Tuesday, February 3, 2009

The Little Book Of Value Investing: Step 3

The following summary was written by Frank Voisin, who regularly writes for Frankly Speaking. Recently, Frank sold four restaurants and returned to school to complete a combined LLB/MBA.

Step 3 Analysis: Interrogation
At this point, you have narrowed your list to just a few potential investments (perhaps just one or two). Now is the time to conduct an interrogation. This may involve asking questions of the company directly, or it may mean an internal dialogue you have with yourself, playing devil’s advocate. Here are the questions to ask:

  1. What is the outlook for pricing for the company’s products? Can it raise prices? Consider Porter’s Five Forces.
  2. Can the company sell more? What is the outlook for units? Will it have to decrease prices to sell more units?
  3. Can the company increase profits on existing sales? What is the outlook for the gross profit margin? Do they have any control over their basic costs (no company has control over fuel or commodities!)?
  4. Can the company control expenses? If not, what are the expected trends in these expenses? (e.g. are they heavily reliant on interest rates that will have to be refinanced periodically at a rate they don’t control? If so, what are the expected trends in interest rates?)
  5. If the company raises sales, how much will flow to the bottom line? (Not much if the only way to increase sales is to increase marketing or incentives)
  6. Can the company be as profitable as it used to be, or at least as profitable as its competitors? (e.g. GM just cannot compare to Toyota for profitability)
  7. Does the company have unprofitable operations that it can shed? What happens to the calculations above if these operations were shed?
  8. How does the company think it will do compared to the market’s estimates? How has it performed in the past based on its own estimates?
  9. How much can the company grow in the next 5 years, and how will this growth be achieved?
  10. What will thec ompany do with excess cash? If re-invested, will it earn a return to justify the reinvestment or should it have been distributing as dividends?
  11. What do you expect its competitors to do?
  12. How does this company compare financially to its competitors?
  13. What is this company worth if it was sold? (Look at comparable sales multiples in the recent past)
This was a great book, and I would highly recommend the series.

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