Sunday, 22 October 2017

5 Key Elements of Quality Companies

Quality of a company is reflected in its ability to deliver superior returns on capital invested while treating stakeholders in a consistently fair way. This ability should be deep rooted and hence sustainable. Quality of a company can be characterized in two specific dimensions – Quality of a business and quality of management. Followed are the 5 key elements of quality companies you need to analyze before opting to invest.

Profit Pool Industry

Profit Pool is the aggregate level of absolute profit earned by all players in a sector. It helps one understand the long term potential of the sector. Very high profit pool player are good quality companies for a long term investment. Over the years statistics show that profit pool of companies benefit long term investors.

Value migration

Value migrates from outmoded business designs to new ones that are better able to satisfy your key priorities. Value Migration results in a gradual yet major shift in how the current and future Profit Pool in an industry is shared.

Competitive landscape

Businesses with low competitive intensity are more favorable for investors in a long term investment philosophy. Competitive intensity is not solely a function of the number of rival players in a business. Thus, in the Cement sector, competitive intensity is relatively low despite a large number of players. On the other hand, competitive intensity is high in sectors like wireless telecom and tyre, despite a handful of players. If a company enjoys return on capital higher than industry average the company has an Economic Moat over the competition.

Managements with integrity, competence and growth mindset

Quality management is one which has competence and can be seen in the industry leading margins they command. Quality management is also characterized by a rational capital allocation policy. Management drives the potential in terms of quality of a company. The integrity of the management towards leading the growth of company makes a vital point.

Innovation and transparency

Quality companies not only think innovative but also implement innovation in terms of their products, processes and relative selling approach. They bring businesses to the new age. They are always transparent in their dealing and provide adequate disclosures. Such companies are usually trustworthy and honest.

Quote for the day

“Character cannot be developed in ease and quiet. Only through experiences of trial and suffering can the soul be strengthened, vision cleared, ambition inspired and success achieved.” - Helen Keller

Saturday, 21 October 2017

The 5 Categories of Financial Ratios

By Joshua Kennon

Financial ratios can be a great tool in your analysis toolbox as an investor. They can help you gauge the strength, profitability, efficiency, and quality of a business from a variety of different angle, as well as monitor changes in the firm's core operating metrics over time. This can help you both offensively, looking for opportunities, and defensively, seeking to protect yourself whether you own the stock, invest in the bonds, or somehow expect to enter into a real estate investment with the business, such as a landlord doing a sale-leaseback transaction with a major drug store or restaurant chain.

It's important that you memorize the most important of these financial ratios. It helps to mentally classify them under five major categories.

Leverage Financial Ratios

The financial ratios that give you an idea of the leverage inherent in the business, such as the debt-to-equity ratio or other ratios that allow you to see a company's capital structure, along with the potential benefits and risks of such a capital structure and how it compares to those of competitors in the same sector or industry, are what I call leverage financial ratios. It helps to put them in context with a complete understanding of the variables at play in a DuPont ROE analysis of a firm.

Liquidity Financial Ratios

Liquidity financial ratios that show the solvency of a company based on its assets versus its liabilities; things like working capital per dollar of sales and the current ratio. In other words, it lets you know the resources available for a firm to use in order to pay its bills, keep the lights on, and pay the staff.

Do not underestimate the importance of liquidity as a lack of it has caused even highly profitable businesses to go bankrupt. 

Operating Financial Ratios

This category of financial ratios show the efficiency of management and a company’s operations in utilizing its capital, especially through the cash conversion cycle in pursuit of profit.

In the retail industry, this would include metrics such as inventory turnover and accounts receivable turnover. Companies that consistently have superior operating financial ratios often possess something known as franchise value.

Profitability Financial Ratios

A firm's profitability financial ratios are designed to give you an idea of how lucrative it is relative to some particular metric. A firm that has high gross profit margins from a sustainable business from a core product like bleach, laundry detergent, or chocolate, to provide an illustration, is going to be much harder to put out of business when the economy turns down than one that has razor-thin margins. Likewise, a company with high returns on capital, even with smaller margins, is going to have a better chance of survival because it is so much more profitable relative to the shareholders’ contributed investment. Of particular importance are return on equity and return on assets.

Solvency Financial Ratios

The final major category of financial ratios new investors should know are meant to give you a reasonable idea, to the extent it can be predicted from the historical financial statements, the chances of a company being unable to cover its obligations when liabilities are subtracted from assets.

Even the most wonderful business can be in danger of wipe-out if it is undercapitalized and lacks the equity to absorb any challenges should the economy enter a recession or depression.

Realize that Financial Ratio Are Only the Beginning

As useful as financial ratios are, they can't tell you everything. Imagine you were considering investing in a horse and buggy manufacturer when Henry Ford came out with the Model T. The historical income statement, balance sheet, and financial ratios wouldn't have told you what you needed to know as the business you were examining was on the brink of suffering a significant decline in income. On the other side, imagine looking at the incredibly ugly financials of what was then called Apple Computer, now just Apple, prior to the return of Steve Jobs from exile when he transformed the business he founded, taking it on a run that ended up resulting it in having the world's largest market capitalization.

Quote for the day

"Look, the point is there's no way to be a hundred percent sure about anyone or anything. So you're left with a choice. Either hope for the best or just expect the worst." - Sarah Dessen

Friday, 20 October 2017