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Presently, about 1 billion out of the world’s 6.5 billion people are active participants in the global economic system.  By 2050, we expect there will be 2 to 3 billion out of a world population of about 8 billion who are frequent consumers, savers, and investors.

GLOBAL INVESTING WHITE PAPER


 

4. Industry & Company Selection

by Monty Guild

 

 

 

 

DETERMINING THE INDUSTRIES AND COMPANIES THAT ARE ATTRACTIVE


The next step is selecting the most attractive industries.  To find industries that have superior growth prospects and tailwinds, we employ many of the same techniques used to identify attractive countries.


INDUSTRY SELECTION IS KEY.  MANY PROFESSIONAL INVESTORS WILL TELL YOU THAT AS MUCH AS 75% OF A STOCK'S PERFORMANCE COMES FROM ITS INDUSTRY'S TRENDS AND DYNAMICS. 


Sectors and industries have unique characteristics, growth rates, and different metrics that are important to determining their attractiveness.  Understanding these differences (some of which are very subtle) is a key component to investing.  Some industries are cyclical, others may be more growth oriented.  Recognizing whether an industry is being commoditized and knowing what the product life cycle in the industry looks like, are some of the possible items to consider.


Look for trends that can prolong the growth (and the visibility of that growth to investors) in the industry you are looking into.  Our newsletter on www.guildinvestment.com frequently discusses different sectors and industries that we think have tailwinds.  Please feel free to use it as a guide. 


 

COMPANY/STOCK SELECTION
 
Once determination is made as which countries and Industries have the strong tailwinds and which are appropriately valued for investment, what next?


INTERVIEWING COMPANY MANAGEMENTS
Here are some of the questions we like to ask when we visit with the management of a company.   

Click here to download a list of questions to ask company management.


A. INDUSTRY BACKGROUND


  • What is the expected growth rate for your industry?
  • Why do you believe that the industry will grow at this rate for the next 1, 3 and 5 years?
  • What economic social and political drivers impact the expected industry growth rate?
  • What are the barriers to entry in this industry?
  • Who are your major competitors?
  • In each line of business who are your major competitors?
  • Are they focused only in your industry or are they multi industry companies?
  • Who are your most skilled and direct competitors?
  • What is your ranking as a national and international competitor in each line of business?
  • What competitive advantages do you have as a company?
  • What competitive advantages do your major competitors possess that you do not?
  • What barriers to growth exist that may keep you from becoming dominant in each line of business?
  • What are the major industry changing developments on the horizon (positive and negative)?
  • What are the barriers to entry for new companies to come into this industry?
  • What economic variable may we monitor to get an idea of the growth prospects for your industry?

COMPANY BACKGROUND
 


  • Please describe the business segments of your company.
  • What are the growth rates, current and expected by division / business segment?
  • What are the probabilities that your internally budgeted growth rate will be achieved in your opinion?
  • What are the potential events or circumstances which could cause you to fail to meet your projected growth rates?
  • Please describe your markets (e.g. young women’s apparel ages 20 to 30).
  • Please describe your plan to approach and grow your presence in these markets?
  • On which of your markets will most of the company’s resources be focused?
  • Will you grow internally or by acquisition?
  • What type and size of company would make an attractive and compatible acquisition?
  • Would acquisitions be made for cash stock or a combination of debt cash stock and etc?

NOTE: IF THE COMPANY GROWS BY ACQUISTION THERE ARE MANY POTENTIAL RISKS.  A WHOLE SERIES OF QUESTIONS ABOUT THEIR PROCEDURES FOR THE ACQUISITION AND ASSIMILATION OF THE NEW BUSINESS MUST BE ASKED.


  • How many employees do you have?
  • What are their areas of focus, for example how many in production, research and development, sales, marketing, finance?
  • Who are your major suppliers?
  • How long have you worked with these suppliers?
  • How many suppliers do you use for each major component or product area?

FINANCIAL DATA
After examining the company’s balance sheet, income statements and statements of cash flow and the appended notes, many different types of questions may be appropriate. Here are a few examples.


  • What is your capital spending budget for the next 12 and 24 month periods?
  • What are the capital spending plans for longer periods if available?
  • How will the capital spending plans be financed?
  • What about investing cash flow plans from bank loans, share issuance, or other?
  • Your gross margins are currently what percent?  What is your internal goal for gross margins this year, in 3 years, and in 5 years?
  • Where can you expect operating margins to be long term?
  • Selling general and administrative expenses are what percent of revenues this year?
  • Given your expected rate of sales growth, where will SG&A expenses be this year, in 3 years, and in 5 years?
  • Your R&D (research and development) is what percent of revenues?  Do you plan to keep it at this level or increase or decrease it?
  • Your tax rate is what percent this year?  Will it continue at this level? What will your full tax rate be long term under current tax law?
  • How many shares do you have outstanding fully diluted?
  • How your options and warrants, if any, are structured; and how much of your total capitalization is options and warrants?
  • What is the reporting number of shares and how does it differ from the fully diluted number?

