How do you analyses businesses to decide if they have a good business?
Hi everyone. I am trying to learn how to analyses business. Forget financial statements or valuations. How do you analyses business?
This is how most of my friends analyses businesses
- SMRT is a monopoly company. Their business is assured. No competitor at all. Its a good stock to buy
- Sheng Siong is a supermarket. Economy up or down, surely got customer. You still need to buy groceries.
- All the banks are backed by government. If economy crisis or currency crisis, no need to scared. Furthermore, Singapore has has tight MAS regulations.
- Medical is a good sector to invest. Our Singapore population is aging. Surely have good business.
What they say do have truths in them. But its insufficient to make good judgement whether to buy the stock. What other research and analysis needs to be done?
Pls do not come and say I am FATA master and then joke about it, give trollish answers. Hard to get any serious replies one. I really want to learn about analyzing businesses.
I recommend you read the book The Little Book that Builds Wealth by Pat Dorsey on economic moats for a start
Wahkao, your reputation precedes you. So you have to live by the posts you made.
In any case, I don't have all the answers. For myself, I do second level thinking. I question the assumptions I make. I'm more interested in risks than returns - specifically how a stock is right for myself. (A good business may not be a good investment.)
Take one of your examples:
"SMRT is a monopoly company. Their business is assured. No competitor at all. Its a good stock to buy"
My questions:
- is smrt in the right industry? How is the industry faring globally and locally?
- are there regulatory that prevent economic moat?
- is the industry fitting into my investment portfolio?
- are there trends that impact the business adversely? Eg labor cost increasing
- how has the management fared over the past 5-10 years?
- am I in contact with an employee from smrt? What is his view on his company?
- am I able to observe their efficiency in deploying capital?
- have I understood their financial report, specifically how money is used and earned? (For this, I suggest you read japanfood latest annual report. It is easy to understand their business and link the flow of finances and how they run their business)
- does the growth of the company match my portfolio objectives? Is it a short term high growth or long term sustainable business?
- is smrt business really assured? Are there any shock events that may decrease singapore population?
Too many points to make - and I believe this is the challenge of a retail investor. Analyzing business cannot be a textbook case, but more on a consulting research study.
Be thorough enough, make sure you are very comfortable with all the issues u can think of, and buy with a certain level of margin of safety.
Hope this helps.
Characteristics of a good business
Cash flow generative - eg earnings do not need to be reinvested to support existing revenues
Good organic growth potential - eg growing market
High rate of return (on invested capital) growth opportunities - growth is an obvious one but if it's supported by high capital investment eg shipbuilding then that's not as attractive. Value comes from investing at markedly higher returns than the cost of capital
Low risk to cash flows
For a shareholder, one that let's you share in the gains of the business through dividends or capital returns
Characteristics of a bad business are the opposite of the above.
The 'rules of thumb' you've cited are too simplistic. Eg SMRT is a monopoly but are the cash flows low risk? They are price takers on revenue so the risk of the cash flows is higher because they can't pass on cost inflation. Supermarkets have lower risk to revenue but margins are at risk in a competitive marketplace like Singapore.
What you need to do is look at the major issues for each company and consider the company in light of how those factors impact the above criteria.
That said, whether it's a good or bad business is irrelevant without considering the price. You make money buying horrible companies at dirt cheap prices and you lose money buying fantastic
companies at sky high multiples. The trick is to find companies that are either overlooked by the market or misassessed by the market (qualify of the business implied in the valuation is different to your assessment of quality).
One of my criteria, among others, is the story of the investment, can be fully described in half page, or at most full page, with my writing skill
If the story is compelling, then invest, otherwise drop it.
2 words: Business model
This may sound cliche but it is important to know how they make money. Do they intend to make money as a price leader or niche? Do they fund their clients or suppliers to get better deals? What is the Porter's 5 forces impact on their model? How does their model differ from competitors? Green field strategy will be different from brown field.
I have alluded for some time to the 3 layers analysis which I repost below:
(21-07-2014, 02:06 AM)specuvestor Wrote: [ -> ]There are AT LEAST 3 layers in a complete analysis IMHO but roughly we can looks at the Asset, Business and Structure layer in general
Assets can be factory to property to internet site. At a certain volume it produces certain profitability. This is primarily the ROA which many value investors look at.
Encompassing this asset is a bigger layer called the business layer which many business minded investors including Buffett analyses which includes working capital, SG&A, positioning, bargaining power, porter's 5 forces etc. Sometimes u might need low ROA asset to support other parts of the business, for example SMRT having low ROA rail biz so that it can have high ROA advertising biz. Those who just focus on assets and ROA and concluding whether assets should be sold to improve ROA, or evaluating business on ex cash basis, etc is missing the point. Thats what happened during the boom years of sale and leaseback. They don't understand the business and just looking at the asset layer. This is the ROIC of the business.
