A checkup on the S&P 500 index

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A checkup on the S&P 500 index

Post by dcarste » Fri Nov 24, 2017 1:21 pm

I will post this to deliberate what is going on in S&P 500 companies. This is not a perfect screen, using Finviz free stock screener, but pretty much the easiest screen you could do on the S&P 500...and this concerns me. Here is a simple "If I was doing business, in it's simplist form I would at least expect".

Universe: S&P500 companies
Profit Margin: 10% or greater (why would I do business in general if I can't make a simple 1 dollar of net income out of 10 dollars of sales)
Payout Ratio: less than 80%. Meaning company shouldn't be paying more than 80% of its earnings in dividends. They need money to invest too.
Current Ratio: >1 times.

The current ratio show how many times over the firm can pay its current debt obligations based on its assets. The current ratio is calculated from balance sheet data as Current Assets/Current Liabilities. So, if a business firm has $200 in current assets and $100 in current liabilities, the calculation is $200/$100 = 2.00X. The "X" (times) part at the end is important. It means that the firm can pay its current liabilities from its current assets two times over.

Guess How many companies pass this Finviz screen out of the 500 of the larges US companies, using a 1X Current Ratio?

141 companies (28%)

If I change (loosen) the profit margin to allow companies to come through the screen that make at least a 5% profit margin (50 cents in net income for every $10 dollars in sales.

212 companies (42%)

What concerns me more than anything is only 42% of the S&P 500 is able to meet current liabilities with its current assets, can make a 5% profit, and isn't paying out more than 80% of ALL of their earnings in dividends (payout ratio).

This screen ignores all price discovery whatsoever. Simply, hey can you make 1 dollar, or 50 cents, on 10 dollars of sales? Can you please not spend all of your earnings on dividends (<80% payout ratio), and hey maybe you should have enough current assets to at least meet 100% of your current liabilities. This is basically a solvency screen of even considering if the business is even invest-able.

Sounds overly simplistic but I don't like the looks of this. Not to say this matters in terms of investment returns...but I'm saying at today's current picture...maybe I'm crazy but something fishy seems to be going on. I'm a passive investor. But god this is crazy in the simplest terms.

Can anyone tell me I am looking at this all wrong, not in terms of investor returns, but in fact how this is ludicrous?

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Re: A checkup on the S&P 500 index

Post by nedsaid » Fri Nov 24, 2017 1:39 pm

Well, the business world is very competitive and this might explain why profit margins aren't to your liking. The S&P 500 companies face world-wide competition and thus face fierce price competition. This would put pressure on margins. What I have been reading is that in recent years, profit margins have been near all-time highs. So maybe 10% is just too high in the real world.

As far as current ratio, there is a school of thought that a business doesn't want too much non-productive cash laying around, particularly in a very low interest rate environment. The steadier the cash flow, the less "emergency" cash a company needs. The more volatile the cash flow, the more emergency cash a company needs. My suspicion is that cash flows for S&P 500 companies are relatively steady and predictable. I further suspect that company managers want cash productively put back to work in the business rather than laying around doing nothing. S&P 500 companies would have access to credit also and this can function (in most cases, 2008-2009 financial crisis being the exception) as emergency cash.

Also we are over 8 years into a major bull market and this causes stocks to look expensive. I have been looking at the valuations of my stocks and funds and it is making even an optimist like me feel rather uncomfortable.
A fool and his money are good for business.

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Re: A checkup on the S&P 500 index

Post by dcarste » Fri Nov 24, 2017 2:00 pm

since the current ratio includes 'current assets' - wouldn't that include cash? So the current ratio as I have researched, at bare minimum, any sane manager would run above 1X? I'm not an accountant and I know debt is cheap, but the current ratio helps companies who face quick short term downturns. The ability to keep raising cash by selling corporate bonds is what is keeping this afloat, which should come home to roost should said company need to raise funds in a bond offering - which would presumable be at a higherinterest rate they would have to charge.

Regardless, thank you for your comment. the acid test (quick ratio) is worse by the way, this is a corporate debt binge, and I just hope they don't have to refinance at higher rates, given these companies are operating on RAZOR thin margins, except the 4 or 5 big tech companies.

I'm just trying to be sane, if I ran my business and knew I only had enough or not enough to fund short term liabilities, so I rely on the debt market to raise funds, I would consider myself a terrible business manager. I would also question my business model if I couldn't make a 5% profit, and I would also question myself as a business if on top of those two, I was paying over 80% of my earnings in dividends. Guess they could just cut or eliminate dividends for a few years to survive the downturn. Luckily debt markets were the strongest on record for the oil industry in America, a lot of lenders came out to save a lot of jobs and companies. My brother works in oil and gas as he said just the past 2 years, the cost of getting oil out has gone down to around 40 in more of the 'easier' oil fields.

