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:
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.