CHARACTERISTICS OF AN ATTRACTIVE INVESTMENT
People often wonder how to choose a company to invest in. The truth is, there are several things to look at when determining whether a stock is a buy or not. With certain investors, what brings a stock to their attention, before they get the chance to analyse it, is an event of some sort that shifts the share price to a point at which they believe it may be undervalued. But once this occurs and they have a stock in their sights, what are some of the things that most smart investors look at?
Warren Buffett says that you want management that is honest, smart and hungry, but honesty is the most important because without it, the other two will kill you.
It is crucial that management is honest, communicative with the market and articulate; you wouldn’t believe how many companies lack some of these qualities. If you can’t trust management, you simply can’t own stock in that company. But beyond these qualities, many smart investors also look for a company where the board and/or management own shares in the company. Those involved in the company know the company better than anyone, so if they are willing to part with their hard-earned dollars by investing in the company’s shares, that’s a very good sign. One of The Rivkin Report’s favourite catalysts for looking at a company is insider (board or senior management) buying.
Another characteristic to look for in a company is some kind of competitive advantage that the company has. The Rivkin Report recommended subscribers buy Brambles and one of the things that attracted them to this company is its almost monopolistic CHEP pallet business that dominates the industry around the world. Or think about your local Woolworths store… nobody else can just build a grocery store next door or across the road. When you think of soft drink, most people think of Coca-Cola. A brand like that is irreplaceable. These are all barriers to entry or competitive advantages. When looking at an investment, always ask yourself: what is it that makes this business special, how does it maintain a sound return on invested capital and survive the inevitable hits?
Ratios are the mathematical part of analysis and it is very hard to make investment decisions without some consideration of numbers, because that is what it is all about. Many investors seek businesses that generate high returns on equity (ROE). ROE may well be the most used ratio by value investors. Expressed as a percentage, it is one of the best indicators of a company’s quality and profitability. “Equity” is a combination of the money shareholders have contributed to the business and retained profits that have not been paid out in dividends. The “Return” part is generally measured by using after tax profit (although some analysts tweak that). Therefore, your ROE simply tells you how much profit is being generated from the equity in the business. The more profit a company can make from a dollar of equity, the higher the returns to shareholders. Many smart investors are attracted to businesses with stable ROEs year to year, which is more predictable and therefore easier to value.