Anyways, seems like we have a lot of bunk CEO's running these companies, you do end up with a lot of high quality companies though ~150 that can pass a sane test.

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Re: A checkup on the S&P 500 index

Post by patrick013 » Fri Nov 24, 2017 5:50 pm

Pick one of the stocks in that screen and look at Moody's bond
rating sheet on their website. Looked at ticker R (Ryder) a few
days ago. Their ratios are somewhat poor especially Debt/Equity.
They spend every dime they get. But they still hold on to a BBB
bond rating, barely. Interesting story. They are vulnerable to
economic events.
age in bonds, buy-and-hold, 10 year business cycle

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Re: A checkup on the S&P 500 index

Post by venkman » Fri Nov 24, 2017 8:58 pm

dcarste wrote:
Fri Nov 24, 2017 1:21 pm
Universe: S&P500 companies
Profit Margin: 10% or greater (why would I do business in general if I can't make a simple 1 dollar of net income out of 10 dollars of sales)
For the 12 months ended 1/31/17, Wal-Mart had net income of $13.6 billion on revenues of $485.9 billion (only about a 2.8% profit margin).

I can think of 13.6 billion reasons why they bother to stay in business, in spite of the low margins... :happy

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Re: A checkup on the S&P 500 index

Post by petulant » Fri Nov 24, 2017 10:06 pm

Your ideas about net profit margin are incorrect. Many large companies rely on high volume, low margin strategies that make them significant earnings.

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Re: A checkup on the S&P 500 index

Post by Dominic » Sat Nov 25, 2017 2:32 am

I don't think the margin screen is necessary. If a company is making a lot of profit per share, it doesn't matter how much they spent to get there. As long as the profit is sustainable, it's good. Similarly for the dividend screen: I don't care if a company reinvests everything or nothing. If I get a dividend, it's reinvested. Either way, I get the same result.

So I screened only for the debt/equity ratio. 162 S&P 500 companies have more debt than equity. Then I sorted them by market cap, to see which companies had the biggest impact in an S&P 500 cap-weighted index fund. Amazon is the largest one in this group. I personally think they'll grow a lot in the next few years, but are still overvalued. Next up are the big banks. A crash would hurt them for sure, but they're still value stocks and would probably survive a crisis, even if they're in debt.

As you move down this list, the other large companies are solid. You have telecoms, food products, pharma, and defense contractors. These are business that are mostly low P/E, and their demand doesn't sink in a crash. They will handle the debt. When the companies shrink down to the $40B cap range, it doesn't look as great, but a good number of them seem like they provide essential products/services, and many of them are value stocks.

Ultimately, I think the S&P is a good index. I prefer total stock market, but in a pinch, there's nothing wrong with the S&P. It's a decent representation of the market. Whether or not we like it, there are some junky looking stocks in the market. They're mostly cheap, so it can't hurt own them too and see how it pans out.

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Re: A checkup on the S&P 500 index

Post by bgf » Sat Nov 25, 2017 8:58 am

Most stocks don't perform well. MOST of them. you cannot look at the individual components of a market cap weighted index and apply the concepts of simple averages and bell curves, e.g., the false assumption that if the 'average company' is doing poorly then the index is bound to do poorly or the false assumption that most companies should perform generally in line with the index with some doing worse and some doing better, again, that is a totally false assumption and not at all characteristic of how market cap weighted indexes perform.

with broad market indexes, most companies in it are going to UNDERPERFORM the index return! that is precisely the reason why active management is so difficult! the majority of companies do worse individually than the aggregate market!

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Re: A checkup on the S&P 500 index

Post by UncleLongHair » Sat Nov 25, 2017 9:44 am

A 10% profit margin (assuming you're talking about net profits) is pretty high. As someone else noted, a large retailer like Walmart usually runs at 3-4% profits. Costco is closer to 2%. A typical grocery store will run margins as low as 1-2%. Manufacturers can be higher but still not 10%, like John Deere is usually around 7-8%. On the other hand, Apple's net profit margin is nearly 20%.

By screening for companies with a profit margin of 10% or greater you're really just selecting the highest profit industries but there are large segments of the economy that can be healthy and happy and run at lower profit margins.

Another interesting metric to consider is return on equity or return on invested capital. This shows how well a company can turn one dollar of invested capital into more than one dollar of value. Think of the business as an engine that consumes money and produces money, if it isn't producing more than it is consuming at a rate that is better than inflation or risk-free rates, it is not doing anything for the economy. Values of 5-15% are typical, but it's a rare company that can sustain a high level of returns here.

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Re: A checkup on the S&P 500 index

Post by AndrewXnn » Sat Nov 25, 2017 5:55 pm

The S&P500 index is weighted by free-float market capitalization, so more valuable companies account for relatively more of the index.

It consists of 505 stocks issued by 500 companies, but less than 5% (24) of the companies make up over a third of the index.
So, weighing each company equally results in a significantly distorted view of the index.

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