Value Investment Criteria: The First
Question You Should Ask
The Dynamic Wealth Report
November 15, 2010
I don’t know about you, but I love conferences. When I was an investment
banker, I was always attending different industry conferences. I’d fly
all over the country to spend a day or two meeting with the movers and
shakers in a specific industry.
I’d meet with current clients, just to say “Hi”! I’d meet with
prospective clients to get updates on their business and discuss the
next financing.
I’d look for new clients and dig up new contacts.
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Some people would call this schmoozing, I called it research… and best
of all, I enjoyed it! I enjoy making new connections. I always walked
away with a better understanding of the industry, the company, or the
impact of recent news.
If you’re ever at a conference, I’ve got a question for you to use.
It’s the first thing I ask a management team when I meet with them. But
first, let me share with you a recent experience…
Like I said, I love conferences… so when the local financial radio
station announced they were hosting a conference, I could hardly wait.
I signed up for the event two months in advance…
A week before the conference I downloaded the speaker list. I
highlighted who I wanted to see. I also took a look at the companies
attending. I figured out who to target with my limited amount of time. I
identified companies I absolutely had to see.
I had a game plan.
Being organized is very helpful. My goal was to identify two or three
solid companies I could then research further. You always want to cherry
pick the very best. And of course, don’t forget to do your follow-up
research.
Keep your eyes peeled. Unless you live in a remote part of the country,
there is sure to be some event or conference in your neck of the woods.
Prepare like I do. Identify the speakers you want to see, what time they
go on, and then focus on a handful of companies to gather materials
from.
Most importantly, ask a lot of questions.
When I go to a conference, I always ask the same first question… This
question uncovers a lot of detail about the company and it gives you a
map to where you should do further research.
So, what’s the question?
My very first question is always… “What are you selling and why do your
customers buy it from you?”
Now this question is very deceptive. On the surface, it doesn’t seem very
complex… but that’s the beauty of it.
You’ll quickly realize how different the responses are!
Amazingly, some companies find this simple question incredibly difficult
to answer. I’ve heard it all. One management team told me,
“Well, we’re
not selling any products yet…” Another said, “We’re still in the R&D
stage…” Yet another said, “Our mine doesn’t open until 2014…”
These are all red flags.
I understand some industries like mining or biotechnology have zero
revenue… then they suddenly make millions. And if that’s the case, you
simply adjust your expectations. But, if a company doesn’t have any
revenue, you might want to take a second look and think hard before
investing.
On the other end of the spectrum, I’ve seen management team’s offer up
fat sales numbers. They say something like, “Last quarter we did $8.6
million in sales.”
It sounds good at first, but we need to keep the number in perspective.
How much did they sell the quarter prior? If they sold $10 million, sales
are actually shrinking by 14%! If a company is seeing their sales slide,
management had better have a very good reason.
When revenue falls significantly, it’s another red flag in my book.
The worst response, however, is when a company’s sales are flat. Revenue
is the same quarter after quarter after quarter. It means management
can’t figure out how to grow the business. Or it could mean the company
is tied into a few long term supply contracts.
Long term contracts aren’t always bad, but if the contracts are long
term and the company isn’t profitable, look out!
Now here’s the answer you really need to watch out for…
Some management teams offer up the first half of the question, but
conveniently forget the second half.
“…why do your customers buy from you?”
The answer to this question can lead you right into the briar patch.
You’ll quickly understand what customer relationships are like. They
might sell a commodity product… in which case supply and demand is very
important to research. Or they might have locked in profitable long term
contracts… in which case the customer might jump ship the second the
contract ends.
Finally, they might just provide a better product, with top of the line
service.
The responses are limitless.
Let me leave you with one last experience. A few years back, I sat down
with a CFO and asked him about his sales numbers… after two minutes of
hemming and hawing, he finally looked me in the eye and said this:
“Because of an accounting issue, our revenue numbers are actually
negative…”
Needless to say, I didn’t invest in that one.
Just keep in mind, when you’re looking for a good investment, start at
the very top. What is the company selling and why are customers buying…
The wealth of information you uncover is stunning!
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The Gambling Industry is seeing stock prices rise across the board. The
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companies like Las Vegas Sands (LVS), the stock is up 43% in the last
month.
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