theo20185 (40.47)

The Theo Score V2.0

July 03, 2011 – Comments (0) | RELATED TICKERS: CCRT , AEA.DL , QCCO

The Theo Score system has been retooled. V2.0 does not focus on EPS but has included FCF as the measure of profitability instead. The score gives a rough valuation per share for a given stock, gives the valuation an appropriate discount based on the CAPS rating, and then gives the price to valuation ratio. The final ratio is the Theo Score.

The valuation for a given stock is estimated by the following formula:

(Net Net Working Capital per Share) + (10 * Annual Free Cash Flow) + (10 * Annual Dividend)

Net Net Working Capital comes from Benjamin Graham. It takes current assets and discounts them appropriately. Cash and cash equivalents are not discounted. Receivables are discounted by 25%. Inventory and other current assets are discounted by 50%. TOTAL liabilities are then subtracted. Divide this amount by the number of shares outstanding, and this is the NNWC per share, or an estimation of how much a shareholder would be entititled to in the event of a liquidation.

Annual Free Cash Flow is taken from the most current fiscal year. Annual dividend is calculated by the listed dividend multiplied by the number of times in a year the dividend is paid. Special dividends are not included.

Discount the value appropriately based on the CAPS score. I use the following formula: ((4 + CAPS Rating) / 10) * Valuation. A 5 star rated stock receives a 10% discount. An unrated stock receives a 60% discount.

Divide the discounted valuation by the stock price to get the Theo Score. Anything over 1 indicates a stock price that is below your discounted valuation. I pick outperform for all stocks that score greater than 1, and then end the picks after they fall below 1. For my fantasy portfolio, I add the following criteria that I don't use on CAPS: The company must be based in the US, have current filings, and must be reported in US dollars (no ADRs or foreign income statements/balance sheets/cash flow statements).

A stock that has a negative valuation scores 0. A stock that has an annual dividend greater than the annual free cash flow scores a 0. A stock that has a negative annual free cash flow scores a 0.

 The big winners this month have been cash advance companies. They are hammered by fears of pending regulations. Their cash flows are fantastic. I believe that these stocks will rebound. Whether it's the short term or long term is up in the air.