The 2021 Earnings Season is right around the corner, and I intend to start diving into individual companies to help you decide if they meet your investment objectives. This article will lay the framework for evaluating the investment potential and risk.

Today, I am going to lay out the initial methodology that I will use to analyze the tangible and non-tangible attributes of the ticker symbols as I go through them. I intend to focus on the most Drone-Dedicated businesses, because that is the primary subject of this blog. Time permitting, I will lightly touch the Drone-Diversified businesses, to help you understand their role in the U.S. Drone Industry. My analytical methodology will probably evolve over time, and I invite your constructive feedback via Comments or contacting me directly via Chat, Social Media, or Email, which are all linked at the bottom of this page.

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There are a couple of investor adages that have stuck with me through the years, and I’d like to share them with you.

“The Market is never wrong.”

“The Market is entitled to a correction from time to time.”

I share these to help remove some emotion from the practice of investing. Getting angry at the Market for not seeing it your way is about as useful as getting angry at the NFL referee through your TV screen—you are simply wasting noradrenaline and cortisol on a fruitless venture. Save it for the zombie apocalypse. Meteorologists have a higher success rate than Market Analysts because unpredictable humans can’t influence the weather.

Just as I have divided the DRONES U.S. Drone Market Index into three portfolios (Income, Growth, Speculation) based on investment objectives, I will outline three distinct approaches to analyzing individual companies to help you determine if they have a place in your own portfolio. I intend to reference this post as I analyze each company to give you the best snapshot I can. My Spotlights will include some combination of Fundamental, Technical, and Business Analysis.

Before we dive in, let’s lay out a few definitions (courtesy of Investopedia.com). 

Risk: Risk is defined in financial terms as the chance that an outcome or investment’s actual gains will differ from an expected outcome or return.

Volatility: Volatility is a statistical measure of the dispersion of returns for a given security or market index. In most cases, the higher the volatility, the riskier the security.

Revenue: The money generated from normal business operations.

Earnings: The profit a company produces in a specific period.

Cash Flow: The net amount of cash (and cash equivalents) being transferred into and out of a business.

Yield: A return measure for an investment over a set period of time.

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Income

Our DRONES Income Portfolio consists of mature companies who happen to be Drone-Diversified. With one exception, they are all Large- and Mega-Cap S&P 500 companies (the one exception is a former S&P 500 listing, and is now categorized as a Mid-Cap). They all historically offer a healthy, if somewhat unimpressive, dividend (though one company has temporarily cut its dividend to mitigate COVID-induced revenue loss).

Income investors tend to be very patient and stable. The ideal Income investor places a large sum of cash into a low-risk investment asset that generates a reliable and predictable dividend cash flow year after year. This cash flow may be reinvested into the same asset to increase future returns, or it may be withdrawn as income. Income investors tend to shy away from risk in favor of predictability.

In general, Income-worthy stocks tend to be boring companies with low Beta and minimal share price growth.  Part of the business profit is distributed to its shareholders instead of being reinvested back into the company’s growth.  The Utilities and Telecommunications sectors historically hold the highest dividend-yielding stocks. 

A rising share price is nice, but the appeal lies in price stability and dividend sustainability. You’ll want to ensure you pay a fair price for a great company, because you don’t expect the price to rise very fast, and you’ll own it for a long time. Price stability is important because you do not want your investment’s asset value to decline faster than your dividend distributions are accumulating. Some of the highest dividend yields I’ve encountered have been due to a depressed share price, and there is always some risk of the price going to zero. Dividend sustainability is important because you want the company to pay a consistent, or even increasing, dividend for years to come.

I tend to use Annual Reports to smooth out some seasonal cyclical fluctuations and get a long-term perspective. For a quick-look, here are some of the metrics I’ll look at for evaluating companies in our DRONES Income Portfolio:

• Forward Yield
• Beta
• Analyst Recommendations (Weighted)
• P/B Ratio
• Dividend Payout Ratio

I picked these metrics for the reasons I described above: ensure a solid, stable, and sustainable dividend yield for shares at a fair purchase price. I’ll be using my automated investment research tools to extract open-source information and conduct the basic arithmetic in milliseconds.

