To start our investigation for shares with huge upside potential, we have to check the connections between individual ratios quantified a year ago and the total return of the next year. For the sake of this chapter, we picked the following ratios. We took the values from 1 year earlier so that we can contrast these with last year's TRS:
- Cash/assets 1 year ago
- Net fixed assets/total number of assets 1 year ago
- Assets/1000 employees 1 year ago
- Price/cash flow average of last 5 years 1 year ago
- Price/cash flow 1 year ago
- Operating income/net sales 1 year ago
- Dividend payout ratio 1 year ago
- Asset turnover 1 year ago
- P/BV 1 year ago
- Operating income/net sales 1 year ago
- Revenue growth in the last 1 year 1 year ago
- Long-term debt/capital 1 year ago
- Debt/EBITDA 1 year ago
- Market capitalization 1 year ago
- P/E 1 year ago
Calculating Pearson's correlation coefficients may be a good start:
d_filt <- na.omit(d)[,setdiff(1:19, c(1,2,18))] cor_mtx <- cor(d_filt) round(cor_mtx, 3)
When looking at the correlation table, there are two important conclusions to draw. They are as follows:
- There are only four financial ratios that show a significant correlation with TRS, but even there, the connections are very weak; that is, they remain in the range between -0.08 and +0.08. This means there is no clear linear connection between any of our ratios and the TRS.
- The financial ratios chosen are quite independent. Out of the 105 (15*14/2) potential connections, only 15 are significant. Even all those fit into the interval of -0.439 and +0.425, and only eight of them have a bigger absolute value than 0.2.
So, we see that it is not easy to set up a good strategy. Just relying on one single ratio would lead us nowhere. We shall go for more complex methods.
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