Eliminating Some Stocks from the Green Screen

After the weekly Green Screen update this weekend, I wanted to take a moment to step back and consider the screen from a more industry-level perspective.

We are looking for a very specific kind of business to invest in. Specifically, we are looking for:

• Out-sized revenue growth over the next 5+ years (ideally 10% or more).
• A majority of revenue (70% or more) coming from recurring revenue sources (subscriptions, "toll-booth" models, etc.).
• One or more identifiable economic moat factors (switching costs, network effects, consumer branding, etc.).
• Proven leadership with a long-term, business-oriented focus (NOT hired gun, quarter-to-quarter managers).
• Strong financial metrics - a rock-solid balance sheet and high cash returns on investment.

Some of these factors are company-specific, but many of them are also industry specific.

Put simply, many industries lend themselves much better to this kind of strategy than others. For example, software-as-a-service (SaaS) is inherently recurring revenue and frequently involves meaningful switching costs. On the other hand, a business like selling automobiles does not have recurring revenue, clear economic moats, and generally is a lot harder to maintain strong financial metrics with!

This fact allows us to comb through the Green Screens and eliminate some stocks pretty quickly. I wanted to take a moment and do that today. Let's look at a few industries of screened stocks that can be pretty much eliminated wholesale.

Commodity Extraction Businesses

Here, I'm talking about companies that are in the business of pulling commodities from the earth and selling them at market prices. These kinds of businesses can be lucrative when conditions are right — i.e., when the price for the commodity trades at higher-than-normal prices. However, the opposite is also true. Commodity prices regularly swing 25-30% or more in any given year. When this happens, the financial health of these firms can get dicey very quickly, given the amount of capital investment it requires to run them.

Given that fact, I prefer to just stay away from them altogether. We've eliminated a lot of oil and gas exploration and production (E&P) firms in the past, and I have another to remove today in Diversified Energy (DEC). Additionally, I'm removing Peabody Energy (BTU), a similar kind of firm in the thermal coal business.

Project-based Engineering & Construction

There are two "E&C" firms in the Green Screen right now — Tutor Perini (TPC) and KBR (KBR). E&C firms usually have a mix of project-based revenue and ongoing maintenance and operations revenue. The former is less interesting to me, as it indicates a less-predictable flow of sales and also eliminates the potential for switching costs. Of these two, TPC focuses mostly on project wins, while KBR earns about 2/3rds of its revenues through operations contracts with the government. Given this, I'm eliminating TPC today and may revisit KBR in the future.

Clinical Stage Biotechs

A clinical-stage biotech is a company that has not yet had a product approved by the FDA and on sale to the public. These companies show up on our screens because they receive milestone payments from partners from time to time, based on clinical milestones reached (e.g., passing a Phase II trial). These provide one-time "shots" of revenue into the company, inflating their growth and cash flows, and getting them onto our screens. But those are not sustainable revenues, and these firms are highly risky to invest in. I'd rather just stay away.

The Green Screen entries being removed here are: AC Immune (ACIU), Krystal Biotech (KRYS), and Xencorp (XNCR).