The Chicks' 12 Steps to Picking a Stock*

Click here to view Companies Run Through the Chicks' Dozen.
Click here to use the Chicks' Dozen Worksheet.
 

STEP 1 | Buy What You Know »
How well do you know it, how often do you use it and how much do you like it?

STEP 2 | K.I.S.S. »
Keep It Simple Sister. Can you easily explain the product's industry to your cute little niece? Can you draw it with a crayon?

STEP 3 | Industry »
Who are its competitors? Is the industry growing faster than other industries? Do you understand it?

STEP 4 | Leader In Its Field »
Is the company Top Dog in its industry? Is it the Leader of the Pack?
(Sing it with me: Leader of the Pack... vrooooom, vrooooom)

STEP 5 | Repeat Profitability »
Is this a company that has an opportunity to make a profit from its customers time after time? Will consumers use it again and again or over and over? (Be honest, how many cola beverages do you drink?)

STEP 6 | Gross Margins »
Are gross margins at least 50%?

STEP 7 | Net Margins »
Are net margins at least 8%?

STEP 8 | Cash To Long Term Debt »
Does the company have more cash than long term debt?

STEP 9 | Flow Ratio »
Is the company's Flow Ratio better than 1.5?

STEP 10 | Increasing Growth »
Is the growth of the company (and its industry) moving in a positive direction? Are revenues (sales) increasing?

STEP 11 | Strong Management and History »
Who are the people running the company? What have they done? Do you like what they stand for? What is the company's history?

STEP 12 | On Sale »
Is its stock price lower than its 52-week average?

Click here for a list of companies which have been evaluated using the Chicks' Dozen.

1. Buy What You Know

Open your refrigerator, what do you see? Who made the steak sauce? Heinz. Whose product is the soft drink? Coca-Cola. Wassssuuup with the beer? Anheuser Busch. Got Gatorade? Quaker Oats. Go to the pantry... who makes those Fritos? Frito-Lay. Graham Crackers? Nabisco. Go to your medicine cabinet, who made the Q-tips? Johnson and Johnson. Go to your purse, whose cell phone is that? Nokia. (Are you starting to get this "Buy What You Know" concept yet?) Go to the mall, which store is the busiest? Abercrombie and Fitch? Hop on your computer, your DELL computer. Go to the internet, what is your favorite web site? Amazon, AOL or Yahoo? Who provides your car insurance? Geico. Start by looking at companies that are familiar to you -- ones you know and love -- and buy what you know.

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2. K.I.S.S  (Keep It Simple Sister)

Keep It Simple Sister. Keep It Simple Sweetie. Keep It Super Simple. Anyway you write it, it's still K.I.S.S. Peter Lynch (The King of Investing) would ask, "Can you draw it with a crayon?" Do you understand the industry that produces this product? Food, clothing and car insurance are pretty easy to understand... but cell phones might be a bit more difficult. Trying to understand bandwidth or the language of the airwaves requires a bit more research.

I wouldn't know a thing about mechanical hydraulics, if there is such a thing, so trying to explain that kind of company to a fifth grader may not make sense coming from me. Our companies must be easy for us to understand. When you can understand a company and its industry, you can more easily predict product or service is going to be in demand in the coming years, or if consumer appeal will dwindle.

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3. Industry

If you can understand an industry, what do you feel the growth over the next decade will be? Do you think that it will have quite a few years of breakthrough growth, or just average growth? Is your company on the cutting edge of something, like a new technology? A Chick looks for a company in an industry whose growth will be greater than average. (This calls into play some female intuition.)

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4. Leader in its Field

Is the company the leader in its field? Would everyone recognize the name if you said it? To look for the top brands in an industry, name the first company that comes to your mind. Kids clothes? Gap Kids. Chocolate? Hersheys. Say the word computer, and what comes to mind? Dell? Apple? Compaq? They all work. What is your favorite restaurant... Outback Steakhouse? McDonalds? Enough, you get the picture. Erectile Disfunction? Pfizer. Okay, that's really enough.

