Tuesday, September 10, 2013

Accounting for risks

Whenever I find a company I like, maybe due to a blogger suggestion, a research report, or a trigger such as constant shares buyback. I will go through some checklists before I do detailed digging. I look for some red flags, or more accurately absence of red flags.


1) High Gearing.

How high is high, well, property and construction sector will likely to see high gearing, but even with these capital intensive businesses, gross gearing of 1 and above is too much for me.

Otherwise, I would look for gross gearing of below 0.5. Why? You have to remember you need to discount for assets, inventories might not sell, receivable might not be collectible, cash is the only King. BUT, you cannot discount liabilities, especially banks loans.

2) FCF

I don't need FCF every year, although I would very much prefer that. But I cannot stand companies burning cash faster than making profits consecutively for years.

3) Red flags

I look for frequent fund raising, if there is a rights/placement exercise, what is the funds used for? It is used as management planned? Is there any big stake sell-off by insiders, especially the directors or business owners? Is there frequent movement of key personnel like the CFO in particular, frequent change of audit company, etc

4) Can I understand their business model?

Most business plans are not that hard to understand, except those in the semi-conductors industry, I really blurred when this one is concerned, I used to own UMS, but sold out after the Founder sell a significant stake for a second time. The price went up after that, but no regrets.

5) Net Margins

I can accept low margins, but not anything lower than 5%. I also will not risk my money with companies that have margins that seems too good to be true or looks like a loser when compared to it competitors. A few percentage difference is fine, but if the difference is in the tens, I would look again carefully.

6) Earning records

I am very bad at identifying strong growers, I usually buy cyclicals or stalwarts,  so profit resilience is very important here. I need to see their profits even during downturns.  Unless I am buying a turnaround, (My record also super bad with this ), I usually is rather unforgiving with losses

If the company pass the above 6 pointers, then I will proceed to dig deeper. I will start reading the prospectus,  learn about their major customers and competitors/peers. Look at the fine prints of their AR, basically there is no end to research. If after some preliminary digging, I still like what I see, I will start with a small stake, and that will usually motivate me to work even harder to find out about the business, both qualitative and quantitative.

Please leave a comment, if you have some other ways of looking at a company



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