I’m introducing only very basic metrics to ensure that the current price is reasonable, and that the current dividend is at a safe level to sustain longevity. Given the size and maturity of these companies, I don’t feel compelled to dig much further than that—there are other blogs that specialize in this topic.

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Growth

Our DRONES Growth Portfolio consists of mature companies with a measurable Earnings history and a low to nonexistent dividend. Two are Drone-Dedicated, and the rest are Drone-Diversified. Their sizes span the entire spectrum of Market Capitalization (Mega, Large, Mid, Small, Micro). 

Growth investors share a sense of optimism and hope in the companies’ fortunes. They have market averages to rely on, taking comfort in the fact that the preponderance of mature stocks will rise in price over time. They have a moderate risk tolerance, and accept some volatility as the cost of doing business.

A company can generally be considered to be a good Growth investment if there is reason to believe (a) it is currently under-valued and will eventually return to its fair share price (also referred to as ‘Value Investing’), or (b) it is priced fairly at its current size and Earnings, and will sustain future growth with a corresponding rise in share price. In most cases, a rise in share price will be the only meaningful profit its investors see. Business profit is reinvested back into the company to increase its future potential.

Growth stocks are moderately sensitive to current events, but I see the most volatility during Earnings Season. Each quarter, the companies report their Revenue and Earnings, as well as their forward-looking expectations for the next period. If Earnings missed the previous period’s guidance, the price usually falls. If Earnings met the guidance, price remains somewhat stable. If Earnings beat the guidance, then the price rises. I find that the market prices in forward-looking guidance almost immediately rather than waiting until next quarter to see how well the company actually executed its plan.

I tend to use Quarterly Reports to get recent figures and appreciate the trends throughout the previous year. For a quick-look, here are some of the characteristics I’ll look at for evaluating companies in our DRONES Growth Portfolio:

• P/E Ratio
• P/S Ratio
• PEG Ratio
• Price/Book Ratio
• Return on Equity
• Industry Averages (P/E, P/S, PEG, P/B)
• Analyst Recommendations (Weighted)
• 3-Year History (Earnings, Revenue)
• Analyst Price Targets
• Discounted Cash Flow Net Present Value
• Price vs 50-Day vs 200-Day Moving Averages

I picked these metrics for the reasons I described above: determine if the current price is at or below fair value, estimate its ability to increase in the future, and assess the story the current momentum is telling. I’ll be using my automated investment research tools to extract open-source information and conduct the basic arithmetic in milliseconds.

I’m using Industry Averages to put the previous ratios in context, to help determine how fairly the stock is currently priced. For example, I would expect a company in the Information Technology (IT) sector to have a higher P/E ratio than a company in the Consumer Staples sector (39 and 28, respectively). Similarly, within the IT sector, I would expect the Software industry to have higher P/E than the Hardware, Storage, and Peripherals industry (59 and 27, respectively). If a company’s P/E is significantly higher or lower than its industry average, then we will question if it is fairly valued.

I’m also using trends and forward-looking estimates as methods to predict future growth potential. I’m pulling technical indicators to gauge short-term momentum and Bullish/Bearish patterns. After all, some of these companies are less than a decade old but could become future Fortune 500 participants. How wonderful it would be to flag them in their infancy!

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Speculation

Our DRONES Speculation Portfolio consists of early-stage companies with no positive Earnings history or dividend. They are Drone-Diversified in the Mid-, Small-, and Micro-Cap weight class. High-risk, high-reward, as the saying goes. 

Speculation is the act of making an investment that has substantial risk of losing value, but also holds an opportunity of making a significant gain. The majority of speculative investing depends on short-term gains that depend on daily market fluctuations. This is largely the realm of day-traders and swing-traders, though I will not cover that style of investing.

Many speculators depend on a series of short-term trades to rake in large profits. For example, if you could consistently net 1% profit each day exchanging FOREX or Cryptocurrency, then you would be looking at 200-300% pre-tax profit per year. Unfortunately, this investing style does not fit the objectives of my blog, so I will not be covering it—there are other blogs that focus on this style of real-time speculation. I will focus on the drone companies whose metrics lump them in th

Speculative investors have a high risk tolerance. They accept the fact that some, perhaps most, of their picks will turn out to be duds, but the few diamonds in the rough will generate gains that far outweigh the losses. They look for opportunities that outweigh the risks.