Also, do you recognize the company name and what it does? If I said General Motors, would you say cars? If I said America Online, would you say internet? If I said Keebler, would you say cookies? Yes, yes and yes. Those are all top dogs, leaders in their field. When you look for companies, look for the top dog. Chicks don't want to invest in small start up companies. They're too risky. We want the leaders in the field because they are established and proven.

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5. Repeat Profitability

Ask yourself if the company you are looking at has a chance to repeatedly profit from its consumer. For example, do people need and use this product often? A phone company would be an example of repeat profitability. Everyone needs to pay her phone bill once a month, and there ain't no way we could live without the "tellie." As Chicks, we look for these companies -- the kinds that get their customers addicted. We want the businesses that the consumer neeeeeeds.

Other examples would be internet web sites, drug companies, clothing manufacturers, financial services, soft drink companies, telecommunications, technology providers and utility companies. The makers of television sets, automobiles or airplanes aren't going to enjoy the same daily profit luxury from each consumer. We don't buy those products as often. (I am not even going to admit what kind of profit Coca-Cola makes off me each day. Did you know they also sell water? Dasani. Call me a Dasani Junkie.)

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6. Gross Margins

We want gross margins of at least 50%. Oooof, gross what? Gross Margarine? What on God's green earth does investing have to do with moldy and gross margarine? Sorry, but we have to throw a couple of investment terms in our Chicks' criteria. Relax, you'll be throwing the words out soon enough and impress the heck outta your friends during dinner. Gross margins simply put is: How much profit does the company make off each product?

Gross margins compare a company's price for a product (Sales) to what it cost them to make it (Cost of Goods Sold). The words in bold will be used again and again, so start becoming familiar with them. They are the percentage of gross profit (Sales minus Cost of Goods Sold) relative to revenue. So, after you subtract how much it costs to make a product from the price of the product, you compare it to the company's sales of that product. This is found on a company's INCOME STATEMENT.

This is also sometimes written as:

When you get the Gross Margins figure, don't forget to change it to a percentage. (This is third grade math, but even I still forget how to change a decimal to a percentage. But ask me which kind of laundry softener is best, this I know.) All you have to do is multiply a decimal by 100 to change it to a percentage. For example, if your answer to the above is .37, then multiply by 100 and you have 37%. (Easiest way is to move the decimal point two spots to the right.)

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7. Net Margins

We want net profit to be at least 8%. To become a Chicks Dozen stock, we want the company's Net Margins to be at least 8%. That means we want them to be making at least 8 cents on every dollar. This is after they have deducted all of their expenses for researching, creating, advertising, marketing, and paying the Head Honcho. This number is also on the INCOME STATEMENT. To figure out Net Margins you simply divide the net income by the sales. Like this:

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8. Cash Greater Than Long Term Debt

We want the Cash Hogs!!!! Yessssirreee! We want the Bill Gates of the Business World. We want the Budweiser of Beers. We want the Rockefeller of Companies. We want money to be growing out of our company's ears. We want the Featheral Reserve. We want cash growing on every tree in their lot. We want…well, you get the picture. $$$$ Remember, the more money a company has, the more it can do with it. Just like when you play Monopoly, the more cash you have, the more property you can buy, or the more freedom you have to build houses on your property and crush your Uncle Bob. Cash gives you freedom. Like I need to tell you this. Duh. These numbers are found on the company's BALANCE SHEET. Look for Long Term Debt under Liabilities. It's a simple sentence.Cash is found at the top of the Balance Sheet.

