Month: December 2014

The-Most-Importat-Thing

The most important thing

The last post of 2014 would be to learn from one of the investment classics, “The most important thing” by Howard Marks.

The book has a clear disclaimer in its introduction and I love, it reproducing for you below

You won’t find a how-to book here. There’s no sure fire recipe for investment success. No step- by- step instructions. No valuation formulas containing mathematical constants or fixed ratios— in fact, very few numbers. Just a way to think that might help you make good decisions and, perhaps more important, avoid the pitfalls that ensnare so many.

Now coming to understand what is the most important thing in investing, the Most Important Thing is not a single thing but a of host things . . first up is second- level thinking , in words of author

First- level thinking is simplistic and superficial, and just about everyone can do it (a bad sign for anything involving an attempt at superiority). All the first- level thinker needs is an opinion about the future, as in “The outlook for the company is favourable, meaning the stock will go up.” Second- level thinking is deep, complex and convoluted. The second level thinker takes a

… Read the rest

Use earnings framework to find great business

One quote is copy pasted on my desktop as a sticky note and I read it every time I look at new investment opportunity

What to look for in a great business?

A high return on capital (not contributed by a very low margin operation where margins could fall) which is sustainable – pricing power, low cost advantage etc. Ability to deploy incremental capital at high rates of returns i.e. growth prospects. Ability to self-fund growth – Prof Sanjay Bakshi

A useful way to start would be to create a framework that can help us identify great businesses. Let’s try to build a framework by analysing earnings of company as in long run it is earnings which drive stock prices

But how do we analyse earnings of the company? I use a triangular approach

Determine the authenticity of Earnings – To ensure an accountant is not cooking the books and accrual earnings reported by company are authentic

Composition of Earnings – A simple DuPont break down of ROE to determine sources of a company’s return on equity. This would help us understand what contributes to high or low return on capital

Source of growth of Earnings – Understanding what factors … Read the rest

Porter

Get a template to analyse companies using five forces

Porter’s Five Forces Model is very qualitative in nature. It does incorporate some quantitative factors but for the most part, it is a very subjective approach. This post attempts to set quantitative assessment of Porter’s five forces.

A general check point before you begin Porter five force quantitative analysis, one should be able to clearly articulate and understand the economics behind the business of the firm which you are evaluating

Use the below template to analyse five forces

Porter Force How to Analyse
Threat of Entry Economies of Scale See if the per unit / tonne cost is going down with capacity expansion
Check if company can outsource non core operations, that should improve gross margins
Check average capex requirements, this should be trending down
Product differentiation Check competitor prices of products, Is it a price maker or taker in the industry
Look at EBIDTA margin, A company with EBIDTA margin is likely to have differentiated product
Check Sales price per piece if applicable and compare it to competitor
Cost advantages Compare net profit margin with peers, stack the competitors from high to low in terms of net margin
Distribution Channels For consumer goods company or companies selling through agents,
… Read the rest