Financial Health is our first and most important Golden Rule.
Developed in 1982 by Lincoln founder, academic and former Olympian Dr Merv Lincoln, Lincoln's unique Financial Health model assesses key accounting ratios relating to each company's profitability, cashflow, liabilities and assets.
Financial Health measures a companies ability to absorb a shock to its operations should something go wrong at an operational or financing level.
Lincoln’s Financial Health methodology, derived from Dr Lincoln’s PhD thesis, used a multivariate approach, whereby a unique set of financial ratios are calculated, combined and weighted to produce an insolvency risk score representing the overall Financial Health of a company.
Dr Lincoln selected these ratios after analysing thousands of failed and successful companies, to separate low risk companies from high risk companies and isolate indicators of potential failure.
The model was refined in 2007 under the guidance of Assoc Professor Neville Norman using newer multi level modelling techniques to take into account new ratios that were previously unavailable but are now accessible because of new accounting regulations and reporting standards.
It then determines a Financial Health rating commensurate with the business risk of the company so investors can quickly identify stocks that warrant further consideration and eliminate those that don't.
Understanding the Financial Health of a company must form the basis of all investment decisions. Stock Doctor expertly performs all key ratio calculations enabling you to focus your full attention on making confident and informed portfolio management decisions.
To meet this criteria a stock must exhibit Strong or Satisfactory Financial Health ratings. A company must be healthy for at least two consecutive periods or more. It is not sufficient for a stock to be healthy for solely one period.
Two model system
The Lincoln Financial Health methodology uses a two model system to effectively discriminate the indicators of failed and non-failed companies.
Given that different economics and dynamics govern each industry group, the characteristics of each sector were reviewed carefully to determine the optimal groupings.
The first model applies to the “Real Producers” sector which includes companies in the materials, energy and industrials sector. The other model is for “The Rest” which includes all remaining companies (except Bank and Insurance companies).
Bank and Insurance Stocks
Stock Doctor analyses Bank and Insurance companies separately because they operate under a different financial structure to other ASX listed companies. Hence, the Financial Health for the companies in this sector is assumed to be ‘Strong’ as they are already subject to rigorous prudential and liquidity standards and requirements.