RE:RE:RE:RE:RE:RE:Is the market efficient? - NoWhen I'm drilling down on a company, I'll look at everything. Regulatory filings, transcripts from conference calls, articles, books. You also need to know about the competittion, which is crucial, and so I do the same for them as well. The more knowledge you have the better your decision making capability and the more accurate your intrinsic value estimate can be.
It's kind of like playing the game 20 questions. This is a game played by two people. The first person chooses the name of someone famous but doesn't tell the other person who it is. The second person has to figure it out by asking one question at a time that can only be responded to by "Yes" or "No". After each response to your question you narrow down the field of possibilities and eventually you make your guess as to who the person is. You only have 20 questions. The more information you have, the better your changes of guessing the name of the person.
It would be almost impossible to guess the right name after only one question. In investing it is almost impossible to make a great investment by looking at only one thing.
The more questions you ask, the better the picture of the person that was selected in 20 questions. In investing, the more areas you look at, the better and clearer the investment picture gets
The more knowldedge you have about the company and its competitiors the better your odds of "being right".
Of course, this is very time consuming and so I'll first start by looking if the company that I'm interested in has certain characteristics that could lead to a good situation.
It's almost impossible to narrow it down to only three quetions only but four very important areas to look are:
1) Competitive advantae
2) Debt
3) ROIC
4) Management
You could make three questions out of this such as:
Sometimes competitive advantage is easy to spot. Unfortuately if it is easy to spot, it is most likely already reflected in the stock price. And if it is not easy to spot you will likely need to roll up your sleeves and do some work.
1) Can a company repay its debt, assuming it does not pay a dividend, in three years or less?
There is no hard rule on this. It's just what I like to see. I like a company that has the flexibility to take advantage of situations if they come about and having too much debt prevents you from doing this. Maybe debt works out when everything is going well but what happens when you hit events like the Great Recesson of 14 years ago and the pandemic? I want a company that can survive anything. Too many smart people have gotten in trouble because of excessive debt.
2) Does the company earn a high return on its capital?
I like to see ROIC at 15% or more for many years. It may be saying the company has a competitive advantage, which is the most important thing in business, if it can sustain this high ROIC for 5 years or more. It is also like compound math. If the company is growing its capital at say 18% then this means it is doubling its capital every four years. The investor will do well unless the stock was overpaid for.
3) Is management treating its shareholders well? Does it do the things it says it is going to do? I like to read an annual report of a few years back and then the latest one to see if they did what they said they were going to do. Is it buying back stock, when undervalued, or is it paying any price for the stock? Is it paying a dividend when it has a very high ROIC? Doesn't make sense if they are doing this unless the capital cannot be deployed at these higher rates or return.
These are only four areas but important ones. Competitive advantage, debt, ROIC, management. In other words you are looking at what differentiates one company over another (competitive advantage), if it can survive very hard times (debt), how fast it can grow its capital (ROIC), and the quality of the people running your business for you (management).
The more you know, the better your decisions are.
Focus on free cash flow and not earnings. Focusing on earnings will lead you down the wrong path. Capital expenditures are very real and in inflationary times can be really brutal. I like companies that are not capital intensive.
I have read a lot of books on finance and investing since I was a kid. Most are not good. One book that I highly recommend is: The Outsiders by William Thorndike - Eight Unconventional CEO's and Their Radically Rational Blueprint for Success.
It truly is a very good book and very worth reading for any serious investor.
I hope this helps a bit Sage!