How do you analyses businesses to decide if they have a good business?

[specuvestor]

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:

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