Mastering Variables for Success: Insights from a Lemonade Stand
If you want to know what helps find hyper-successful companies, it’s precise criteria. After learning the value in the power of operators, you need to amplify your view of how to create equations and consider the variables at play.
What is a variable? A variable is a characteristic/quantity that can measure and assume different values.
Imagine you have one equation evaluating the P/E of a company and then another equation evaluating the Accounts Receivable and Payable of a company. Those are separate variables. Don’t let your mind explode, but having multiple variables allows for more specification in your screener.
Evaluating The Lemonade Stand
Rebecca is doing well with her lemonade stand, but she’s to such a level of success that she decided to sell her business.
Barney is interested in buying it but wants to evaluate several company components before purchasing to ensure it is a wise investment. He wants to evaluate Rebecca’s revenue, profit, and costs.
Those three aspects that Barney wants to evaluate would be three separate variables to input into a stock screener. If he were using Equities Lab, he would create a tab for each variable to create the complexity when observing the lemonade stand.
Once Barney evaluates those, he decides to move forward and purchase the company because of the positive performance.
Common Example Using Multiple Variables
An influential and respected way to evaluate the stock market using multiple variables is the Piotroski F-Score. Think of it as a 9-point checklist to determine the health of a company. The following variables are the 9 points that evaluate a company.
- Is_profitable – making money gets you a point. It seems trivial, but money-making companies are less likely to go out of business.
- Is_cash_flowing – companies with positive cash flow can spend that cash if needed. Companies without a positive cash flow must raise money, even with positive income.
- Is_roa_increasing – squeezing more income from the same assets is good.
- cashflow_greater_than_income – net income is not as useful as cash flow, and accrued income has a way of vanishing.
- Is_repaying – No debt is good, as is a shrinking debt-to-asset ratio.
- Curr_ratio_improving – high current ratios are good, and increasing ones are better.
- Shares_outstanding – shareholder dilution means more shares are needed for the same income/dividend/whatever.
- Margin_improving – If a company can make more money on a given sales volume, that portends more profit.
- Asset_turnover_quicker – if a company can get more sales from the same set of assets, that also portends good things.
The 9 methods for scoring are the 9 different variables. They demonstrate how complex stock screeners can become (but not even close), along with the necessity for complexity to determine success.
Takeaways
In the 4th homework, you plot the Market Cap in one tab and then the Net Income in a separate tab. By doing this, you are using multiple variables to evaluate an increasing income. With the Piotroski F-Score, you can utilize 9 different variables to analyze the health of a company, and so becoming in tune with the possibility of how to include multiple equations can lead to a developing investor ready to adjust and create more powerful screeners.
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