Mike:
A great post that deserves a much longer response than I can give it now: I am on my way out of town very early tomorrow morning, but when I return it will be at the top of my list to respond comprehensively.
But a couple of quick thoughts for now:
WRT to your comments about ratios and other financial statement analysis, I use duPont ratios heavily, particularly on a quarterly basis, to break down the components of returns. I try, sometimes not very successfully, to do incremental return analysis to determine how effective management is at _improving_ the returns on cash retained in the business. Frequently when I talk to companies, the questions I ask center around what aspects of their business are being affected on an incremental basis and try (hard) to tie that back to what my analysis is showing. I find this especially important in businesses that aren't in high growth businesses but have above average returns. Not only does it help me understand the numbers, it also gives me a flavor for how shareholder oriented management is.
Another very important tool for me is benchmarking. Regardless of how overpriced/overvalued a company appears to be, I find it a useful and very important exercise to compare the very best company in an industry with the one I am analyzing. It's very important to me to understand as fully as I can what are the differences in underlying company performance between the very best and the potential investment I am making. Although I don't have enough experience to really tackle it, my benchmark for a Corel analysis (ignoring, for the moment, the fact that it wouldn't be of interest because management on the face of it did not operate in shareholders' interest) would likely be Microsoft, again independent of the fact that a PE of 40 or whatever is something I couldn't cope with under any circumstances I might concieve of. The usefulness is that Microsoft, from a financial performance standpoint, is the very best and so becomes the benchmark and the basis for understanding the differences. The issues to grapple with are, first, what environment has been created (Buffett's "moat") that gives rise to the exceptional financial performance and, second, what specific traits does management have at the very best company that created the environment. Some traits are obviously universal, but others are industry specific. Then I can start to grapple with comparing it to the people running the company whose securities I am interested in.
For almost 10 years now and with two types of exceptions, I have never made a investment with less than about 5,000 words of analysis in my binder. (The first exception is event-driven moves like WNT, where price change is entirely dependent on an event ocurring that is highly likely but clearly overlooked by others, and the second is straight tax-sterilization placements to improve after-tax returns.) My conclusion, after several years of not doing this complete an analysis, and bearing the pain of the results, was that, if I couldn't put together something at least that complete, I didn't know enough to make the investment. I've covered a lot of industries in that time, so the industry analysis naturally becomes more abbreviated, but I have also found that, if I really focussed more on how the people did their jobs and how they actually oriented themselves toward creating shareholder wealth, the better analysis I did.
I've been looking around for someone who thought a little more deeply about investing since I joined SI a couple of months ago. Your post shows that you do and I look forward to continuing.
Best wishes
Linden Doerr |
