Great businesses are everywhere and it makes great sense to buy a portion of such businesses through the stock market. If you can find great businesses through research, enter at a fair value and stay invested for considerable time, there is a fair possibility of getting wonderful returns on your investment.
I highlight the 'enter at fair value' because buying something great at an exorbitant is not really going to be fruitful for an investment. If a commercial property pays high rental income then it may be a great investment but you need to make sure you don't overpay for it else it will cease to be a great investment.
There are 3 qualities that I have noticed some great businesses possess:
1) Debt free - firms that don't carry any debt on their balance sheet.
2) Cash rich - firms that are flush with cash on their balance sheet.
3) Negative working capital - Firms that can charge the customers an advance for their products and as a result maintain negative working capital. In effect, the customer is paying the company to make it's product.
NOTE: It's important to note that there are great businesses which may NOT possess these qualities so the vice versa is not true.
The third point above is the most significant of the 3 and the reason is because it means that these firms have an established strong business model with which they can continue to charge their customers advance payments for their products and still keep having queues of buyers. That's indicative of a much wanted product. When you find a company that suits these criteria, your next step should be to estimate how likely the company is going to continue being in it's position which means you need to estimate how likely the product demand is going to continue. If the product is something that customers are not going to switch because they are habitual to it, care for the brand then the company is much likely to continue its position of strength. For ex, someone who buys Bournvita or Horlicks is very less likely to switch to a new brand even if the new one is cheaper.
While screening for firms on these criteria, make sure that the first two are also true or at least one is true and there is good explanation for the other one to not be. If that is not the case, it may be possible that the business is just distressed.
Low margin businesses: Not all low margin businesses are bad. A business which employs low amount of capital to generate high revenues and sales is still a good business even if it has low margins. For ex, if a business employs 25 cr capital to earn 450 cr in sales (less excise tax). This means the capital turnover ratio is 450/25=18. Now if this business only earns a 5% margin on a sale then the Return on capital still turns out to be 18*5=90%. If you find a business with that ROCE, you should more likely be buying it rather than reading this.
Formulae for margin:
Margin=Sales (minus tax)/Profit before tax (minus other income)
OR
Margin=PBT (minus other income)/Employed income(invested capital to get the sales)
I highlight the 'enter at fair value' because buying something great at an exorbitant is not really going to be fruitful for an investment. If a commercial property pays high rental income then it may be a great investment but you need to make sure you don't overpay for it else it will cease to be a great investment.
There are 3 qualities that I have noticed some great businesses possess:
1) Debt free - firms that don't carry any debt on their balance sheet.
2) Cash rich - firms that are flush with cash on their balance sheet.
3) Negative working capital - Firms that can charge the customers an advance for their products and as a result maintain negative working capital. In effect, the customer is paying the company to make it's product.
NOTE: It's important to note that there are great businesses which may NOT possess these qualities so the vice versa is not true.
The third point above is the most significant of the 3 and the reason is because it means that these firms have an established strong business model with which they can continue to charge their customers advance payments for their products and still keep having queues of buyers. That's indicative of a much wanted product. When you find a company that suits these criteria, your next step should be to estimate how likely the company is going to continue being in it's position which means you need to estimate how likely the product demand is going to continue. If the product is something that customers are not going to switch because they are habitual to it, care for the brand then the company is much likely to continue its position of strength. For ex, someone who buys Bournvita or Horlicks is very less likely to switch to a new brand even if the new one is cheaper.
While screening for firms on these criteria, make sure that the first two are also true or at least one is true and there is good explanation for the other one to not be. If that is not the case, it may be possible that the business is just distressed.
Low margin businesses: Not all low margin businesses are bad. A business which employs low amount of capital to generate high revenues and sales is still a good business even if it has low margins. For ex, if a business employs 25 cr capital to earn 450 cr in sales (less excise tax). This means the capital turnover ratio is 450/25=18. Now if this business only earns a 5% margin on a sale then the Return on capital still turns out to be 18*5=90%. If you find a business with that ROCE, you should more likely be buying it rather than reading this.
Formulae for margin:
Margin=Sales (minus tax)/Profit before tax (minus other income)
OR
Margin=PBT (minus other income)/Employed income(invested capital to get the sales)
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