9.7 Yardstick for analyzing a company
You should do a company analysis considering every aspect. For easy analysis, you may use the following as your checklist.
- Background: When and where was the company promoted? How long has it been in operation? This information helps to know whether it is an established or a new company.
- Promoters and Management: This is the most important criterion for selecting a company. In India, we have no dearth of suckers and fly-by-night operators who siphon off funds, cheat the investors and shareholders, and manipulate annual reports. A company backed by good promoters fetches a high P/E ratio (for example, Tata's) and vice-versa.
- Capital History: There are companies which are quite liberal in declaring bonus (for example, Colgate Palmolive) or rights issue. Such companies are a good bargain. Similarly, some companies mismanage debts and approach the capital markets too often. Such companies should be avoided. Also consider the capital history to determine if some convertible debentures are reaching maturity or not, for if so, it results in dilution of EPS.
- Shareholding Pattern: If you know the shareholding pattern you can guess the floating stock. If you know the shareholding pattern, you can analyze the trend of share holding by promoters, financial institutions and FIIs.
- Growth: Check the past growth trend in terms of sales, assets and profits. A high growth-oriented company always has the potential to be a blue chip. Divi's Laboratories is an example. Another important factor is to compare its growth vis-a-vis industry growth for judging the relative performance. So, if you can identify a good company at its blooming stage, the rewards would be much higher.
- Market Share: It has been observed that companies with high market share generally have higher profitability and vice-versa.
- Technology: Superior technology always fetches a premium. Similarly, the more the indigenisation, the less would be the cost of production. To evaluate the technology, you need to consider the age of the plant, investment in fixed assets, degree of indigenisation, modernization programme, investment in R&D and the track record of the collaborator. Most of such information is provided in an annual report.
- Marketing Capabilities: For this, you may consider how is the company's product faring in the market? How good is its brand image? How is the distribution network? What are the price and promotion strategies?
- Export: In the era of globalisation and liberalisations, companies with high export earnings attract the investor. You must track information about the destination of exports. Companies exporting to erstwhile USSR and Eastern Europe through rupee payment are facing a crisis. But, companies with export destinations to developed countries are faring well. Similarly, if the company has a buy-back arrangement with foreign companies, an export market is assured. In this regard, the forex rates also have a great implication - an appreciating rupee will reduce the export earnings of the company. This holds well in the present scenario with companies in the software industry.
- Production And Capacity Utilization: Use of the latest production management techniques is helpful in increasing productivity. High capacity utilization indicates strong demand.
- Resource Availability: Availability of resources has a big influence on industries. A plant set up in a location away from its raw materials sources (for example, setting up a soya processing plant away from soya growing areas of Madhya Pradesh and Gujarat) can prove erroneous.
- Human Resources Management: Good industrial relations lead to workers' motivation, while bad management results in frequent strikes, work stoppages and hence fall in production.
- Profitability: The past trend of profitability is one of the most important measures to judge the ability of the company. The details of profitability ratios and their application have already been discussed.
- Capital Structure: How sound is the company in debt management? Is there a chance of default in repayment? Will the future profits and EPS be eroded by rising interest cost? For answers to these, you must study the capital structure ratios.
- Liquidity: Apply liquidity ratios to know if the company has enough liquidity for making payments for day-to-day operations.
- Activity Ratios: How good is the management in controlling working capital? How good is the inventory management and collection of debt or repayment of creditors for generating higher sales? For information on these, apply the activity ratios.
- Expansion Plan: You can know about it from the director's statement in an annual report or from press releases flashed in business newspapers. An expansion plan always raises hopes for getting a rights' issue. You could also predict future expansion by looking at the capacity utilization as mentioned in the annual report. If the capacity utilisation is beyond 90 per cent, be sure that an expansion is in the offing. Moreover, increase in capacity in the future would result in higher sales and profits and a higher EPS.
- Diversification Plan: Diversification also adds to the company's growth in sales and profits and results in a higher EPS in the future. The possibility of getting a rights' issue exists here as well. But, always interpret diversification with a pinch of salt, for sailing in unknown water is always difficult, and many companies burn their fingers. However, if the diversification is related to the existing line of operations (say Philips venturing into the computer monitors' segment), the risks are less. Commonly, companies manufacturing a product venture into making raw materials. In management jargon, this is called ‘backward integration' (for example, HLL is planning to manufacture LAB, a chemical used in detergents). At times, companies may prefer to manufacture products in which its existing products can be used as inputs. For instance, some sponge iron manufacturers are planning to set up mini steel plants. This is called ‘forward integration'. Forward and backward integration are less risky than an unrelated diversification.
- Strategic Plan: A strategic plan means a company's current decisions for managing the future operations. Growth, expansion and diversification are parts of the strategic plan. If you know, for instance, that Tisco is aiming to be an EVA (economic value added) positive company in the foreseeable future while L&T is planning to concentrate more on its engineering division and is planning to become global in its operations, you can be assured of a sound long-term health and good value for their shares. A good strategic plan differentiates future blue chip companies from obscure ones.
- Turnaround Company: If you come across a company that is turning around after years of loss-making operations, be sure its price would shoot up. The best time to make such an evaluation is to look at its half-yearly results. Even if the company has made some profits after years of loss-making operations, grab the shares.
- Rights or Bonus Issue Candidates: Potential rights or bonus issue candidates are excellent buys.