Tips to Analyse the Numbers of a Good Business

Investment Perspective – April 2015

“Neither the investing method nor the fundamentals of the business are right or wrong because the mood of the market is favourable or unfavourable toward the “stock”. That is because when you really think about it, “stocks” (shares) are all about the financials and the trading price, the share price… the cash up value. What matters more is the economics of the business” 

Peter Flannery

It’s The Numbers Stupid!

One of our programs at WISEplanning provides business coaching and help for both experienced and successful business owners as well as aspiring business owners.

For the aspiring business owners it is about finding a business that is either doing okay now (we call this a free cashflow business) or businesses that are “broken” so to speak and need some serious attention.

In order to find suitable business candidates, whilst the analysis we carry out on each business is important in order to identify suitable opportunity, actually their success in finding a suitable business comes down to how motivated they are to look at lots of businesses.  That way they stumble across a business that offers the best opportunity – hence the phrase “It’s the numbers stupid!”

The Analysis

There is a significant amount of analysis carried out by analysts, accountants and investors around the world. It turns out that the analysis comes in bunches or batches. The difficulty for newcomers into the investment game, is understanding which lots of analysis go well together.

When looking at retail businesses such as Briscoes or The Warehouse for example, “same store sales” is a pretty useful number to analyse no matter what.

At the same time, a common ratio known as price to earnings (P/E) ratio that compares the trading price per share with the earnings per share can be a useful guide but is somewhat of a “blunt instrument”.

For example, the simple price earnings ratio does not account for growth (positive growth or lack of growth). Without factoring this in it could mean that some more mature stocks could appear cheaper than they really are if they are not growing by using the P/E ratio analysis.

Also, the quality or variability of earnings is not always taken into account with the P/E ratio. 

Further, and more importantly in my view, the price earnings ratio does not take into account movements within the balance sheet and therefore price earnings ratio as a valuation method is not actually giving us the full picture.

The reality is that there is no one number that could be considered “the secret sauce” if you like. However the right combination of numbers or analyses appears to be the key to successful investing. 

One of the Secrets to Successful Investing – Thank You Warren Buffett

The competitive advantage of a business is something that Warren Buffett has focused on as he has significantly grown the wealth of Berkshire Hathaway and their investors (which includes our clients by the way).

A sustainable competitive advantage can give rise to strong underlying business economics which is what ideally we as Value Investors like to invest in rather than the latest hot tip from other participants in the market who may have a vested interest that is not aligned with making money long term for investors.

Many novice investors fall in love with the great story – sometimes that works, sometimes it doesn’t. Often they can also fall victim to positive sounding recent profit announcements from a particular company which is surrounded by other positive sounding data but overlooking the number that really matters which is profitability (not profit). 

Profitability is important because it can tell us something about how well a particular business uses its capital. Profit on the other hand simply tells us how much money they made for that particular period. These are very different things and focusing on the more useful one can make a lot of difference to the long term result.

Keeping Our Powder Dry – Remaining Disciplined

Although it is possibly uninteresting to say it, my experience confirms that remaining disciplined around our model is another important key to investment success, particularly when there is lots of action (noise) on the markets and conditions are changing significantly.

It is easy to start doubting what we are doing when there is lots of volatility on the markets.  Self-doubt can sometimes emerge. Best to adopt a fundamental approach and remain disciplined about the application of our daily practice. The fundamentals always matter…at some point.

We are investing in specific opportunities within the market rather than across the market.  Also we are investing in the underlying economics of the business (not the rising or falling stock price or the latest profit announcement).