The Questions you need to ask about a Company

  • Are they selling their product? Check the sales figures? Can these be believed?
  • What kind of product is it? Human nature implies that booze, fags, drugs, guns, fantasy and sex all have lasting appeal, whereas novelty and entertainment are very perishable and susceptible to the vagaries of fashion. Companies which rely on new technology often founder because they are not really doing anything new at all — when the novelty wears off, they go under.
  • Are they making profit on it? Ultimately, the value of the shares in a company, must be related to its ability to generate profits.
  • What market are they in? Is it new or mature, expanding or contracting.
  • Where are their markets? Are they mainly exporters or home-based? Who are they selling to?
  • Do they have orders for next year? — i.e. will they be selling. But is the order book genuine? Several companies have gone bust after foolish takeovers based on valuations of the target's order book.
  • Are they expanding or contracting? For example, if a company has just managed to scrape a profit, but this is down to savings from layoffs, then this profit level will not be sustainable next year.
  • What are their workers like in terms of skill level, productivity, union militancy and general morale? Are they relatively well-treated? Happy bees make more honey, in the long term. Squeezing worker's rights can work wonders in the short term, but is likely to store up trouble for later on.
  • Who owns it? And what is their agenda?
  • Who runs it? Are the top management certified genii, or greedy dullards? What is their track record? How long do their contracts have left to run?
  • Have there been recent changes in personnel (e.g., loss of the technical guru or financial wizard who was responsible for their success in the first place)?
  • What does it own? All large companies tend to have lots of subsidiaries; their structure is quite naturally complex. The reason for having such a structure is perhaps that the company bought other profitable businesses when it had cash to spare, or it is using a series of holding companies to reduce tax liabilities — this is very common. The big danger sign is when a company has a very complex structure, far more complicated than can be justified on business grounds alone, as this is almost surely being used to commit, or hide, large scale fraud.
  • Who are its rivals? And who could be its rivals? Are they a big fish in a small pool — and how long will this last? What do their rivals say about them?
  • How does it compare with other companies in the market, the sector and against its main rivals — for all matters of interest? Is it an underperformer or an overachiever.
  • How did they do in the last year and over last 5 years, the last 10 years; do they show signs of steady growth and wise decision-making at the top, or is there a lot of variation in their performance.
  • Is the sector expanding or contracting? A company is largely at the mercy of its environment — the larger environment being the economy as a whole. In whatever business model one adopts, of whatever granularity and complexity, ultimately, at the bottom of the chain must lie a customer who wants to buy what they are selling.
  • Are the management loaded with stock options? And are they exercising them? A top management loaded with stock options is one of the worst warnings signs one can see; with stock options the potential payouts (for a large company) are enormously in excess of what are already large management salaries — there is thus the temptation to pump up the share price in the short term, by whatever means necessary, in a way that must be ultimately unsustainable. (Awarding stock options became popular in the 1990s as this was a way of providing an incentive that does not show as a cost on the balance sheet.)
  • Are the management dealing in their own shares? Are they buying or selling? Naturally this is of interest to the investor — after all, if the folks who run the company would not invest in it, why should you? People sometimes make rather more of this than they should — there is nothing wrong with either situation. What would be a warning sign to look out for would be a burst of selling over a relatively short period by lots of the top management — this almost certainly signifies some pending difficulties — a half decently competent manager should be able to smell disaster coming from some distance, and then quietly take steps to save his assets. Watch out for this.
  • What risk exposure do they have? One of the easiest ways to lose large quantities of cash is to lose a lawsuit, especially in the US, or to have large potential liabilities through derivatives trading — i.e. complex financial contracts, poorly understood by the management.
  • Do they appear a lot in the press? Here we would take the view that no news is usually good news.
  • Have there been any unusual events? For example, share buy-backs?

How the company spends its money is crucially important, for example:

  • Marketing

    Poor products need to be marketed to death. In a market where there is very little technical innovation and a wide choice of products with similar qualities, a high degree of marketing will be needed simply to maintain market share. Public relations and lobbying also constitute a kind of 'marketing' for the entire company; but too often these disciplines descend into sleazy backdoor deals and simple lying to the public.
  • Management salaries

    All directors packages are lavish by the standards of the worker's wages, but occasionally one comes across situations where the management are compensated in such a shockingly exorbitant manner that it takes the breath away. In such a situation we obviously have the feeding-trough mentality at work; all the company is about is short term greed — the management are like jewel thieves manically stuffing their pockets with booty before they are found out. This is very bad, and signals likely long term difficulty.
  • Worker wages

    All workers are poorly paid by management standards, however occasionally one comes across a company which pays its workers so badly that it is an affront to human dignity. Such a workforce is likely to be demoralised.
  • Taxes

    Companies will go to very great lengths to avoid these; we like to see companies which have at least some conception of social responsibility.
  • Unknown expenditure

    A large figure would be very worrying — why should it be unknown? The sad fact is that there is often a lot of bribery involved in winning contracts — these black holes must show up somewhere.
  • Research and development

    Or, why invent when you can steal? The relevance of this depends on the sector; obviously hi-tech companies should need to spend a lot more than biscuit manufacturers.
  • Capital equipment

    The newer the better, as it will increase efficiency. A company buying brand new equipment is one which obviously thinks it has a future.

Or even more simply — in an nutshell

  • Do they make something people want?
  • Are they well-run?
  • Are they heading for trouble?

This all sounds fair enough, but the trouble is that a lot of what is mentioned above is simply not available from the conventional sources, cannot be easily quantified, or is obscured by weird jargon. Unfortunately, getting the 'real deal' is tricky.

A lot of common and well-respected trading strategies depend on things like the P/E ratio and variants of this; and there seems to be an implied assumption that some combination of these, quite crude, indicators will lead to the perfect strategy — that basically, these measures, or some combination of them is an infallible guide. This is not proven; company accounts and reports are there to hide the truth, not reveal it, and so indicators based on these simplistic ratios don't tell the real story. You have to dig deeper, a lot deeper, and consider the totality of the information that is available. There are even deeper truths than the so-called 'fundamentals'.

A new look at fundamentals

As an attempt to take a radical look at company fundamentals, StockWave is in the process of gathering data for a companies information database; this will be unique in character — there will be the usual fundamentals of course, but a lot of new types of information hitherto unconsidered; the granularity of the data will be increased as well as, for example, ethical and environmental information; it will thus be a lot more thorough, and will allow a genuinely holistic view to be taken as to what a company is really like, what sort of culture it generates, and what its future prospects will be; for example, do you want to invest in a company that provides fantastic short term growth, but finds itself, 5 years down the line, in receivership, with half its top managers in jail? Or do you want steady, if a tad unspectacular, long term growth.

The StockWave Company Database will have powerful query and data-mining tools which can be used to identify anomalous behaviour, plus a revolutionary 3D user interface to visualise the extent and character of all these interrelationships. Once the database is at a mature stage, it can be sifted for internal patterns — one can then identify the characteristics of good and bad companies to generate a set of indicators. The overall importance of fundamentals comes through only in the longer term; stock prices can shake around randomly over weeks and months, being thrown around by rumour and speculative trading, but ultimately, for example, a company must make a profit sometime, it has got to sell something that people want, and you cannot make losses indefinitely; common sense really.