3rd layer is the structure which often is done to benefit the major shareholders, from directors' remuneration to company registration in Caymen, to dividend payouts and leverage is part of this structure. This is where most analysts look at, ROE and DDM, without understanding the purpose of the structure. And like Gautam pointed out, it can be a superb business miserable to opmi. The more extreme case is the chinese internet structure that the offshore entity do not own the underlying assets but have economic interests linked to the business. This is also the layer where the legality issues apply at the holdco, which most of the time does not operate any of those business but owns stakes in it. Listed equity in itself is a "derivative"
So in order to understand what we are investing, when we buy the holdco that is wrapped within the listing framework, we need to understand how these 3 layers interact instead of purely focusing on assets and ending up in a value trap, or looking at a business like lion gold without knowing the assets, or investing in a cash rich s-chip without knowing the structural layer.
My 2cts
Looking at SMRT example again, what are theire ASSETS? Do they own the rail, the stations, the rolling stock or the infrastructure? (see the SMRT thread for answer)
As to their BUSINESS of rail, it is currently not a good return business. But that's not the full business model. Because they have the rail, they have the advertising and rental business. So you can't separate the 2. Put in another way: If they lose the mediocre rail business, will they be able to keep their advertising and rental business?
As for their STRUCTURE, who are their biggest shareholders? What are their interest?
After taking into all this, what is the PRICE (taking into account MOS) and CATALYST. That will determine your strategy. Mr Market never require your decision to be binary. It also never require you to act now. 80% of my work never translate into action next 6 months.
Hope this helps and it pays to heed what thor666 said
To add on, how you very much define what is "good" is very much contingent on the assumptions you hold --> the assumptions underlying your strategy. The rest have said some really good stuff, but it always pay to remind yourself of the assumptions you hold in assessing a business so you remember what goes into a buying decision. I didn't mention selling, because personally my time horizon be forever (doesn't happen all the time though).
Valuations and financials are important, both qualitative and quantitative aspects go into giving you a fuller picture of what is happening.
You might find this book useful:
https://doc.research-and-analytics.csfb....6sWwif4%3d
It does incorporate what is said above and involves different areas of assessing a business. Personally, it's important all the different elements tie up to become a coherent strategy. Do check out the book recommended by financiallyfree, there should be an e-copy somewhere online.
and when you analyses businesses you have to be quite hard up on dividends.
saw this post in business analysis today
have some truths in them, but what's missing.....?
1. SMRT
2. SBS
a. Revenue are no longer bound to a silly revenue increment equation with CORE CPI as a variable
b. It's difficult for new players to compete. SBS is part of Comfort Delgro which is a very successful competitor and is the 2nd biggest of such company.
c. Temasek is also reliant on dividend income from SMRT to feed its total portfolio which shown a very dismall 1.5% recent year performance
d. Growth in public transport.... especially the more profitable MRT lines
e. New revenues from property management linked to MRTs like KallangWaveMall. They finally learnt the HongKong's MTR's ways
f. SBS got great management as shown in their minimal fine and ability to support SMRT with bus captain's during SMRTs breakdown. Temasek will also not let SMRT's handpicked generals? look bad and will surely support.
3. SingTel -
a. This is the heaviest weight in temasek's portfolio.... @ 13% and Temasek owns 51.88%.
b. Temasek is dependant on its dividend payout and a high dividend payout means good support in share price
c. 'MOAT', Telco license
d. Little backlash if Telco up phone bills as everybody was once given a share and mobile bills are usually paid by companies
e. Population growth.
4. UOB Kay hian. -
1. You can't go wrong with the Wee's
2. Though there is fear of reduced trading volume, UOB Kayhian delivered consistent results. Imagine what will happen if trading volume improves?
3. The Boss buying back shares on and off. Slowly and surely increasing shareholdings
4. Increasing NTA relative to stock price. This share is getting cheaper by the day
5. South East Asia's largest stock broker
6. The bigger you are, the better, as the rich will not want to put their money into smaller and lesser reputable companies
7. Historic annual returns, is also about 10% per annum. Half from dividend and half from share price increment. When compounded, will be just as good as the Banks
(07-08-2014, 12:10 AM)thor666 Wrote: [ -> ]Too many points to make - and I believe this is the challenge of a retail investor. Analyzing business cannot be a textbook case, but more on a consulting research study.
Be thorough enough, make sure you are very comfortable with all the issues u can think of, and buy with a certain level of margin of safety.
Hope this helps.
I totally agree that each is consulting or rather strategy breakdown of the company. And it takes a lot of time.