Value investor Benjamin Graham once wrote that investing is most intelligent when it is the most businesslike. Just like many of the other ideas from this investing genius, this brilliant thought is very profound because of its simplicity.
We’re going to try to figure out exactly what he meant. Imagine you got a phone call from a chief executive officer who is a casual acquaintance, and he offers to sell you his company stock at what appears to be a very low price. What would you say to this person?
Your natural reaction would most likely be: Why are you selling the stock? Why would you offer me such a good deal?
Some other questions you might have are: what does your company do? What products do you sell? How does your business make money? Why do customers choose you over some of your competitors? Who are your main competitors, and what is their behavior? Why do you not have more competitors?
If the company operates overseas, you’ll want to know more about the countries in which it competes. What could potentially happen if things go wrong in these countries? Also, you’ll need to know how much the company depends on its suppliers? What could happen to the businesses the taste of the customers change? Are the management running the company very trustworthy?
If the answers to the questions meet your satisfaction, then you’ll want to start looking into the numbers. As an example: what is the average cash profit generated by the company each year? How much can they make in a good year? How much will they make it a bad year? How do you explain the discrepancy between the two?
You’ll also want to know how the company fares during different economic environments. If the economy is going through deflation, will the company be able to hold onto its prices? Can the company prices rise along with inflation?
Now you’re going to have to try and justify the purchase price. How long is it going to take before you’ll be able to recoup your investment? If the business fails, what can the company liquidate, and how much of that money will you personally get back? If the business grows steadily, how much of the money must get put back into the venture, and what will the rates of return be? Will the return be better than other potential investments and uses for your money?
What’s really interesting are the questions that have been asked, like:
What is the current stock price of the company? Where was the stock price one year ago? Where will the stock price go next month – is the run already over?
When looked at on the stock chart, does it form a bearish diamond and drop through support levels? What will be the next quarter’s EPS, and will you come in higher or lower when compared to the Street consensus? Does the stocks P/E or PEG ratio compare well with its peers, or the market on the whole?
What is the stocks daily liquidity? How many analysts are considering it a buy as a recommendation, how many have it as a sell and how many have it as a hold? What is the stocks beta? To the shares of zag while other shares zig?
You certainly would’ve asked these questions since you are thinking about this as a business man or business woman. The ultimate decision you wanted to come to is whether or not the business is worthy of buying at the price currently being offered to you. If it isn’t, then you have to politely thank the CEO and hold onto your money. The company just wasn’t cheap enough for you to purchase.
Tomorrow, when we publish part two of this article, we will look at some important information that you’ll find the most disciplined of investors regularly keep in mind.
We’ll see you soon…