The 9-point checklist for finding winning stocks

In a market where an increasing proportion of the winnings are going to a decreasing proportion of companies, it can be difficult to consistently find quality stocks at the right price.

Medallion Financial Group, an investment advisory firm, uses a nine-point checklist to identify stocks with strong fundamentals outside of the S&P/ASX 50.

For established companies, these include a market capitalisation of more than $100 million, two years of consecutive revenue and earnings growth, a return on equity of more than 10%, positive free cash flow and operating margins, low gearing, a price-to-earnings-growth (PEG) rate of less than 2, and growing dividends.

In the video below, Medallion's Michael Wayne takes you through these metrics above - and how the firm applies these to both established and emerging companies.

Plus, he shares one COVID-bashed stock that the above process has identified as a future winner.

Note: This video was filmed on 22 April 2021. You can watch the video or read an edited transcript below.

Edited Transcript

Can you take us through your investment philosophy? 

Basically at Medallion, we employ what's called a top-down, bottom-up investment approach. So first and foremost, we look to scan the macro-economic environment for areas of the economy that are booming and have natural tailwinds. So if you think about the ageing population, emerging middle-classes in Asia - in our opinion, it makes sense to align yourselves to the healthcare sector. Likewise, technology - we're using technology more frequently. It's invaded every little aspect of our life. It makes sense to target businesses within the technology sector. 

So the idea is once we've identified sectors of the economy that we think have the brightest outlook, we'll then try and identify certain companies within those sectors that have the best fundamentals. Some of those fundamentals that we look at are things like revenue growth, we like businesses that have had year after year of revenue growth, companies that have got good earnings growth, good cash flows, good free cash flows. They've got constant or expanding margins, low levels of debt. So these are some of the points that are on our checklist.

THE 9-POINT CHECKLIST FOR ASSESSING ESTABLISHED BUSINESSES. SOURCE: MEDALLION FINANCIAL GROUP.

TWO EXAMPLES OF ESTABLISHED BUSINESSES USING THESE METRICS. SOURCE: MEDALLION FINANCIAL GROUP.

Those metrics work very, very well for more mature established businesses. Often these days there's sort of new-age tech companies on the market that might not be as established and don't really have the earnings on the board yet. So things like customer churn rates are very important, we think, for many tech businesses. Things like margins for those companies, things like whether they have intangible assets or tangible assets? So these are all different factors that people can consider when investing in companies. But do understand that one metric for one industry might not be so relevant for another.

THE CHECKLIST FOR MEASURING EMERGING BUSINESSES. SOURCE: MEDALLION FINANCIAL GROUP.

AN EXAMPLE OF AN EMERGING BUSINESS USING THE ABOVE METRICS. SOURCE: MEDALLION FINANCIAL GROUP.

What sector is currently being overlooked by the market?

At the moment, it's not so much individual market sectors I think that are going unnoticed. We've obviously had COVID-19 unfold over the last 12 months. And I think what you're seeing at the moment is there's definitely been the COVID-winners; so that part of the market that has done very, very well and almost benefited from the conditions that have been at play. Then you've got the other parts of the market that have been the COVID-losers that have struggled in this recent period and are struggling to get out of it. I think you could probably lump together the tourism stocks as being an area of the market where I think if you take a medium to longer-term view, there is definitely some value to be unlocked, and it doesn't have to be the smaller speculative part of those tourism stocks like a Webjet (ASX: WEB), which I think could do okay, but other more established players like Auckland International Airport (ASX: AIA) or Sydney Airport (ASX: SYD); real quality infrastructure assets that have a monopoly. We think that that's an area of the market that is potentially unloved at the moment.

What is one emerging leader that your process has uncovered? 

One specific stock that we quite like outside of that area of tourism but was still a business that suffered a lot through COVID-19 is a company Audinate (ASX: AD8). Effectively, this is a technology business that sells a product called Dante. It's effectively a protocol that allows different types of audio and visual equipment to communicate with each other without the need for cables and cords and those sorts of things. So often live music venues or outdoor stadiums would use these products, but obviously, with COVID-19, all those sorts of things have been in lockdown. 

Well ahead of the competition. Michael's emerging ASX leader. Source: Medallion Financial Group.

Essentially it's a protocol, a piece of software, which allows these different pieces of equipment to communicate with each other. It's embedded in Yamaha products, Bose, and Bang & Olufsen. So essentially 70-75% of new electronic products that are coming to market include this Audinate Dante protocol. So it's dominating the market, it's growing at 17 times the rate of its nearest competitor. So for us, we think that's a business that has long-term attractive tailwinds. In many ways, if it continues to develop on its current path, there'll be an unregulated monopoly. Not too dissimilar from Bluetooth, except the technology is a lot better and Bluetooth is part of a cooperative rather than a single business. 

Audinate has a market cap of $655.19M. It has a price to book ratio of 8.14x. source: medallion financial group.

Audinate is one of these companies in the tech space that is emerging, so many of the traditional metrics that you look for in a company don't necessarily look that attractive for a company like Audinate, particularly when you factor in the COVID-bump that they experienced last year. So many of their metrics don't look as attractive as other companies, particularly in more established businesses. But we do think from a value perspective, it does look attractive. It's got very attractive margins, the rates of adoption by people in the industry and the rate of progression relative to their competitors is very, very attractive. It's a capital-light company. So they don't have a lot of assets to maintain in terms of the old fashioned property, plant and equipment.

They're investing a lot in building up their product, improving the technology of their product, as well as entering new markets. So in the past, it's been mainly in the audio space. Now it's the digital visual space as well. So they're a business that has a lot of good metrics going for them in terms of a new age business, but for a more established company, things like consecutive years of earnings growth haven't been as attractive as potentially you would like for more mature companies. But it's just a business that we think is attractive at current valuations, has been hit by COVID-19 and a long-term outlook looks very appealing for them.

A unique approach to investment management

Medallion Financial is a specialist wealth advisory firm, with expertise across a range of domestic and international markets.