Seven most important things about Investments

Investments and investing is an intellectual game, with rewards which are financial in nature( makes the process all the more exciting). While easier said than done,picking the right investment is a skill and requires some work(discipline,curiosity and basic math skills) on behalf of the investigator (stock selector).

Moreover, while it is preferred to have  as much information available about the company  a few of the things becomes really important while looking at a business, and deciding if it has the characteristics of forming part of a long term investment. 

In this article we touch at the things we consider to be really important while selecting a stock/business and talk about why these things are important and how can they make a big difference. 

Investing is like working as a detective collecting and analyzing information and processing it intelligently to arrive at a decision, which in our case is valuation.

Listed below are the seven most important things to look at while selecting a long term business, we shall look at each one of them separately and in brief with as many examples to make the point clear for our readers.

So without wasting much of your time here are the 6 most important things to look in a business.

1) Product
2) Scalability
3) Return on Equity
4) Free Cash Flow
5) Cost Structure
6) Corporate Governance
7) Price

1) Product : The obvious question in everyone mind is why is product the first thing here ? If it is here why is it here ? Before we talk about product, we would like to touch upon what Mr.Buffett had to say about business in one of his famous quotes " If business does well, the stock would follow". Sounds like an amazing thing to say, and makes sense logically as well if we assume that there is a direct relationship with Business and Stock in the long term, which as a matter of fact do believe here at ValueeInvestor.

Now the question is so what forms a business ? Obviously it is nothing else, but the products a business has to offer. What forms Titan in India ? or Coca Cola business worldwide ? It is the products that these businesses have to offer.

However one may ask well all the businesses do offer products, how does one decide if the product is a good one, or something that can be relied to outperform or in demand for the long term. So to start with lets narrow our focus to things that are simple and easy to understand, products that either have a brand name and/or a monopolistic influence, or a lower cost structure in a competitive commodity like market which cannot be replicated by any other competitor.Things that make the product special, as well as give it a competitive edge over competitors is the product we want to look at.

Examples of which are : Coca Cola ( biggest in its industry with a dominant brand name) Posco ( steelmaker with a patented cost structure which makes the products cheaper by 15-20 percent in a commodity like business), Lovable Lingerie in India ( biggest market share , and dominant brands)

While it was a brief introduction to the product segment readers got an idea about, why and what products are important to look at during the preliminary search phase for strong products as well as products for which there is a recurring demand.

2) Scalability : Once we have recognized a product, the question that strikes first is how big is the market for this product? How many people can I sell this product to? The bigger the market the better the scope, and more the growth in earnings over the future years as well as increasing dividends.

For e.g How big is the market for underwear's ? Now sounds like a silly question but everybody world over needs it, and branded products do and have made a substantial foot print world over - Fruit of the Loom is a perfect example in the medium range branded product. Coca Cola is another.

While the market need not to on a world basis, if a company is just starting out and is domestic with a huge domestic need that is also a big market to look at, and plays a significant role during appraisal of the business.

3) Return on Equity(ROE): Why is return on equity of any consideration while buying a business/investment ? The same way why is interest important when you put your money in a savings account ? If money was free, we wouldn't have included this concept in here. But while that is not the case, and after selecting an outstanding product, with a big market the other most important check is to see if it is profitable or not as well. The best way to see if the product the way it proclaims about its outstanding stature in the industry is right, and you haven't made any errors yourself while looking at the company, and selecting a good product.

While Return on Equity is a matter of subjective choice , we prefer to look at Return on Equity in the 15-20 percent rage over a period of 5-10 years ( higher the better , but the higher ROE should be again to see if there hasn't been tempered with through financial engineering)

4) Free Cash Flow : What are the Free Cashflows from the business? Cash left after accounting for Capex, for the entire firm.( i.e debt holders as well as equity holders of the business) This is the cashflow that can be technically taken out of the business every year, and the one to use for valuation using the Discounted Cash Flow Analysis. It will be lower than Net Income for a growing company.

5) Cost Structure : The world if investment could be a scary place, if you don't know what affects your business, and its financial results.Keeping a tab and know how about costs affecting a business are ultimately really important.While one time change in cost structures ( e.g COGS , and SG&A) are less of a problem a certain addition or reduction in certain costs for the long run could change the valuation substantially.This is the part which can and will have maximum risk on the valuation if it is not fully accounted for, and understood during the stock selection process.

6) Corporate Governance: Most importantly who do you want as the stewards to your financial success ? People to look at the fact that things are running the way they are supposed to be running, and no nature of illegal activity is at play. If there is one it is detected at the first sight , taken care of and the system is cleared not to even think of that thing happening again. So every-time you look at a business make sure you know the history of the Management Committee , as well as the Board of Directors. While it might not be of a big difference in a short term , in the long term proven and successful management will stand miles apart from their weaker competitors financially, and in praise from their shareholders.

7) Price : Very last, but the most important of all is the price. You can end up being right on all the six factors mentioned above, but if you missed the last one you would still end up having a mediocre result. Price is ultimately what you pay , and value as Mr.Buffett would say is what you get. Value in our case is the valuation derived by us using the free cash flows that we can get out of the business for lets say 10 years and discounting it all back to todays time.

If that is higher than the current price the market puts on the business , you my friend have made yourself a fortune if not then even though you might be right on all counts a wrong price could certainly harm your results substantially.

As somebody once said , you make a fortune when you buy not when you sell. So if the price is right the sky is yours. Every asset has a value the only difference is the price paid to acquire that value. Lower the price relative to value paid higher the re


We hope our readers enjoyed , and learned from the 7 most crucial points about an investment , and would be able to look at investments in a better way now moving ahead.

If you have any questions feel free to write to us at info@valueeinvestor.com

ValueeInvestor Team®