— CFA Institute® (@CFAinstitute) June 23, 2017
Research is very important in every area of our life. Investing is also not outside of it. May it be Fixed Income, Commodity or Equity, its important to check before investing. There is No hard and fast checklist for doing such things. But still Some things are important. In this post I am trying to explain some of them.
- Corporate Profile : A). What is company doing for existing and giving return on capital to its investors and making wealth? There are some companies which are doing more than one thing. Like Goldman Sachs. Mutual funds, Banking services. so how to analyse them? For that you need to find what is their product or service which is making them biggest revenue? Best example here is ITC. Though they are manufacturing so many products from Perfume, Note Books, Beauty soap, Biscuits, hand wash named Savlon, Fruit Juice and much more. But 60% of their revenue is coming from Cigarettes. Even with banks, you suppose to study the sector wise allocation to advances. Like how much percentage is toward Airlines, Infrastructure, utility, Chemical, Home Loan etc. it helps you to assess the risk profile of such banks so you can study the difference in between Deutsche Bank and Bank Of America. B ) what is position of company in industry also makes difference. You simply can’t compare Vanguard and T Rowe price. Both of them are totally different. But you can compare Vanguard and DSP BlackRock. Both of them in same type of business. C) What is history of company? Volkswagen, Chevrolet, JLR, Ford. History Matters. isn’t it? D) Some Business need Research and development which increase cost and makes them capital intensive business. Pharmacuticals business is one out of it. another example is Technology sector. you can’t ignore Research and Development in business like Alphabet, Apple, Amazon. Capital expenditure is one important factor as many times working capital expenses are same for many business but it is capital expenditure which is making identity for business. E) Board structure and management is also making difference. In fact making acquisition difficult and defending your own company is one objective for making changes under the name of staggered board. Such thing is bad for investors as if the takeover possibly makes wealth for shareholders. Corporate Governance is also one more important thing which affects return. You don’t want to invest where management ignore even the shareholder holding more than 11%. Warren Buffett is very correct about it when he says chose the companies where management is not trying to keep their job and think to make wealth for shareholders. Management is very important in such analysis. Management Buy in or management buyout may make changes which makes company successful or failed. Jeff Bezos, Steve jobs, K M Birla, Uday Kotak, Warren Buffett, Travis Kalanik are such examples of management who makes good companies either from zero or develop the business which is already great. F) Retirement benefits is one important factor. If the company is following Defined Benefit plan then if there is any shortfall in retirement plan, then company is supposed to make provision for it, which affects shareholders wealth and act as Debt. G) Insider ownership may make or break company. In fact in his world famous book, One upon wall street, Peter Lynch mention that if insides are buying the stock, there is only one reason and that is the future is good for company. Berkshire Hathaway, Insiders holding very less.The reason is when insiders hold Large chunk then they can take any decision which is good for them like giving special bonus to some special peoples which are nothing but relatives of promoter. Shareholder holding large chunk may sell the company ahead of small shareholder at different price, which is completely unethical. when such things happened, Regulator and judiciary come into picture. is there any action pending against company? because such things make uncertain situation, finally affects business. H) But sometimes, there are some special advantages for company. warren Buffett Perfectly mention them as MOAT. Simple Example is Google in Internet browser business, Amazon in Cloud business and E commerce. Facebook in social Networking. You cant defeat them in their business.
