iBooyah.com Investment Matters

Analyzing the company’s fundamental is extremely important of any research.  The need to look closely at the company’s competitive position, sales and profit margin, capital structure and future prospects are necessary steps in any stock analysis.  For example, if the company is growing at 50 percent year over year and trading with relatively low P/E ratio in comparison to its peers, this would be a strong signal the stock is undervalued. 

Given the market is very efficient, undervalued scenarios are difficult to find. While it is difficult, it is not impossible.  We see stock priced incorrectly all the time.  Typically this occurs when a company delivers unexpected negative news causing investors to panic and sell their positions.  In a lot of these cases, this is the best time to buy the stock at a deep discount.  The worse time to buy any stock is when it is trading at its 52 week high.  In most cases when a stock reaches its 52 high, we typically will unload some of our positions and lock in the profit. Buying when a stock is at its highest point has resulted in negative return; at least this has been from our experience. 

A key aspect of this analytical process is company analysis, which involves an in-depth study of the financial condition and operating results of the company. The company's balance sheet, income statement, and statement of cash flows are all used in company analysis. There are several broad categories one should concentrate on.  Here are some recommendations:

1. The liquidity factor is very important as it will tell us the company's assets (cash and securities) and its debt or liabilities.  Obviously, we would be interested in company with little debt and high level of Free Cash Flow.

2.  The recent activities of the company are also important.  What has the company been doing with their cash? Are they re-investing it in the business or is it sitting in the bank? We prefer companies that choose to re-invest their free cash into the business or return the profits to shareholder in the form of stock buybacks.  Dividend is not important to us. In fact, dividend is a tax liability.  We would rather see the company use that cash to increase stock holder value. 

3.  The leverage factor will tell us how much the company is borrowing. It is important to note just because the company is highly leveraged does not necessary signal a red flag. It really depends on what the company is planning to use the funds for.  For instance, if the company is borrowing to repurchase shares when interest rate is quite low, that’s actually a good move.  Additionally, in some cases, companies will leverage to finance promising technology.  In contrast, if the company is leveraging itself to cover their expenses because they are unable to support their operation, this would be a signal of desperation.

4.  Profitability and margin is probably the most important area to consider.  The profit margin is extremely important. For example, in the case of Intel (INTC) and AMD (AMD), these two companies profit margin has drastically declined as a result of their current price war.  Price war is great for the consumers, but hurts the involved company’s bottom line. An excellent case of a company with great margin is Google (GOOG).  Unlike companies that sell tangible products, Google provides a service.  The systems in which these services are being provided are already in place.  While there are routine maintenances and expansions cost, these systems are actively generating revenue.  The margin for these types of companies is generally very high, especially when the company clearly holds a large lead over competitors. 

When evaluating earning, it is important to look at the quality of the earnings.  A quality earning must include recurring income with high cash flow.  On the contrary, poor quality earnings usually means there will be a large non-cash component and non-recurring revenue stream. For instance, if a company receives a one time large order for the quarter which then pushes their revenue past expectation, this would be an example for poor quality earnings.  The quality of a firm's balance sheet is also important to consider.  Make sure there are no hidden liabilities or obsolete inventory or assets that have market values significantly below book value. Watch out for Window dressing.  This is a technique to make financial statements look better than they really are. For example, seasonal factors can distort ratio analysis. At certain times of the year a firm may do much better than other season. 

While the process of evaluating companies is indeed a lot of work and involves a lot of efforts, if you consistently keep these things in the back of your mind before deciding to buy or sell, it should help you become a better investor.   Best of luck!