TAKE NOTE: Cash is all the liquid cash we have sitting in the till plus any short term investment securities such as stocks or bonds that can be converted to cash in the blink of an eye. These are called SHORT TERM INVESTMENTS. So, when we say the word CASH, we are always talking about the Cash plus Short Term Investments. The Short Term Investment line on the Balance sheet follows the Cash. The next line on the Balance Sheet is the Cash and Short Term Investments. (They do the math for you). This is the formula we use when we talk about CASH:

Cash = Cash plus Short Term Investments
Cash > Long Term Debt

We just want our company to have more cash than it has long-term debt. A company that has more Cash than it does Long Term Debt will have a better chance of surviving if the economy were to crumble and interest rates went sky-high. They would be able to pay off their long-term debt and save paying high interest rates. Brilliant. The richer the company the better.

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9. Flow Ratio

We want a Flow Ratio below 1.5. Here's the formula before you get the long-winded explanation.

* Includes short term investments

We incorporated this calculation from the Motley Fool. (I don't know if I told you this yet, but there are some geniuses over there at their website, www.fool.com. We love their Rule Maker philosophy.) I don't remember seeing an investment approach that incorporated this figure, and it's one of the most important, so we'll give them credit. The Flow Ratio measures how well your company is managing the cash flow in their business. We want the cash coming into our company (the profit part of the cash) faster than we pay it out (expenses). The lower the Flow Ratio, the better. FYI, this is the hardest point of the Chicks Dozen to grasp, so don't worry if it takes you some time. We'll be talking about it a lot on this site to help you get used to the concept. (It took us Chicks at least six months.)

Current Assets minus Cash is the top part of the equation. If you look on a company's BALANCE SHEET you will be able to find both of these numbers. Current Assets are what the company expects to turn into cash in the next year. Expects is the key word. It doesn't always work out the way they planned. Since Cash is on the Balance Sheet under Current Assets, we want to take the Cash out of the Current Assets, and what we have left is what they expect to turn to cash in the next year. Hopefully the number left will be really small, which would mean that whatever their business is, its product turns to cash very quickly.

Now to confuse you just a tad more, sometimes there is a line on the Balance Sheet under Current Assets, right after Cash called "Marketable Securities", "Cash Equivalents," or "Short-Term Investments". What this line represents is also considered Cash. It would be any type of short-term investment like CD's, bonds, or treasury bills that the company can turn to cash as fast as they can dial the phone. We need to figure this number into Cash also. When you are thinking of the term Cash, also think to include in it: Marketable Securities, Cash Equivalents or Short-Term Investments. When this term does appear on the Balance Sheet, it will be the very first line after Cash. (Some companies include it already in their Cash line).

The bottom number, the Current Liabilities, are bills and expenses that our company will have to pay in the next year. Even though this may sound bonkers, we would like the Current Liabilities to be high. We want to hold off the people that we owe money to as long as we can. If we owe Nick and Nora, the makers of our pajamas, $30,000, and we can take up to 90 days to pay them the balance, why not wait? Why not keep the $30,000 in our pocket for the next 90 days and earn the interest ourselves?!?! Novel idea. Current Liabilities are like short-term interest free loans. Thank you very much. But wait, we have to deduct the Short-Term Debt figure because that is truly a short-term loan with interest. We don't like that. We want to postpone paying creditors as long as possible.

It takes a very special company and smart business people to master this balancing act. If they have it mastered their Flow Ratio will be below 1.5. This is a good business. To figure the Flow Ratio you need to get to the company's Balance Sheet. Take the Current Assets minus Cash and divide it by the Current Liablities minus Short Term Debt . This number will be your Flow Ratio.

* Includes marketable securities

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10. Increasing Growth

Now we just need to find some numbers to help check out the history of the company. Is their growth really moving in the positive direction? We need to track what its past sales growth has been up to this point in time. To add numbers to your belief in the growth of the company, you can find them on the INCOME STATEMENT. All you have to do is take the Revenues from the most recent quarter, and compare them to the Revenues of 3 months ago. Is the number larger or smaller? If it is larger, then sales have increased. If it is smaller, then they have decreased.

