Past 5Y % --------|
| --- Recent 3Y % ---| | --- Past 3Y % ---|
| -- 1 Year %--|
The basis or understanding for importance should be quite obvious. If a Company has come-to-be in a bad financial position but has an increasing margin, it's only a matter of, "Time," before it adjusts to a good financial standing. Contrastingly, if a Company is in a modest financial position but has declining Margins, it is only, again, a matter of, "Time," before it's likely in a bad financial position. It is here, we might decrease our risk, or determine Price Vector of the Investment.
At this point of analysis, I Allocate, on accrual for each segment outlined, points. By applying points to these Time Segments, scoring potential Price Vector is established. So when Margin growth is seen, in one of the four recent segments a point is allocated. In contrast, if there's a decline (Decreased Margin) one point is deducted. By doing so, if the Company is not showing a Margin Increase in more than half the duration segments, it will obtain zero points. Further comparisons are not performed, here (If at Zero I wish to convey), as the company is not demonstrating an "Invest-Grade".