- Industry Characteristic : A) Exactly at what stage the industry is? is it in childhood? or Growth? or shakeout? how much the industry is sensitive for economic changes? Automobile and infrastructure sector are different and so is companies in them. You may be shocked but, Increase in demand for explosive is starting point for many new things in economy as mines and metal and commodity business need them. More the demand for explosive from mining companies, more the production from them. B) life cycle of product in many industries is limited. Take an example of Kodak camera. Great product but not unlimited life. 2G technology? Calls on mobiles? The reason is when technology is changed, that product may face competition. Manufacturer of Photocopy machine, Xerox, was maybe stunned when they realized that high resolution camera, Internet messaging like whats app and simple printer of computer may make them headache. it was not even in dream for Kodak that Samsung, Apple will give them good competition. But you cant say the same about Good Year TYRE or MRF. They are in business. C) A customer is the one who is paying to all expenses of companies. is it possible for your brand to keep him loyal to you? I am not making any wrong comment. Amazon brand is doing that. But some industries cant do that. All players in the industry are making homogeneous products. but still they will advertisement about it by saying their product is different then others. Water Purifier is best example. D) Sometimes there are high entry and exit barriers in some industries. such industries are different and you cant ignore it. Best example is Reliance Jio, that company which is making life worst for many telecom operators is not new entry. It was existed but with different name and under different owner. Mukesh Ambani only Buy it. The reason he know that entry is difficult for new player. similarly if you are factory owner in India, having some debt, you simply can’t shut it down one fine day and leave. ( though Vijay mallya did that. Not shut down full fledged.) there are some restriction from govt, which will act as Exit Barriers. E) number of competitors. Simple thing. More competition, more expense, high risk. In Combination with High Exit Barrier, it will make life worst for company making profitability low. you don’t want to invest in such companies. F) Industry supplier consideration. Whole problem for Indian IT industry is here. Indian IT industry is all outsourcing from US. NOW after Trump administration taking adverse action on H1-B visas and outsourcing difficult, SUPPLIER for this companies like INFOSYS, TCS, TECH MAHINDRA are in panic. Their profitability and also revenue are in Danger. Perfect example. G) Govt regulation. operating in tight regulation is double edge sward. You can understand it by comparison of Mutual funds and Hedge Funds. one is completely regulated and another is not regulated. Investment in one and another having completely different. H) Is the industry completely depending on technology or beneficiary of technology. company like Google and Walmart are different by their industry. and you can’t ignore it while analysing companies. I) sometime whole industry is depending upon labor. In such case, problem in one company may affect another. So relation with labor in industry is very important.
- Demand for Company’s product and service : A) From where the demand is coming? is there one single buyer dominating ? any single geography? I saw many examples where if there is one single dominant factor in demand and that was reason for downfall. Important thing to check. say even if that dominant factor will not go outside of business, the risk for company is sufficient big. B) Product differentiation : How different products company have ? are they serving customers? or are they competing with each others? Cannibalisation is thing. Best example here is Google Duo. when already there is Hangout which is available for large public as it is in-built in all android phones, there was no need to develop such product. in some cases new product will start giving competition to own product. C) Outlook : is it good? I saw many companies where their products are either useless or they will be in short span of time. If not, How large is the market for it? best example is again Indian E commerce. so many Venture Capitalists, Private Equity, Entrepreneur entered but their calculation went wrong with size of market. Many of them taking it as whole population that is 1.25 billion. funny. large part of India is living in rural area and unaware about Flipkart and Paytm. In such case, if you decided to sell fashion cloths and not day to day items, you are going to loose.
- supply of product : Is it possible for company to sell their product wherever there is demand? is the network strong? once again India is very difficult market. from Kashmir to Tamil nadu, from eastern states known as seven sisters to gujarat there is large diversity in geography and religion. selling product to all customers is challenge. making yourself leader is not small thing. Ultratech cement, Hero Honda, Maruti, Airtel are leader in their own segment. Its not easy game. if company is exporting its products then picture is even different.
- Analysis of cost : What and how is the cost structure of company. There are many types of Cost. Operating cost, administrative cost, finance cost, Cost of goods sold, labor cost. Which type of cost is dominant. you don’t want to invest in company where finance cost is large as it is not in companies hand and if interest rates increase, no one can handle it.
- Pricing Power : some business don’t have pricing power, whereas some holds great control on pricing. Pharmaceuticals, Automobile, Mobile Phones holds great pricing power. some sector don’t have such can’t hold. Best example is Depository like CDSL and NSDL in India. their business is hold securities in Electronic format in the account of investors. like banks hold money. Interesting is even though there is such useful service, but they cant decide pricing. its SEBI, our Capital Market regulator, holds pricing power and so both having same pricing. Banking business partly having pricing power but say if i want 10 million as debt. I am having good rating then I can negotiate with banks.
- Relevant Financial Information : Though there are many ratios and not all of them are useful in everywhere. but still I am writing some of them. here is a list
Debt to capital, Debt to asset, Financial leverage ratio, cash flow to debt, interest coverage, Off balance sheet liabilities, Growth Rate of REVENUE and Profit, Net Income, Net Profit, Operating Cash Flow, EPS, ROA, ROE, ROIC, GROSS PROFIT, Operating Profit, Current Ratio, Quick Ratio, Cash Conversion Cycle,
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