Do You Have A System To Analyze Stocks? Try My System (2024)

Here are 3 questions that all investors should ask themselves:

1. What type of investor are you?
2. Where are you focusing your current investments?
3. Do you know how to analyze securities of interest?

For years, those questions would popup from time to time in my subconscious – especially when the market turned on me and I didn’t know how to handle it. As time went by and I became a little more serious about investing, I realized I had to answer the questions. Yes, I could spend my time reading articles from analysts on their stock-of the-day; but after a while, I began to lose my focus. Every analyst has an area of interest and a different way of analyzing the stocks they are interested in.

Over time, I discovered I had a preference for investing in income producing securities rather than investing in securities that produced capital gains from rising prices. But I still did not have a good idea of how to analyze a stock. Most people want to learn to fish, not take fish from others. It was the same for me with investing. It is wonderful to get advice or recommendations from experts in the field, but ultimately, I wanted the skills to do my own analysis.

With that said, I began a journey to develop my own system of analysis. Today, I am introducing the Where’s the Metrics system of stock analysis.

As you might guess from the name, the system uses financial metrics to determine the overall health of the company and their ability to distribute the dividend on a reliable and sustainable basis. The 5 financial areas that are part of the Where’s the Metrics system are:

1. Earnings
2. Payout ratios
3. Debt Ratios
4. Credit Ratings
5. Dividend Metrics

If the company meets the requirements for overall health, we can then move on to the next level to determine if the yield that is high enough to meets the investor’s risk/reward requirement.

For many people, knowing the company is healthy and currently provides a satisfactory yield is enough. However, for investors who are also interested in timing their purchase, there are a few things they might want to consider. This includes reviewing the price-to-earnings ratio, the 52-week high and low status, the price-to-book ratio (or price to Non-GAAP ratio), the PFF ETF to determine the overall preferred stock market, the 10 year treasury rate, and finally the stock chart can be viewed for technical analysis.

For the purpose of this article I will focus on the Where’s the Metrics system to determine the overall health of the company. The tables below list the parent company first in the yellow and gray row. Directly under each parent are the preferred stocks that they have issued. All preferreds are traditional cumulative issues with par values of $25. The columns provide information and financial metrics to help determine the overall health of the parent company. The table lists 6 Hotel REIT companies. It is helpful to compare stocks in the same industry.

The first area to analyze is earnings:

(click image to enlarge)

(courtesy of I Prefer Income)

GAAP Profit & Loss: The first 2 columns in yellow list the number of years and quarters the company has been profitable in the last 5 years and 5 quarters. This is using GAAP earnings. Keep in mind that Non-GAAP earnings or cash flow may be more important, but all companies must report GAAP so it is an important starting point. There are 2 sets of numbers. AHT reports: 1 (4) | 0 (5). The first set of 2 numbers indicates the earnings for the last 5 years. The 2^nd set of 2 numbers identifies the earnings for the last 5 quarters. The first number in each set is profits and the 2^nd number in each set is losses. I then place a ( ) around the result for the last period. The result for AHT is that 1 year of profits and 4 years of losses, with the last year a loss. They also show 0 quarters of profits and 5 quarters of losses.

The investor must dig a little deeper to determine if the company reports Non-GAAP earnings. In the case of hotels, all report AFFO (adjusted funds from operations). The IPI! database program provides the tools to see both the GAAP and Non-GAAP earnings. Just click on the earnings in yellow. See the green table below. There is a huge difference between what AHT reports. It shows that all Non-GAAP years and quarters are positive. Almost the direct opposite of the GAAP earnings. It is very important to understand the difference between GAAP and Non-GAAP and to obtain the appropriate data. You might be surprised at the results.

(courtesy of I Prefer Income)

The second metrics to analyze is payout ratios

(click image to enlarge)

(courtesy of I Prefer Income)

Type Payout: This identifies whether or not the payout ratios are determined by GAAP or Non-GAAP metrics. GAAP earnings are identified by EPS (earnings per share). There are a variety of Non-GAAP earnings that companies use, including FFO (Funds from Operations), AFFO (Adjusted Funds From Operations), DCF (distributable cash flow) and others. The purpose of payout scores is to determine if the company is creating enough profits or cash flow to pay the dividend. It is the ratio of earnings or cash flow to the dividend.

A score below 1 tells us that the company is earning enough to cover the dividend. A score over 1 tells us the company is not earning enough to pay the dividend. That is a warning to investors that a change will have to happen to improve that score. The company will either have to improve their earnings, lower the dividend or pull money from other internal sources to pay the dividend.

3 Payout Ratios: There are 3 payout ratios. All are based on TTM (trailing twelve month) data. The first is stock dividend payout. This means the ratio is based on the common stock dividend. If the company does not pay a dividend, then there is no payout score. Remember that the common stock dividend provides a buffer for the preferred stock dividend. The company cannot stop or delay the preferred dividend until they have first stopped paying the common stock dividend.

The second payout is preferred dividend payout ratio. This compares the preferred dividend to the earnings that is used to pay the dividend. On the balance sheet, this comes before EPS is determined. This is an important difference between EPS and the earnings used to pay the preferred stock. The final payout ratio is the preferred dividend to operating cash flow ratio. One of the important functions a company performs is to create cash flow. The more it provides, the better able it is to operate and grow their company.

There are several cash flow metrics used to identify this, including operating cash flow and free cash flow. This metric uses operating cash flow to determine the ratio. I consider payout ratios to be one of the most important metrics used to determine if a company will be able to pay the common and preferred dividend on a sustainable basis.

