Get an Edge With Reward/Risk

Another company I like is KHD Humboldt (KHD Quote). Its reward/risk score is 13.6 times, meaning every dollar of risk offers $13.60 of reward. But beware that earnings forecasts are falling, and per-share growth is expected to decline 55% year over year.

Rowan Companies (RDC Quote), OM Group (OMG Quote), Dawson Geophysical (DWSN Quote), (RTI Quote) and Western Digital (WDC Quote) also earn high marks by this measure.

For Apple (AAPL Quote)AAPL), I get a score of about 2.1 times, meaning that at $86, you get $2.10 of reward for every dollar of risk. Since Apple's free cash flow is higher than GAAP net income, I use the former to estimate intrinsic value. If free cash flow converges to GAAP net income, then intrinsic value and reward/risk may be overstated. Since Apple has a competitive advantage (its durability is speculative, however) my worst case scenario uses tangible book. To earn a reward/risk score of 3.5 times, Apple's stock must fall to $66 with no change in any key assumptions.

Another tech blue chip, Google (GOOG Quote), earns a reward/risk score of just 0.1 times, meaning there are 10 cents of reward for every dollar of risk. Two factors that depress its score are a price-tangible book value of 4.3 times (the higher the P/TBV, the further a stock can fall) and my forecasted 3.5% annual increase in share count for the next decade. The more shares outstanding a company has, the smaller your share of the pie. Google's stock must fall to $123 to earn a 3.5 times reward/risk score. As with Apple, my worst case scenario uses tangible book value.

Although reward/risk scores are in tenths, when it comes to stocks, I am not a fan of decimal points. Fractions create a false sense of precision, which can get you into trouble.