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PR Newswire
07-08-2014, 12:53 AM
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).
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).