When I began investing, I was starting from a knowledge base of zero.
One of the first books I read was The Motley Fool's Rule Breakers, Rule Makers. In it, Motley Fool co-founder Tom Gardner laid out specific criteria for crowning a company a Rule Maker: A mature, consumer-facing business that's king of its market space, and an investment that can confidently and profitably be held onto for years with only quarterly check-ins.
His step-by-step process for analyzing a business was an easily understandable way for a beginner like me to quickly get up to speed; but its back-to-basics approach will benefit even advanced investors. Today, we're going to run big-data solutions provider Teradata (NYSE:TDC) through Tom's merciless gauntlet, and see exactly what makes it a classic Rule Maker.
1. The mass-market, repeat purchase of low-priced goods
This space is normally reserved for companies that 99% of the population have already heard of. Teradata isn't one of those companies, but it has such a relatively simple -- and globally in-demand -- business model, that I just couldn't pass it up.
Teradata is a business-to-business company that provides hardware, software, and consulting services for companies that need to manage vast amounts of data. Does that sound useful? You can probably name five companies off the top of your head that might need the services of a company like Teradata, such as an Amazon.com, or an Apple -- any company that's dealing with so much data, it literally doesn't know what to do with it. Not only does Teradata help companies store data, it helps them make sense of it.
Teradata may not be a mass marketer of products in the consumer goods sense, but it certainly serves a mass market. And while Teradata doesn't neatly fit our Rule Maker idea of supplier of low-priced goods, it certainly will do a repeat business with the products and services it offers. As such, while Teradata doesn't ace our first Rule-Maker benchmark, it performs solidly.
2. Gross margin
Gross margin indicates manufacturing efficiencies, brand power, and pricing power. The ideal gross margin for a Rule Maker is 60%.
- Teradata's gross margin is a strong 56%.
- Longtime rival IBM (NYSE:IBM), however, only manages 48% here.
- Peer EMC (NYSE:EMC) pulls off a hearty 62%.
- Finally, Oracle (NYSE:ORCL) does best of all, with a blistering gross margin of 79%. Well done, Oracle. That's one tight ship.
3. Net-profit margin
Net-profit margin dictates how many pennies a company gets to keep from every dollar of sales. Tom Gardner likes to see net-profit margins of 10% for his Rule Makers.
- Teradata's net-profit margin TTM is a benchmark-beating 15.59%.
- IBM also beats up on the Rule-Maker benchmark, with a net-profit margin TTM of 15.53%.
- EMC is up there, too, generating a net-profit margin TTM of 12.68%.
- Again, Oracle swings big on a Rule-Maker metric, with a net-profit margin TTM of 26.33%.
4. Sales growth
Year-over-year sales, or revenue, growth counts even for big companies, where it will naturally slow with age, because it's an indicator of business momentum. Top-tier rule makers grow their sales by 10% every year.
- Teradata grew its revenue by a solid 7.5% YOY.
- IBM's revenue contracted by 5.4% YOY.
- EMC grew its quarterly revenue by a solid if not stellar 6% YOY.
- Finally, Oracle only managed 3.1% on this metric.
5. Cash-to-debt ratio
Rule Makers should be cash heavy and debt light, ideally having at least 1.5 times more cash than debt:
- $909 million in cash and $278 million in debt gives Teradata the Rule Making C/D of 3.26.
- $12.3 billion in cash and $33.7 billion in debt gives IBM the unenviable C/D of 0.36.
- $5.45 billion in cash and $1.71 billion in debt gives EMC the very enviable C/D of 3.19.
- And $29.7 billion in cash and $14.8 billion in debt gives Oracle the similarly enviable C/D of 2.0.
Money is so cheap right now. As such, too many companies are in debt up to their corner offices. Kudos to three of our companies here for keeping their balance sheets in top Rule-Making form.
6. The Foolish Flow Ratio
The Foolish Flow Ratio measures how well a company manages its inventory and cash. A company should be keeping its inventory and accounts receivables low, and its accounts payables high. These are strong indicators of market-space dominance.
To calculate the Foolish Flow Ratio, take current assets minus cash, cash equivalents, and short-term investments, then divide by current liabilities. The acceptable upper limit for the Foolish flow ratio is 1.25, but the lower the number the better:
- Teradata comes in solid on this metric, with an F/F of 0.94.
- IBM also does very well, with an F/F of 0.91.
- EMC comes in with an excellent F/F of 0.57.
- Oracle also hits an excellent F/F: 0.47.
7. Your familiarity and interest
What's in a name? Quite a bit. Your familiarity and interest with a company help you understand exactly what it does, and how it makes money, thereby lowering your overall investing risk.
While you may have never heard of Teradata before, a clear understanding of how the company makes money -- which you now have -- should go a long way toward giving you a solid level of comfort investing in it. As such, Teradata gets solid marks on this final Rule-Maker metric.
Teradata: A classic Rule Maker
Teradata missed a bit on gross margin, and a bit on sales growth. That's okay. Teradata may not hit all our Rule-Maker metrics out of the park, but it doesn't need to. A Rule Maker needs to be strong on the metrics and strong over the long run. That's what counts, and that's what makes Teradata a classic Rule Maker.
But always remember to check in on your Rule-Maker investments once a quarter by running them through this simple checklist. In Rule Breakers, Rule Makers, Tom Gardner goes into even greater depth and detail about what exactly makes a Rule Maker a Rule Maker. So I suggest you pick up a copy for yourself, and get the whole story from the man who wrote the book on it.
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