WHAT IS COMPANY ANALYSIS?

CHAPTER 6: WHAT IS COMPANY ANALYSIS?

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WHAT IS COMPANY ANALYSIS?
Is it a Good Business?
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Investors tend to view company analysis as rocket science. In reality, if we strip it down to the fundamentals, company analysis is aimed at answering three very basic questions:

1. Is it a good business?
2. Is it a good company?
3. How much are we willing to pay for the company?

 

Is it a Good Business?

The first question refers to understanding whether a business is good business or “not-so-great” business. Note that I use “understanding” and not “concluding”, as two persons may look at the same business and form very different opinions on whether or not it is good. Ultimately that is the beauty of investment analysis. It is an art, and not science.

As a business owner, you want to own a good business. Likewise, when investing, you would want to invest in a good business. To be able to understand whether or not the business is good, one of the crucial skill sets needed is: being able to view the nature of the business at its most fundamental core. This can be best described during the oil & gas rally from 2011 to 2013. During this period of irrational exuberance (a term made famous by Alan Greenspan), many vessel operators were being conveniently classified as oil & gas companies when in reality the nature of their businesses were not in the industry of extracting or even refining oil, but more towards leasing their vessels to service oil producers.

Their business is no different from vessel operators in other industries – which involves the purchase of vessels via bank loans, equipping the vessels with necessary equipment, and subsequently, chartering the vessels to clients. However, just because the clients are oil & gas players, investors were willing to pay high valuations for these operators. Although one may argue that the margins they get from servicing the oil & gas industry are higher compared to those who charter to other commodities such as coal or sugar, the reality is such that high margins are not sustainable. And this unsustainability finally hit investors hard subsequently when the oil price corrected.

Similarly, the companies that construct oil rigs are also being conveniently classified as oil & gas companies, when in reality they are more of construction companies. Even the revenue recognition methods are similar. The only difference is that oil rig builders are constructing structures that float on water as opposed to those on land.

Why does it matter, you may ask? In the oil & gas case, global oil & gas players such as Royal Dutch Shell and Exxon Mobil have seen their share prices resuming close to its level before the oil crisis. Whereas the local companies which were deemed to be oil & gas players have yet to see daylight in terms of their share prices.  

Another example is, when we first invested in Perak Transit Bhd (“PTRANS”) during its Initial Public Offering, many were asking what was so interesting about a bus-transportation company? However, what caught our interest then was that PTRANS’s nature of business was more of a bus terminal operator rather than a bus transport provider. This makes PTRANS’s business rather similar to that of a port operator, where the earnings are more stable in nature as it comes from provision of rental services as compared to ticket sales.   

If investors are not able to understand the nature of the business of the companies they want to invest in, they risk not knowing what they are buying into.

However, it is not investing in the stock market that is risky. It depends on whether or not you know what you are buying into. It is because you don’t know or don’t understand what you are buying into that makes your investment risky.

Similarly, buying properties can be risky as well, if we don’t know about the track record of the developer, the demography of the location, etc. So, risk does not lie in the stock market. Risk lies in our understanding of what we are buying into.  

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