ruly Long-term quality: 9 criteria to assess a sound company
A preset strategy to analyze a profitable, lightly indebted company over 10 years or more: each criterion explained, where the thresholds come from, and the limits.
Published
A preset strategy, read-only: duplicate it to adapt it. The thresholds are common benchmarks, not rules, and a strategy verdict never tells you what to do with a stock.
The criteria and their thresholds
| Criterion | Criterion met | To monitor | Criterion not met |
|---|---|---|---|
| Revenue growth (annual average over 5 years) | ≥ 8% | 4% to 8% | < 4% |
| Gross margin | ≥ 40% | 25% to 40% | < 25% |
| Operating margin | ≥ 20% | 10% to 20% | < 10% |
| Average ROIC (5 to 10 years) | ≥ 15% | 10% to 15% | < 10% |
| FCF / net income (5-year average) | ≥ 90% | 70% to 90% | < 70% |
| Net debt / EBITDA | ≤ 1.5 | 1.5 to 3 | > 3 |
| Annual change in share count (5 years) | ≤ 0% | 0% to 2% | > 2% |
| Price / FCF against its 5-year average (calculated) | ≥ 0% | -20% to 0% | < -20% |
| Competitive advantage | Yes | No |
Thresholds read from the preset strategy in the app. A calculated criterion is worked out by the app from two figures you enter.
Who it is for
This strategy is for investors looking for companies that can stay profitable for a long time: a horizon of 10 years or more, high and steady returns, little debt. It follows the “quality” style, one of the factor families that index providers describe publicly.
It is a poor fit if you are after a steady income (the Growing dividend preset strategy suits that better) or a clear discount on current figures (see Value).
The 9 criteria, one by one
Revenue growth over 5 years
A quality company that stops growing eventually sees its returns erode. The criterion uses the average annual growth rate over 5 years, to smooth out an exceptional year. Above 8% a year, the business is growing well ahead of inflation. Between 4 and 8%, growth is still decent for a mature company. See the revenue growth entry.
Gross margin
It measures the gap between revenue and the direct cost of what the company bills. A high, stable gross margin suggests that customers are willing to pay for the brand, the technology or the service. The 40% threshold often separates companies that set their prices from those that have to accept them.
Operating margin
It shows what is left once every operating cost has been paid: salaries, marketing, research, overheads. At 20% or more, the company earns a lot of profit on every euro it bills. Between 10 and 20%, it is still profitable, with less room if things go wrong.
Average ROIC over 5 to 10 years
ROIC compares after-tax operating profit with the capital tied up in the business. It is the central indicator of the strategy: a company that reinvests at 15% a year or more grows its capital well beyond what that capital costs. Averaging over several years avoids relying on a record year.
FCF / net income over 5 years
Accounting profit is only worth something if it turns into cash. This ratio, called FCF conversion, compares free cash flow with net income. At 90% or more on average, almost all of the profit becomes available cash. Below 70%, part of the profit stays tied up in inventory, receivables or capital spending.
Net debt / EBITDA
This ratio says how many years of operating profit before depreciation and amortization it would take to pay off net debt. Below 1.5, the company keeps a lot of freedom, even in a recession. Above 3, debt weighs on management’s choices.
Change in share count
A falling share count signals share buybacks: each remaining share represents a bigger slice of the company. A rising count signals dilution, through share issues or stock-based pay. Green requires a share count that is flat or falling over 5 years, orange tolerates an increase of up to 2% a year.
Price / FCF against its 5-year average
Paying too much for an excellent company can mean years of disappointment. This criterion compares the current price / FCF with its own 5-year average, without judging the absolute level. The app works out the gap from the two figures you enter: green at or below the average, orange up to 20% above it.
Competitive advantage
This is the only qualitative criterion: yes or no, with a free note to describe it. A patent, a network, high switching costs for customers, a strong brand. Figures do not prove it, but high and stable margins and ROIC over ten years are often its trace. See the competitive advantage entry.
Why these thresholds
The thresholds follow common benchmarks in financial literature and among data providers: ROIC above 15%, net debt below 1.5 times EBITDA, a gross margin of at least 40%. They target companies that are clearly more profitable than the average of their market, which rules out most companies from the start.
They are starting points, not truths. A retailer can be sound with a 25% gross margin, while a mediocre software company can show 80%. To change a threshold or add or remove criteria, duplicate the preset strategy: the copy is yours, and the original stays as it is.
Limits
A strategy only sorts past figures. It does not say whether the competitive advantage will last, or whether management will allocate capital well in the future. A company can tick every box at the top of its cycle.
Banks, insurers and real estate companies are a poor fit: their accounts are not read the same way, and several criteria make no sense for them. In that case, tick “Not applicable” on the criteria concerned rather than forcing a value.
Each criterion’s verdict is an aid to thinking. The decision remains yours.
The indicators in this strategy
Sources
- MSCI, factor families (value, quality, yield, growth)
- Morningstar, style box
- Aswath Damodaran, NYU Stern, margins and returns by industry
- Annual reports of listed companies