In the case above, it looks like all of the companies have excellent payout ratios for all 3 payout metrics.

The third metric to analyze is debt:

(click image to enlarge)

(courtesy of I Prefer Income)

Debt Ratios: There are 3 different debt ratios, including interest coverage, debt-to-EBITDA and debt to equity. Debt is a very important part of business. The lower the debt, the better able a company can operate in good and tough economic periods.

The interest coverage ratio measures a company's ability to handle its outstanding debt. A good interest coverage ratio is considered important by both market analysts and investors, since a company cannot grow—and may not even be able to survive—unless it can pay the interest on its existing obligations to creditors. What constitutes a good interest coverage varies not only between industries but also between companies in the same industry. Generally, an interest coverage ratio of at least two (2) is considered the minimum acceptable amount for a company that has solid, consistent revenues. Since ETD are debt, this metric become very important to determining the overall health of the parent company.

Generally, a net debt-to-EBITDA ratio above 4 or 5 is considered high and is seen as a red flag that causes concern for rating agencies, investors, creditors, and analysts. However, the ratio varies significantly between industries, as each industry differs greatly in capital requirements. As a result, it is best used to compare companies in the same industry.

With Debt-to-Equity, the lower ratios (0.4 or lower) are considered better debt ratios. Since the interest on a debt must be paid regardless of business profitability, too much debt may compromise the entire operation if cash flow dries up. Companies unable to service their own debt may be forced to sell off assets or take other measures. A higher debt ratio (0.6 or higher) makes it more difficult to borrow money.

The next area to analyze is Moody’s and S&P ratings

(click image to enlarge)

(courtesy of I Prefer Income)

There are benefits to being rated by the different rating agencies. Much the benefit has to do with borrowing costs and investor acceptance. However, in this case, none of the Hotel companies are rated.

The last and final metric to analyze is dividends.

(click image to enlarge)

(courtesy of I Prefer Income)

Dividends: We start this review with the knowledge that all 6 parent companies pay a common stock dividend.Dividends are generally paid by a company from its profits or from the available cash flow it generates. If there are no profits or no available cash flow, then the company will have to dip into their savings, reserves, sell off assets or cut the dividend. The first thing we want to do is to see what the dividend is and determine if it has been rising or falling. By looking at the 3-yr average yearly dividend growth, we can tell what the company has done over the last 3 years. The I Prefer Income program allows me to click on the dividend to see the last 5 quarters in the green table.

(courtesy of I Prefer Income)

Another metric that I find useful is to compare the 10-yr median yield to the current yield. If the spread between the 10 year and current yield is wide, it could provide some idea as to the present condition of the company or whether or not the company is in or out of favor with the general marketplace. As an example, AHT has a mean yield of 7.4, but the current yield of the common is 9.4. That tells me the marketplace has dropped the price to an area it feels is necessary to compensate for the risk.

SHO is the opposite. The 10-year median is much higher than the current yield. This could mean that the marketplace likes this stock right now.

One other dividend area that I follow is the dividend diamonds. These are companies that have increased their dividend for 5 or more years in a row. That is a nice accomplishment. There are 2 companies designated as dividend diamonds, SOHO with 8 years and INN at 5 years

In Summary

I became a better investor once I focused my attention on income investing. But then it became just as important for me to develop my own system to analyze the stocks I was interested in. Over time, I developed the where’s the metrics system that directs me to review 5 areas that help me determine the overall health of the company and its ability to pay their commitments and dividends in a reliable and sustainable basis.

Earnings: From the review I did with 6 hotel stocks, I generally come away with a favorable rating for these 6 stocks. 4 have good GAAP earnings, but once I reviewed the Non-GAAP earnings from AHT, they looked favorable.

Payout Ratios: The payout ratios of all companies looked very acceptable. I think this is partly due to the fact that hotel companies are always prepared for an economic downturn where earnings and cash flow are hurt.

Debt Ratios: Of all areas that I had concern for, debt ratios were generally high. This will take further research. It might be the normal for hotel stocks.

Credit Ratings: None of the companies were rated so it becomes even more important to analyze these companies ourselves.

Dividends: The dividend metrics provide several ways to obtain more information about the dividend and their ability to pay or even increase it.

I would also like to add that this is my 4^th article on Seeking Alpha. If you enjoyed this article and would like to read the others, they are: Shipping Industry Preferred Stocks - High Yields, But Watch For Riptides and The Highest Yielding Investment Grade Preferred Stocks Available

During the last 3 months of 2018, the market dropped into bear territory. With the scare of rising interest rates, preferreds stocks and other interest sensitive securities fell along with the market. However, 2019 has been a very positive story with many preferreds returning to their previous highs after the fed made it clear that interest rates would stabilize. Even with new highs, there are still many relatively safe and reliable preferred stocks that are available with high yields. This article introduced 6 hotel stocks with 15 cumulative preferred stocks with a $25 par value. 9 of the preferred stocks have prices under par and all have yields above 6% with the highest being 8.3% from AHT-D.

I welcome hearing from others to comment on my system or to discuss the system you or others are using. I am sure that every analyst uses a different process. Great subject for discussion. Please note that I Prefer Income will add a program to our database to rank stocks using a system similar to the where’s the metrics system. In fact, we will be able to rank multiple stocks or all stocks within specific industries.

Thanks for reading,

Rich Hill / I Prefer Income

Disclosure: I am not a licensed securities dealer or advisor. The views here are solely my own and should not be considered as a recommendation. Individuals should determine the suitability for their own situation and perform their own due diligence before making any investment

Copyright I Prefer Income LLC All Rights Reserved

Richard Hill