I’ll use ATI Technologies, to illustrate the value analysis process, to explain how to score a value candidate.

Step 1. Analysts’ Ratings & Forecasts

The best value prospects are stocks that market analysts don’t like much. The Sentiment Index reflects analysts’ buy/sell ratings and the scorecard rewards low sentiment scores. It penalizes firms with high earnings growth forecasts and/or positive earnings growth forecast trends. ATI scored one Sentiment Index point and no earnings growth penalty points.

Step 2. Valuation

Value candidate’s share prices should reflect low growth expectations. The score rewards candidates with implied average annual earnings growth below five percent and penalizes those with implied growth exceeding 10 percent. ATI’s 5 percent implied growth scored zero.

Step 3. Target Price

Buying at the right price is critical for successful value investing. The target price formula establishes both a low- and high-target buy price and it’s okay to buy within or below that range. The scorecard rewards candidates with share prices trading below the buy range, and penalizes those trading above.

ATI was trading below its low buy target, and thus earned one point.

Step 4. Industry Analysis

It isn’t necessary that value candidates be in a high-growth industry, but stagnant or declining industries are bad news. Consequently, the scorecard penalizes firms in industries growing less than 3 percent annually. Participating in a fast growing industry increases your chances of success, and the scorecard rewards firms in industries growing faster than 15 percent.

I forecast ATI’s industry growth at 21 percent; therefore it earned one point.

The scorecard awards one point for candidates in concentrated industries. ATI had only one major competitor, thus earning it one point.

Step 5. Business Plan

Transfer the business plan score computed during your analysis to the scorecard. ATI’s business plan score totaled minus five. Typical of many tech firms, ATI’s score suffered from short product cycles, long product lives, unpredictable revenue streams, and few barriers to entry.

Step 6. Management Quality

The right management can make a good company great, so the scorecard rewards companies with key executive and board quality that you graded as very good or excellent. Ineffective management’s results will show up in other performance measures and the scorecard doesn’t deduct for low grades. I had rated ATI’s management as fair, so it didn’t earn a point for this test.

Most firms do have clean accounting and show reasonable earnings growth stability, so the scorecard penalizes those that don’t pass these tests, but doesn’t reward those that do. I rated ATI’s accounting as clean, and its earnings growth stability as good, so it didn’t lose any points.

Step 7. Financial Health

Failing the appropriate financial health test disqualifies a candidate. ATI qualified for the busted cash burners test and passed.

Step 8. Profitability

Your best value candidates are firms that were highly profitable before they stumbled and can be expected to return to previous profitability levels. The scorecard rewards firms with expected return on assets av- eraging above 14 percent, and penalizes those below 6 percent. ATI’s ROA averaged around 20 percent before it hit bad times in its 2000 fiscal year. I assumed it would return to that level, earning it one point.

Step 9. Red Flags

Since a value candidate’s financial statements are probably already in shambles, the analysis doesn't look for red flags. However it does compare historical capital expenditures to depreciation write-offs, a yellow flag test, and deducts a point from firms failing this test. ATI’s capital investments consistently exceeded its depreciation expenses, so it wasn’t penalized.

Step 10. Ownership

Very high insider ownership spells risk, and this test penalizes firms in that category. ATI’s insider ownership was far below the 55 percent limit, and thus wasn’t penalized.

Step 11. Price Chart

A strong price chart indicates that your candidate’s recovery prospects have already been recognized and it’s probably too late to buy. This step penalizes firms with share prices 10 percent or more above their 200-day moving average.

ATI’s share price was trading below its 200-day MA, so it wasn’t penalized.

Summary

ATI’s minus five business plan score drove its total down to only one point, barely in positive territory. Tech firms tend to have low scoring business plans, and ATI’s unpredictable revenue stream and small number of customers exacerbated the problem.