DIVIDENDS


  • What is your dividend policy if any?
  • How do you determine your dividend payout ratio? What financial variable within your financial statement should we watch to determine how you will act with regards to dividends or other distributions (raise /lower)?
  •  Do you plan any offerings of debt or equity in the next year?

PROFESSIONAL SERVICES


  • Who is your banker?
  • Who is your auditing firm?
  • Who may we speak to at your auditing firm to answer questions about the notes to your financial statements and to clarify the accounting policies that you employ?
  • Who is your investment banker?
  • What investment banks currently follow your company on a research basis?
  • Which of these analysts understands your company best?
  • Who is your Public Relations firm?
  • When will you be having meetings with the professional investment community?
  • Will you be attending conferences sponsored by industry organizations or investment banking firms where you will speak to and answer questions from the investment community?
  • Which type of news items will you be releasing, and how frequently?
  • Will you have periodic conference calls to discuss earnings reports?
  • Will you sponsor analyst meetings at your facilities and welcome calls from analysts such as me?

FOLLOW UP QUESTIONS


  • Are there any questions that I have missed and should have asked?
  • Are there any parts of your company story that I have not adequately asked about and understood?
  • What are the best industry metrics that I can monitor to understand the trends in your business?
  • What are the industry publications that I can read to keep up on trends in your business?

INVESTORS SHOULD UNDERSTAND THAT THESE ARE NOT THE ONLY QUESTIONS THAT CAN BE ASKED WHEN VISITING COMPANIES.  DEPENDING ON THE BUSINESS, SOME OF THESE MAY NOT BE RELEVANT.


Many other questions may come up, especially questions pertinent to a specific industry.


As mentioned above, the questions asked to understand an insurance company are very different that the questions asked to understand a software company. Different types of business have different sets of questions which will be pertinent to understanding that business.


WE DETERMINE WHAT THE VALUATIONS ARE FOR THE STOCKS IN THE INDUSTRY GROUP AND WE SORT FOR THE LOWEST PRICE TO GROWTH RATE.


Other firms have different investment parameters. We use several factors and valuation parameters to pick stocks such as: Price to Book value, Price to Earnings ratio, Cash Flow per Share, Earnings per Share, Enterprise value to EBITDA, and many more.


The appropriate valuation metrics will differ with different industries.  As different businesses use different financial valuation methods to determine how they are doing, an analyst must also look at different parameters to value different types of companies.  A steel company is looked at in a much different way than a retailer.  A bank is valued using much different metrics than a retailer and so on.  Once we have done our analysis and spoken to analysts and, if possible, the company.


We rate the companies by valuation looking at both the current and expected valuation.  For example, we look at the current P/E ratio and other valuation metrics, as well as next years, two years, five years etc same for other valuation metrics.


A valuation is a function of not just current earnings, but also of many other financial ratios including book value, enterprise value, cash flow, EBITDA and others.  It is also valued on other financial metrics and on the discounted value of various future dates in many of these metrics.


Finally, an array of valuations for comparable companies is created and for that the best opportunities are selected.


THE STOCK SELECTION PROCESS
 
Let me give you an example of part of the process that we often undertake to pick stocks for investment at GIM.

1. We look for companies that have fallen in price or have not appreciated recently due to:


  1. Stock market declines leaving the stock cheaper on a statistical basis that its mean valuation over the past 10 years.
  2. Industry group declines due to cyclical reasons or due to market perceptions about a specific industry.
  3. Company specific problems that lead to a stocks underperformance for a period of several quarters.
  4. Problems of market perception that lead to undervaluation because the market does not understand the nature of the company and it prospects, or the market has a difference of opinion with us as to the appropriate valuation for the company.

2. Once the proof of low valuation is established, determine by thorough research and communication with the company, industry peers, competitors and analysts that the problem is short lived or is drawing to a close and a new day is dawning for the company. Outside proof of this is reassuring, like insider stock purchases, changes in the company’s growth rate, etc.


3.  Wait until the end of the period of underperformance is approaching in your judgment and begin to accumulate shares.


4. Use the following traditional valuation parameters EV/EBITDA, PE, Price/sales, discounted cash flow, earnings models, cash flow models, inventory turns, etc.


5. Be sure to account for enough strength in the balance sheet to avoid unnecessary and dilutive financing if current cash flow is a problem.


6. In turn around cases, the cash flow statement is important.  Be sure to know and understand the sources and uses of cash for the coming months.



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