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Understanding patterns of Financial Health

It is essential that you have a complete understanding of the various patterns of Financial Health that Stock Doctor displays when analysing all ASX listed companies.


Dr. Merv Lincoln's research found that the following conclusions may be drawn from the analysis of the graphs of troubled, yet surviving companies:

  • Companies can recover from poor positions of Financial Health, though the recovery is generally slow
  • To correctly interpret a pattern of Financial Health, it is important to have an understanding of the industry characteristics
  • There are certain companies that have a consistently poor level of Financial Health, irrespective of the general economic situation
  • The key to corporate survival appears to be the presence of a competent management team that takes swift corrective action before the situation becomes serious
  • The longer it takes to implement the corrective action, the more the change needs to be serious and far-reaching to be effective.

The Stock Doctor program enables you to examine the Financial Health trends and typical patterns for all ASX-listed companies. By conducting comparisons such as these you will not only become increasingly familiar with Stock Doctor, but more importantly, be better equipped to understand and interpret the information provided.

Patterns of Health

Knowledge acquired from repeatedly viewing company analyses will alert you to tell tale signals that an opportunity may exist with a particular company. These signals come in various forms including Trends in Financial Health (explained below), Case Studies (that provide investors with a historical example that may repeat itself in the current period), Trends in Return on Assets (ROA), Comments by Directors of an impending restructure of company operations and/or management (a sign that the company’s performance is likely to turn around). The more you look at the output that each Stock Doctor analysis provides, the better you will become at identifying opportunities early and the more ways you will find to use Stock Doctor to substantially improve your decision making ability and enhance your investment returns.

Let’s examine in more detail the various patterns of Financial Health that companies can display. (The Grey bars represent the industry average Health score)

There are four main patterns of Financial Health:
(1) Recovery pattern
(2) Consistently Strong pattern
(3) Deteriorating pattern
(4) Financial Tightrope pattern

Examples of the four general patterns of Financial Health are given on the following pages. Please note, the examples presented may have been taken from an earlier period in order to provide a clear illustrative snapshot. Accordingly, when you view Stock Doctor, the latest analysed period may be different to the illustration given here. The pattern of Financial Health or the trend in Financial Health may now be showing a different pattern to that described herein.


Recovery patterns

This pattern of Financial Health is described as that of a Classic Recovery in financial standing. 

In this example the company has a Marginal Health rating at the start of the period. A Marginal rating is where Financial Health is said to be significantly below desired levels and accordingly, if this rating were to be viewed in isolation, it may be deemed that Financial Health is too low (or in other words financial standing is said to be weak) for investment. However, the critical issue is that the trend in Financial Health is in the right direction i.e. improving as exposure to financial risk decreases.

The example below shows the pattern of Financial Health of a Rapid Recovery in financial standing. In this example the recovery is accompanied by a solid increase in Return on Assets/Investment (ROA), i.e. the recovery was profit led. The trend in ROA is often a critical indicator as to whether an investment opportunity exists.


Consistently Strong patterns

This pattern of Financial Health is described as Consistently Strong when Financial Health has been below 0.30 for at least one year (two periods). It has been found that with Consistently Strong patterns of Financial Health a company's share price is highly correlated to an upward trend in ROA that exceeds 8%.


Deteriorating patterns

This is the classic Deterioration Pattern where the company has progressed to a situation of financial difficulty. 



Financial Tightrope patterns

This pattern of Financial Health is described as a Financial Tightrope situation, as Financial Health has remained significantly below average (or in other words, financial risk is consistently above the industry average) for a number of periods. Often these businesses will require an inject of capital to remain viable.


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