I wanted to add some additional points on FCF which I brought up in analysing the Statement of Cash Flows before moving onto the future posts on balance and income statements.
If a company receives a tax deduction when employees exercise their stock options, does this count as cash from operating activities? Or if the company defers its income taxes to a later period, does this count as cash from operations? I don’t think so.
The purpose of the Discounted Cash Flow (DCF) method is to find the sum of the future cash flow of the business and discount it back to a present value. I use the F Wall Street method of valuing a business along with some tweaks here and there to suit my tastes.
The advantage of this method is that it requires the investor to think about the stock as a business and analyse its cash flow rather than earnings. The first and foremost reason a business exists is to make money where money = cash, not earnings. Since cash is what a business needs in order to maintain and grow its operations, it’s only right to consider the possibility of its future cash growth rather than earnings growth.
In this post, I’ll be going over a few basic ideas of what to look for financial statements, not how to read them, for the beginner investor who wants to research or keep up to date with their companies. AeroGrow (AERO) will serve as a very nice example with plenty of warnings signs.
The purpose of this post is to help you get the idea of a company’s health and let you decide whether it is worth the extra effort to take the next step and plug in numbers for ratios and other metrics.
FYI, I exited my position in AeroGrow with a huge 60% loss even though I had the opportunity to lock in a 20% gain. I made many mistakes on this one (let’s just conclude I didn’t even read the statements to begin with) and you will see why I had no other choice than to sell once I woke up. Hopefully, you won’t make the same mistake as me.
I find it much easier to see and understand graphs and lines rather than a row of numbers next to each other. I have to admit that my investing techniques still needs work. So in an effort to iron out some kinks, I will now implement a spider chart (Excel calls it a radar chart) when I analyze companies.
Here is an example. Note the difference between AeroGrow (AERO) (one of my many mistakes) and Coca Cola (KO).
In 1932 at the bottom of the Great Crash, Ben Graham’s fund had dropped 70%, but it was precisely this time when he wrote an article on Forbes about the cheapness of the market and how the market was selling the United States for free. I feel we are close to the same situation.
Stock Market Prognosticator previously shared a list of Net Current Asset Value plays, and I previously wrote about how there were literally hundreds of companies that are being quoted for less than their cash in the piggy bank. One such company that I have analyzed lately is ValueVision Media Inc. These companies are being quoted in the market for much less than their liquidating value, as if they were all destined to be doomed. But does it make sense to be quoted for less than the cash in your hand?
Until Nov 21, you have access to all the premium content on Morningstar. Quickly sign up (no credit card required) or log in now! Go go go. Thanks to Contrarian Value Investing for the notice.
I’ve also made a quick comparison between Morningstar fair value and my fair values.
The October 27,2008 issue of Forbes lists the 200 best small companies of the US. These may be good companies, but I want to know whether they are good investments. So I’ve set up a new challenge.
My goal - go through each company and find the ones worthy of investment.
Joe asked me a very good question and as I was answering it, it started getting long so I felt it should be discussed in a post rather than buried in the comments. (Joe, I apologise if you didn’t want your question to become a topic.) Here I answer the question and more.
Enoch Ko from The Wealth Accumulator brought up some very good questions related to my K-Tron analysis and wrote a interesting follow up post on Thinking About Growth. So while the topic of growth was still on my mind, I decided to revive a couple of old posts I had written in February.
A recent article by Pat Dorsey on Morningstar raised my interest the other day. Morningstar has come up with an additional valuation rating when providing the fair value for companies; the uncertainty factor. Since the future can never be accurately predicted and is only an assumption, a level of uncertainty always exists with any valuation.
Discount rates and the concept of discounting can be very confusing to understand at first. I talk from experience. For a budding investor, trying to understand future value and then discounting to get a present value can be quite tricky. So I’ll try to provide a simple explanation.. (please let me know if you have a simpler way of explaining it)
Growth rate is probably one of the most hotly contested and asked questions regarding companies. Everyone wants to know the growth rate for their stock. Many decisions are based on this number, but how do we know what it should be? Do we just believe Wall Street analysts and blindly accept that companies should perform accordingly for the next 5 years?
In response to my post on the valuation of AAPL, an opinionated user posted this reply on Google finance and so I responded. I don’t mind attacks if it is intelligent and knowledgeable, but if it is based on blind irrationality with no facts or logic other than sheep talk, then I will be hell bent on having lamb chops for breakfast.
