The A. Stotz Stock Picking Checklist plays a key role in our quantitative model
The A. Stotz Stock Picking Checklist is backtested into a quantitative model that decile ranks stocks, best to worst, across a 300-stock universe.
The dream outcome of Uncovered Thai Stocks is to uncover hidden gems that could multiply in value. Many years ago, we read the book 100 Baggers: Stocks That Return 100-to-1 and How To Find Them by Christopher W Mayer. Mr. Mayer was also a guest on Dr. Stotz’s podcast.
Inspired by the book and that conversation, using our FVMR framework, we set out to test what factors stocks that multiply in share price have in common. While finding stocks that return 100x might be a bit audacious, finding stocks that return 3-10x should be possible.
8 common characteristics of stocks that have multiplied in value
From our research, we identified eight common characteristics of stocks that have multiplied in value. From that, we created the A. Stotz Stock Picking Checklist:
1. Growth – Product and industry can support a decade of 10%+ annual growth
2. Sustainable – Competitive strategy creates sustainably high gross margin
3. Quality – Good earnings quality, non-core items are small or non-existent
4. Efficiency – In the long run, sales grow faster than assets
5. Tight – Relatively low cash conversion cycle, negative is best
6. Cash flow – Operating cash flow is consistently positive
7. Capacity – Company has access to capital to fund growth
8. Inexpensive – Valuation is reasonable, avoid very expensive stocks
Let’s look into the eight items one by one.
1. Growth – Product and industry can support a decade of 10%+ annual growth
Every business starts with sales; without it, a company eventually dies. For the value of a business to grow, sales need to grow. Without sales growth, don’t expect any extended increase in share price.
In the past 30 years, the annual revenue growth of all non-financial companies worldwide was 5.8%. So, to outperform, a company needs to grow at 10% or more per year. To grow sales at double digits each year for a decade, it generally requires the business to be in a growing industry. Mature industries rarely see that kind of growth sustained.
2. Sustainable – Competitive strategy creates sustainably high gross margin
A high and stable or improving gross profit margin is the financial evidence of a company’s competitive advantage. A high gross profit margin indicates that the company has pricing power or superior cost efficiency, which rivals cannot easily replicate. This competitive advantage is necessary to prevent competition from eroding the high returns on capital needed for multi-year compounding.
3. Quality – Good earnings quality, non-core items are small or non-existent
Earnings quality ensures that the reported profit truly represents the underlying performance of the business. A reliance on non-core, one-time gains, or aggressive accounting practices (high accruals) provides an unreliable foundation for long-term price appreciation. High-quality earnings, which closely track cash flow, are more predictable and persistent.
4. Efficiency – In the long run, sales grow faster than assets
It tells us the amount of revenue the company generates from its existing assets. Getting more revenue from a company’s assets relative to peers shows that management is better at generating output from their assets. Careful asset growth that is matched with revenue growth preserves the company’s capital. Companies that must constantly spend heavily on assets just to grow sales will have lower incremental returns and a slower compounding rate.
5. Tight – Relatively low cash conversion cycle, negative is best
The cash conversion cycle (CCC) measures how long a company’s cash is tied up in its working capital. A low or negative CCC, where cash is received from customers before the company pays suppliers, indicates that the business is highly efficient and essentially receives free financing from its vendors. This provides an immediate, cost-free source of capital to fund growth.
6. Cash flow – Operating cash flow is consistently positive
Consistently positive operating cash flow is the lifeblood of a healthy business. It confirms that the business model is self-sustaining and generating real cash from its core operations. It provides the necessary funding for capital expenditures, debt payments, and reinvestment in growth opportunities without needing constant dilution or debt.
Operating cash flow is also viewed as a higher-quality metric than net income because it is less susceptible to management manipulation via accounting accruals, giving investors greater confidence in the reported performance.
7. Capacity – Company has access to capital to fund growth
While self-funding via operating cash flow is ideal, all high-growth companies—especially at the small-cap stage—will eventually need capital to scale, invest in large projects, or make acquisitions. Access to capital (via low-cost debt or equity) ensures the company is not financially constrained and can aggressively pursue opportunities. A listed company with low or negative net debt can generally access funding more easily and cheaply.
8. Inexpensive – Valuation is reasonable, avoid very expensive stocks
Buying a stock at a reasonable (or cheap) valuation is crucial because it allows the valuation multiple to expand as the company demonstrates its growth story. Starting with a very high multiple may create a strong headwind. It’s worth noting that investors pay for future growth, so a stock with high growth potential might catch up with or even outpace its multiple if the growth opportunities materialize.