Flashcards in Fundamental Analysis Deck (6)
What is the opposite of an "excellent" business?
A "commodity type" business.
A commodity is:
- a product that is the same from manufacturer to manufacturer
- the primary consumer purchase motivation is price
What traits do commodity type businesses have in common?
- absence of brand loyalty: when brand loyalty exists, the company can charge a premium (which increases profit margin)
- multiple producers: too many companies making the same product, or supplying the same service, translates into intense price competition (they have to lower their prices)
- excess capacity: if there is the presence of excess production capacity throughout the industry, companies are usually forced to compete on price.
# These three traits translate into:
- low profit margins
- low returns on equity
(Two attributes of companies that investors like to avoid)
Metrics that measure the profit-generating ability of a company relative to sales, assets, and equity.
- you can't simply use one profitability ratio. You have to use many, over time.
- they're a good way to judge a company's performance.
They are used in fundamental analysis.
- gross profit margin (GPM)
- net profit margin (NPM)
- return on equity (ROE)
- return on investment (ROI)
- return on assets (ROA)
Return on equity
- profitability ratio that analyzes management's ability to earn a fair return on the shareholder's investment.
- Each company has "shareholders equity", the amount of cash received from shareholders in exchange for shares.
- each company also has "net income" (or "net profit") for the full fiscal year.
- you would divide net income by shareholders equity to get the percentage.
What are the two companies to consider buying?
1). Stocks of businesses that we understand.
2). Businesses that are "excellent" and have expanding value.