If sales have decreased, ask yourself why the numbers might have decreased. For example, let's say you are the The Gap, Inc., and your fourth quarter numbers ending in December had sales equaling 10 million. The next quarter, ending in March, had sales equaling 8 million. (These are made up numbers.) Why would their sales have decreased? Why wouldn't they have sold as much merchandise in the Jan.-Mar. quarter as they did in the Oct.-Dec. quarter? Can you say Christmas? Some companies have direct relationships with the calendar year so it is best to check the months involved and what type of company you own. A company that sells pens, pencils, paper, and notebooks is going to have higher sales in its back to school months than say in April. So ask yourself what was the reason behind a company's sales increase or decrease before you move on to the next point.

We like to figure out the exact percentage of increase or decrease because it helps when comparing one company to another. To figure out the sales growth of a company, go to the Income Statement. Look for Revenues or Sales and write down the number. Then go to the Income Statement of the last quarter for your company and get that quarter's revenues (or sales). Subtract the last quarter from this quarter. That is X. Divide X by the previous quarter's revenues. This answer is Y. Multiply Y by 100 and you get a percentage. Here is the formula:

(Sales Quarter 4) - (Sales Quarter 3) = X
X/ Sales Quarter 3 = Y
Y x 100 = ____%

The Chicks don't have a required percentage increase for our criteria, but we do like to figure out what the number would be, as it helps in picking a stock. A company with a 40% consistent increase in sales would be more attractive than the one with 8% growth.

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11. Strong Management and Operating History

Because the Chicks view on purchasing a stock involves the Warren Buffett way of thinking, we believe we are buying a piece of the company, not just the stock. So if we are going to buy a piece of a company, we want to know everything about it. From who's running it to what is the company's history.

If some man asked for your daughter's hand in marriage, (does anyone do this anymore?), wouldn't you want to know everything about this guy, from his occupation to his family history? You don't want to be sending your daughter off with some loser! You want to know where he came from, what he thinks their future looks like. Are his parents good people? Has he been charged with a felony? Will he make a good husband and father? In the same way, you should give careful attention to a company before you trust your financial future to it.

There is a lot more invested than just what is on the surface. That is why as Chicks we need to know "the goods" on the management. Are they honest, respectable people? Are they trustworthy? Would they be our friend? Do we like his morals? Has he run any other companies? How did he do there? These are all important to look at when buying a piece of a company.

We appreciate a management's openness and candor with shareholders, media and the public. We also like companies where management heavily invests their personal assets back into the company. This means they believe in their company. Otherwise, it's like someone who manages McDonalds, but eats at Burger King. That tells us a lot more than any sales numbers. As Chicks, we also have to understand the company from a historical perspective.

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12. Buy On Sale

Is there one stock that is a better deal than another right now? The Chicks debated and debated whether or not this should be one of our criteria. Buying on sale. We don't want to ever time the market, meaning, watching hourly to see when a stock is ON SALE. That requires keeping track of the market too closely…and that isn't Chicky. We want to buy a good company when we have the money, not just because it's on sale. So why add this point? Just to make a dozen? No, no. Let's say you are trying on a pair of Nine West Shoes and a pair of Steve Madden shoes. They are identical, you know both brands, and you love them. It's an eeny-meeny-miney-mo kind of decision…UNTIL, you find out one of them is on sale, this week only. Ta-Da…the decision is made for you.

Now this doesn't mean that you would buy the cheaper of two companies. It means, when looking at one company's stock fluctuation over the past year, consider where it stands today. Has its stock price dipped over the past couple of weeks? I don't want to give you a precise formula to use, because there isn't one. But, check the price of the stock's 52-week average. Is the price today way above it, or below it?

This isn't an exact science, but it gives you something to go on when it comes down to a breaking a tie. We're women, we have that intuition, and here is where it comes in handy. It's hard to pass up a sale on a good shoe.

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