Hunt the moat from financials
I always struggled to find a knowledge hub where some one can go and with a click of button get the relevant questions and answers on key aspects of investment practice such as Moat, Management, Valuation, Risk and so on.
I hope this will be helpful to DIY (do it yourself ) investors at least in drawing attention to right questions. For new DIY’s they including me can start with gun shot, for experience folks they can correct questions and answers.
I picked up VP term basis on ValuePickr with due permission of @adminph2 .
Please create different checklist as you feel on other subjects which are relevant to look while analysing a stock.
I am starting with a few questions…will keep adding as we progress.
HUNT THE MOAT FROM FINANCIALS
Profit & Loss Account
All numbers to be checked is for minimum ten financial years.
- Is the gross profit of company growing consistently?
Tips- increasing Gross Profit indicates superior pricing power. I use 40% as tentative number.
- Consistent spending of non-cost of goods sold expenses (selling, general and administrative expenses).
Tips- the trick here is consistently, high spending doesn’t matter… fluctuates are the one who may be facing turbulence.
- High spending on R&D may indicate absence of moat. So look out for the companies with little R&D (research and development). My cut off is 15% maximum of Gross Profit.
Tips- most of R&D is related to technological advancement. It points out that company will require always money in for of R&D to stay updated in technology.
- Lower depreciation cost to gross profit as a percentage. Compare with a similar competitor to find out a base.
Tips- higher depreciation cost indicates higher maintenance expenses for managing asset. At bad times this will eat our cash flows away.
- No interest or lower interest expenses. Compare interest to gross profit with a competitor.
Tips- high interest companies often taken loan to fund their capital expenditures, working capital to stay in competition.
Now a caution after warning: concluding anything on a single parameter is recipe for disaster. For high R&D is not always bad, say the pharma companies who spend big bucks to make equally big bucks. Pharma enjoys regulatory protection, which is “Global Restricted Patents” , a super sign of moat.
The first idea is to pluck low hanging fruits, imagine a company who is churning lots profit year after year without spending capex, interest and R&D.
Confession- these questions I have used from my Guru’s note book in turn I think his influence was Seth Karman’s practice notes.
An idea is powerful than a name or tip- Seth Klarman