How to invest profitably in quoted companies (ii)

INVESTMENT TALK WITH EMMA

Emmanuel Ewumi

(Over 20 years investing experience in Nigeria’s financial markets)

Continued from: How to invest profitably in quoted companies (i)

Generally companies doing the reverse of the things done in bad companies ought to be good companies. Soundness of a company has nothing to do with size. A big company could be bad, while a small company could be good. A good company however is one that has a high return on capital, defensible competitive advantage and a winning culture.

Good companies go about their business in a way that leaves them unnoticed by most investors, except shrewd investors who have an eye for discovering good companies. By the time the investing public gets to know about a good company, the stock price would have moved tremendously.

Most investors know about their companies’ stock prices, but they do not know much about the activities, products and management of the companies they invest in. In order to succeed in the stock market, investors should be conversant and knowledgeable about the companies they invest their funds in.

It is possible for a good company to sell at a bad price, while it is also possible for a bad company to sell at a good price. Investors need to learn how to identify good companies, value companies and then buy at prices that give room for margin of safety for the companies’ stocks.

Good companies have the following characteristics:

THE GOOD COMPANY

1. CASH GENERATION: The most important single test of whether a business is good is its ability to generate cash rather than paper profits that are not reflected in cash. Some companies declare dividend which they do not have cash to pay. Just as cash is important to human existence so is cash important to corporate existence.
2. ALERT MANAGEMENT: The managers of good companies are proactive and conversant with trends in their industry. They are able to anticipate the needs of their customers and are well positioned to take advantage of government policies.
3. ETHICAL MANAGEMENT: Good companies have ethical managers; they also hold corporate governance in high esteem. Members of the board of directors are people with impeccable character and pedigree. While it may be difficult to have a role model in Corporate Nigeria, we still have few individuals who are honest, ethical and God fearing in their dealings with customers, workers, investors and regulators.
4. HIGH RETURN ON CAPITAL: This is usually achieved by companies with the highest market share in a competitive market. These companies are market leaders or have some degree of monopolistic power in their industry. Companies that are able to achieve high return on capital are likely to be good companies.
5. PROFIT STABILITY: Some companies do suffer occasional dips as a result of the economic cycle or mismanagement, but good companies hardly have volatile profitability. Good companies have more than five years profit stability. PENCOM compelled Pension Fund Administrators to invest pension funds in companies that have consistently paid dividends for a minimum of five years.
6. WINNING CULTURE: One of the most important reasons why companies can beat their competitors and keep on having better profit growth than the average is due to the company’s culture. It is very rare to find a company with a winning culture that is not a good company, or will eventually become a good company.
7. CUSTOMERS’ LOYALTY: My late grandmother had an account with one of the banks in Nigeria, my mother also opened an account with this bank when she started working, as a teenager I equally opened an account with this bank, now am a father and I have opened accounts for my children in the same bank. Nothing explains customers’ loyalty more than the example given above. Good companies enjoy the loyalty of their customers. Good companies and their products or services are strong brands. Customers have good perceptions and expectations about the satisfaction that will be derived from the consumption of goods or services from strong brands.
8. HUMAN CAPITAL: Good companies invest in the capacity building of its workers and managers. Companies which invest in training of her staff tend to be stable and do better on the long run than companies that do not invest in human capital.
9. MERIT BASED RECRUITMENT: Good companies recruit a minimum of 80% of their labour force based on merit. One of the major reasons why government owned businesses are not profitable is because recruitment is not based on merit. Some of the banks that went under during the last meltdown in the Nigeria financial market recruited based on man know man, ethnicity and religion.
10. STABLE MANAGEMENT: Good companies do not have a high management turnover. A company that has four MD/CEOs within five years is not a good company. Good companies have a stable management; they also have a very good succession plan in place. It is very difficult for an outsider to come and become the MD/CEO in a good company; rather managers from good companies can be headhunted to become MD/CEO of another company that needs corporate turnaround. Good companies invest in capacity building and human capital such that at any given time they have more than two people that can effectively become the MD/CEO. Two managers from FBN are currently the MD/CEOs of two banks in Nigeria, while the current CBN governor was seconded from FBN.

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References

1. Seminar Paper on profitable investment in shares by Emmanuel Ewumi.
2. Techniques of making money in shares by Festus Akindipe.

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Book for the Month

The Millionaire in You by Michael LeBoeuf

Michael LeBoeuf is a retired Professor Emeritus from the Business School at the University of New Orleans USA.

Michael LeBoeuf retired a multimillionaire at the age of 47 in 1989 after teaching for 20 years, he is now a business consultant, professional speaker, seminar leader, and the author of working smart, The greatest management Principle in the World, How to Win Customers and keep them for life, and The Perfect Business.

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Memorable Investment quotes

The people who tell us that money cannot buy happiness either do not have it or do not know where to shop. – Michael LeBoeuf PhD