Value Investment Criteria: The First Question You Should Ask

| November 15, 2010 | 0 Comments

I don’t know about you, but I love conferences.  When I was an investment banker, I was always attending different industry conferences.  I’d fly all over the country to spend a day or two meeting with the movers and shakers in a specific industry.

I’d meet with current clients, just to say “Hi”!  I’d meet with prospective clients to get updates on their business and discuss the next financing.

I’d look for new clients and dig up new contacts.

Some people would call this schmoozing, I called it research… and best of all, I enjoyed it!  I enjoy making new connections.  I always walked away with a better understanding of the industry, the company, or the impact of recent news.

If you’re ever at a conference, I’ve got a question for you to use.

It’s the first thing I ask a management team when I meet with them.  But first, let me share with you a recent experience…

Like I said, I love conferences… so when the local financial radio station announced they were hosting a conference, I could hardly wait.

I signed up for the event two months in advance…

A week before the conference I downloaded the speaker list.  I highlighted who I wanted to see.  I also took a look at the companies attending.  I figured out who to target with my limited amount of time.  I identified companies I absolutely had to see.

I had a game plan.

Being organized is very helpful.  My goal was to identify two or three solid companies I could then research further.  You always want to cherry pick the very best.  And of course, don’t forget to do your follow-up research.

Keep your eyes peeled.  Unless you live in a remote part of the country, there is sure to be some event or conference in your neck of the woods. Prepare like I do.  Identify the speakers you want to see, what time they go on, and then focus on a handful of companies to gather materials from.

Most importantly, ask a lot of questions.

When I go to a conference, I always ask the same first question… This question uncovers a lot of detail about the company and it gives you a map to where you should do further research.

So, what’s the question?

My very first question is always… “What are you selling and why do your customers buy it from you?”

Now this question is very deceptive.  On the surface, it doesn’t seem very complex… but that’s the beauty of it.

You’ll quickly realize how different the responses are!

Amazingly, some companies find this simple question incredibly difficult to answer.  I’ve heard it all.  One management team told me, “Well, we’re not selling any products yet…”  Another said, “We’re still in the R&D stage…”  Yet another said, “Our mine doesn’t open until 2014…”

These are all red flags.

I understand some industries like mining or biotechnology have zero revenue… then they suddenly make millions.  And if that’s the case, you simply adjust your expectations.  But, if a company doesn’t have any revenue, you might want to take a second look and think hard before investing.

On the other end of the spectrum, I’ve seen management team’s offer up fat sales numbers.  They say something like, “Last quarter we did $8.6 million in sales.”

It sounds good at first, but we need to keep the number in perspective. How much did they sell the quarter prior?  If they sold $10 million, sales are actually shrinking by 14%!  If a company is seeing their sales slide, management had better have a very good reason.

When revenue falls significantly, it’s another red flag in my book.

The worst response, however, is when a company’s sales are flat. Revenue is the same quarter after quarter after quarter.  It means management can’t figure out how to grow the business.  Or it could mean the company is tied into a few long term supply contracts.

Long term contracts aren’t always bad, but if the contracts are long term and the company isn’t profitable, look out!

Now here’s the answer you really need to watch out for…

Some management teams offer up the first half of the question, but conveniently forget the second half.

“…why do your customers buy from you?”

The answer to this question can lead you right into the briar patch.

You’ll quickly understand what customer relationships are like.  They might sell a commodity product… in which case supply and demand is very important to research.  Or they might have locked in profitable long term contracts… in which case the customer might jump ship the second the contract ends.

Finally, they might just provide a better product, with top of the line service.

The responses are limitless.

Let me leave you with one last experience.  A few years back, I sat down with a CFO and asked him about his sales numbers… after two minutes of hemming and hawing, he finally looked me in the eye and said this:

“Because of an accounting issue, our revenue numbers are actually negative…”

Needless to say, I didn’t invest in that one.

Just keep in mind, when you’re looking for a good investment, start at the very top.  What is the company selling and why are customers buying… The wealth of information you uncover is stunning!

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Category: Stocks

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The Dynamic Wealth Report works with a number of staff writers and guest experts who specialize in everything from penny stocks to ETFs to options trading. These guest analysts post under the 'staff writer' moniker for ease of use.

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