Our style of speculation relates to stocks that outwardly appear to be poor investments, but have that one-in-a-hundred chance of growing into an industry giant. They are the high-risk assets that represent the highest rewards, and are viewed as opportunities. For example:

• Those investors that bought the computer company Apple during its 1984 IPO for the present diluted value of about $0.10.
• Those investors that bought the college textbook marketplace Amazon during its 1997 IPO for the present diluted value of about $1.50. 

At the time, those investors had no reliable fundamentals to depend upon, but there was a feeling in their gut that said this might be a good move. Think of them as the “moonshots” in your portfolio: they have a less-than-even chance of success, but the minority that prove successful may be multibaggers. For this blog, I am looking at Speculation through a similar lens that Venture Capital (VC) firms do—I just need a few winners to offset the losers, and I’m willing to wait out the hills and valleys.

What does a speculative stock look like, particularly in the U.S. Drone Industry? I wish that I could tell you there was a reliable formula, but that would be a lie. Of the three symbols presently in our DRONES Speculation Portfolio, only two have recorded any revenue at all, while the third is simply eating away at its VC investment funding while it looks forward to making its first sale. (To be fair, the third stock went public within the last year.) Trust me when I say that there are no ratios or trendlines with these stocks that any textbook, journal, or Financial Analyst would recommend a Buy trigger upon. That’s why they are called “moonshots”, and these happen to be the moonshots I found that happen to be in the U.S. Drone Industry (excluding OTCs/Pinks, that is).

Note:

There are two primary reasons for a privately-owned company to go public with an IPO.

1) It needs to raise more cash from new sources for an upcoming capital investment.

2) The current business owners want a convenient method to sell their share for profit.

In general, Speculative stocks tend to be exciting with high Beta. I attribute this phenomenon largely to instantaneous information exchange, public hype, and real-time trading, all three of which nullify many fundamental theorems of investing. A single Tweet could multiply the share value by 2x or 0.5x within the hour, regardless of if it is founded in truth. 

Several of the companies in our Speculation portfolio have little to nothing to report in terms of Earnings; as such, I find P/E, P/S, P/B, and PEG ratios to be somewhat meaningless—we already know these numbers will look awful, so why bother?

For the DRONES Speculation Portfolio, I will bias analysis on forward-looking metrics, vice the dismal rearward-looking ones. I will attempt to estimate how long the company has until it burns through its cash (known as “runway”), as well as make an educated guess as to when it might begin to become profitable. 

I tend to use Quarterly Reports to get recent figures and appreciate the trends throughout the previous year. For a quick-look, here are some of the characteristics I’ll look at for evaluating companies in our DRONES Speculation Portfolio:

• Cash Ratio
• Quick Ratio
• Current Ratio
• Cash & Equivalents
• Operating Expense
• Free Cash Flow
• Price vs 50-Day vs 200-Day Moving Averages

I picked these metrics to help us evaluate the company’s financial health and make a judgement on its current momentum and potential for future profitability. 

There are a few non-tangible items I also intend to look at.

• Company Leadership
• Institutional Investors
• Industry CAGR
• Addressable Market
• Industry Competition
• Momentum
• Social Impact
• Government Policy
• Current Events

I try to paint a whole picture of the company and its place in the market. I find that this adds some context to the numbers we extract from the financial statements. I will probably end up revisiting this younger group of companies a few times per year to track changes over time.

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I will admit up front that I have an optimistic bias toward companies investing themselves in the U.S. Drone Industry. I see Drone Technology lying somewhere between the Internet and the LCD screen in terms of how it shapes our world (hint: you are using both at this very moment). There will be a day when autonomous aircraft fill the sky, and the companies in our DRONES portfolio will be the ones to make it happen.

As I previously stated, many of the companies in our DRONES Paladin Automation U.S. Drone Market Index are unwise investments in general, and may not be well-suited for the portfolio investment objectives. They are merely that minor subset of publicly-traded companies that have forayed into unmanned aircraft, and I am attempting to capture them in the appropriate category of an investor’s portfolio. I am tracking a growing industry; I am not attempting to provide you financial counsel.

As always, please conduct your own research and consult a Financial Advisor prior to committing funds to an investment. I have both long and short positions in several symbols on the DRONES index, and I am generally Bullish on the U.S. Drone Industry.