What I look for in a Company

Companies I avoid
  • Companies that do not yet generate income.
  • For some businesses, it takes money to make money. These businesses usually have huge capital spending requirements before they can generate income. A usual characteristic of such a business is that cash expenses exceed the cash income.
  • Companies that are notorious for diluting shareholders equity by selling extra stock to raise cash. For e.g. REIT.
  • Companies that are in early growth phase where they are deploying most of their earned income back into business. This one might seem controversial. These are usually fast growers and trade at a premium (high PE ratios). The trouble starts when these companies hits a road block or saturation point or encounter one bad earnings season. Within a matter of few days they can lose as much as 30-50% of their value. As mentioned in my earlier post I am not adept at identifying such scenarios and would rather avoid them. E.g LULU, SODA.
  • Companies where management is not focused on creating value for shareholders. For instance, Apple, an extremely profitable enterprise - until recently was sitting on ridiculous pile of cash and would not return the cash to shareholders. Microsoft exhibited the same behavior until 2003. May be the reason such companies prefer to sit on piles of cash is that they operate in fast changing/ rapidly evolving industries and management finds it comforting to sit on piles of cash rather than distribute it. Interestingly enough,I often find companies that meet all of my investment criteria except this one.
Is my 'avoid' checklist perfect? Off-course not. Does it also end up eliminating awesome businesses? I am sure it does, but then again you can't kiss every pretty girl.

Companies I seek

  • Companies that have an history of generating profits for at least 10 years. Why ten years? Ten years is usually long enough period to cover one economic cycle. This is vital piece of information as it provides insights into how economic downturns impact the companies earnings capability. 
  • Businesses that require little money to make money. A usual characteristic of such a business is that their cash expenses are way lower their cash income. Phillip Morris, Kellogg and Coke are some of the very well documented companies.
  • Companies that are in mature phase where they are ploughing only a part of their earned income back into business. These are companies that generate enough income to expand their business without needing to raise cash by selling more stock.
  • Companies where management is focused on creating value for shareholders, through dividends and/or buybacks.
  • Companies that have raised their dividends for at least 10 years in a row. An organization's earnings don't always move up in a linear fashion. Almost every company inevitably goes through challenging times and their earnings are negatively impacted. The trouble(s) plaguing the company can either a temporary one or a severe blow that will be detrimental to future prospects of the company. At this critical juncture, an investor is required to make a 'sound' judgement call whether to exit the position, hold on or to add further. Additionally, the hoopla created by the media added to the mix, I find my ability to make a 'sound' judgement call severely impaired. This is where dividend raises come into picture. I use them as an indicator to assess whether the trouble company is facing is temporary or long lasting.
Is my 'seek' checklist perfect? Off-course not. Does it also end up including awful businesses? I am sure it does, but hopefully the winners will outweigh the losers (handful of quality investment is all you need for a lifetime of financial freedom).

Undoubtedly, I will make mistakes along the way but I hope to learn from my mistakes and continue to build my knowledge.

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