What are my first steps? (The easy way to get started)

The global pool of publicly traded companies is enormous and as value investors we are always chasing that “wonderful business”. I’ve found a way to quickly scan if I should continue investigating if a company (within my circle of competence) is worth continuing building a case on or if I should put it in my “too hard” box. I’m referring to a tray that Warren Buffett, the most successful investor of all time, has on his desk in his office in the Berkshire Hathaway headquarters in Omaha Nebraska. Yes, the most successful investor with a rate of return of 19 percent over 50 years have a tray in his office, where he archives companies that are too hard for him to understand. So, when the most successful investor has companies that are too hard to understand it would be good for us too to acknowledge if something is too hard. And now I’m going to share my method.

The easy way to get started

When I was a new investor, I would find a wonderful business by compiling a list of products or services I enjoyed using and then I would search for this product to find out who produced it. If it was a private company the search ended then and there but if it was a publicly traded company, I could continue to investigate the company - By time I found a way to quickly find out if it was a wonderful business – or a great product but a terrible business.

And now I will share the steps I take to find out if a publicly traded company is worth spending valuable time on:

First, I will check the company’s long-term debt. Debt is what kills businesses and makes them go under, so we definitely want to be careful with companies that has debt. I prefer if the company can pay of their debt within 3 years with their earnings. I use a debt to earnings ratio calculation to find out how many years it would take pay off any potential debt. I prefer no debt and maximum 3 years of debt-to-earnings.

3 important numbers

The next step is to check 3 important numbers.
  • ROIC
  • ROE
  • Profit Margin

Two of the numbers I learned from investing mentor Phil Town, and he taught me to look for following:

ROIC (return on invested capital) indicates how well management have made profitable investments in the past with potential debt removed. ROE indicates how much profitability the management adds. According to Phil Town we want the ROIC and ROE to be above 10% respectively. The bigger percentage the better.

The difference between the two numbers are debt. So if the business have no debt the ROIC and ROE are the same percentage.

ROIC and ROE are numbers that you can find multiple places – for example in the annual reports, on Yahoo Finance, stockanalysis.com and many regional platforms in your own language.

The last number – the profit margin – is my own important number that I always track. The profit margin is the sum that’s left of sales (revenue) when everything is played off: material, labor, tax, rent, waste etc. This number can’t be compared between companies in different sectors but between close competitors you will most likely be able to compare the numbers and that's what I do. My company must have a leading profit margin.

Guru Investors

The last thing I check in the very beginning is if any value investors have invested in the business. For example, Gurufocus.com is a place where you can look up if any guru value investors have bought the stock. For a new investor this is an incredibly large plus because it can help you validate that this company is in fact a good purchase. Read my article about Super Investors to get a list of names of value investors (including Warren Buffett of course) and how to check for guru investors in a company.

These are the steps I take to find out if I should proceed investigating a business. If I find out that the long-term debt is 3 years or more, I can quickly say bye and focus on something else. Is the ROIC and ROE not above 10%, I’ll also archive this business and move on to another company. For the profit margin when I compare it to competitors – if my company is not top 1 or 2 (if there are a lot of businesses in the industry) it’s also easy for me to put it in the too hard tray. If the company passes through all these gates, then I do a last check to see if some of my favorite investors have invested in this business and if they have company shares in their portfolio, it’s a bonus and I know I’m on the right path. Once this is done, I open my checklist and start an in-depth investigation of the business. 


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