Sunday, February 7, 2010

What Is A Good Company?

I like to keep things simple.
So when I look at a company, 5 characteristics that I focus on to determine a relatively safer company to invest in:

1. A Simple Business: The fewer things in motion, the fewer things that can go wrong. Businesses that focuses on maximizing profits from its core operations, rather than massive corporations that have many and often puzzling divisions, diluting efforts away from their strength and taking unnecessary risk into unfamiliar activities. Furthermore, they are easier to understand, and you should not invest in a company you cannot comprehend.

2. Steady Demand: Verify that there is constant and future demand for the product or service. Industries or sectors with recession-proof demand will enjoy consistent demand in good times and bad (eg. consumables, staples, food, utilities, alcohol, tobacco, health care). And especially businesses that have a competitive advantage, a niche, differentiating themselves from the competition.

3. Positive Cash Flow: Check the cash flow statement of the company. If a company is not generating cash each quarter, the only way to carry on operations are to borrow or tap into cash reserves. This is not sustainable over the long-term. Consistent positive cash flow is also a strong indication of profitability.

4. High Cash Balance: Cash is still king when it comes to business. It acts as an insurance against any unexpected slowdowns and gives the company the capital to seize opportunities quickly. It gives confidence that the company is liquid enough to meet short-term obligations.

5. Minimal Need for Credit: Companies that do not need to raise large amounts of capital through credit will be less prone to interest rate fluctuations. Companies with a reasonable, or low debt load also ensures that interest payments will be more manageable. It is also a measure of solvency, the ability of the company to meet long-term obligations.

Of course, as we all know a key factor to a good company is management. But how often do we have access to them and what they respond might not always be the whole truth. However, if the above characteristics are present, it shows the fundamentals of the company are sound and management are doing things right.

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