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 financial-software maker Intuit (NASDAQ:INTU) through Tom's merciless gauntlet and see exactly what makes it a classic Rule-Maker and, as such, quite possibly the perfect long-term stock.
1. The mass-market, repeat purchase of low-priced goods
You're less likely to know the name Intuit than TurboTax, the company's tremendously popular tax-preparation software. And while TurboTax isn't as cheap as a can of soda from Coca-Cola -- the company that practically defines the mass-market/repeat purchase/low-priced goods Rule-Maker category -- it's inexpensive enough that people keep returning to it every year to do their taxes (especially relative to the cost of an accountant), like me.
And just in case you don't know, Intuit makes business and financial software for small- and medium-sized businesses as well. All things considered, Intuit scores well on this, our first Rule-Maker benchmark.
2. Gross margin
Gross margin indicates manufacturing efficiencies, brand power, and pricing power. The ideal gross margin for a Rule Maker is 60%.
- Intuit hits a killer 82% trailing-12-month gross margin.
- H&R Block (NYSE:HRB), which offers face-to-face tax preparation as well as tax-preparation software services, hits a Rule-Making 63% TTM gross margin itself.
- King of the software companies, Microsoft (NASDAQ:MSFT), also knocks it out of the Rule-Maker park here, with a TTM gross margin of 75%.
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.
- Intuit's TTM net-profit margin is a big 19.82%.
- H&R Block's TTM net-profit margin is a very healthy 11.96%.
- Microsoft swings big here, too, with a TTM net-profit margin of 21.71%.
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.
- Intuit grew its year-over-year quarterly sales by a healthy 8.9%.
- H&R Block's quarterly sales YOY were actually down, by 4.1%.
- Microsoft had a tough quarter as well, with YOY sales down by 7.9%.
5. Cash-to-debt ratio
Rule Makers should be cash heavy and debt light, ideally having at least 1.5 times as much cash as debt:
- $558 million in cash and $499 million in debt gives Intuit a C/D of 1.12.
- $940 million in cash and $1 billion in debt gives H&R Block a C/D of 0.94.
- $66 billion in cash and $12 billion in debt gives Microsoft a C/D of 5.5.
Money is extraordinarily cheap right now. As such, too many companies are in debt up to their corner offices. Kudos to at least Microsoft for keeping its balance sheet in proper Rule-Maker trim here.
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 -- strong indicators of market-space dominance.
To calculate the Foolish Flow Ratio, take current assets minus cash, cash equivalents, and short-term investments, and then divide by current liabilities. The acceptable upper limit for F/F is 1.25, but the lower the number, the better:
- Intuit does well on this metric, with an F/F of 0.62.
- H&R Block does even better, with an F/F of 0.22.
- Microsoft is no slacker on this metric either, with a very healthy F/F of 0.55.
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.
Even if you've never used the company's software, it's easy to get your head around what Intuit does: makes and sells financial-solutions software. And if you've used TurboTax, or one of its other products, all the better. As such, Intuit scores well on our final Rule-Maker metric.
Intuit is a classic Rule Maker
Intuit comes in just slightly under our Rule-Maker ideal for revenue growth, and it could have a little more cash and/or less debt on its books, but otherwise the company is a very strong performer and a classic Rule Maker. Remember that Rule Makers don't need to knock every metric out of the park; their strength lies in their ability to perform over the long run, and that's Intuit.
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.
Fool contributor John Grgurich has no positions in the stocks mentioned above. The Motley Fool owns shares of Microsoft. Motley Fool newsletter services recommend Intuit, Coca-Cola, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.