In music the Fab 4 were the Beatles and incredible band that has changed not only the music and but one entire generation.
In my analysis, I have my Fab 4. This is my four principles for evaluating an opportunity:
- Free Cash Flow above 10% and sustainable
- Limited or manageable Debt
- Excellent stewardship from Top Management
- Margin of safety
Strong and sustainable Free Cash Flow
Free Cash Flow is my immediate way to understand company’s profitability, because it’s the money left after pay debt, taxes and regular capex.
It shows the money left for the shareholder, the company could:
- Keep on investing on its business through organic growth
- Reducing Debt
- Buying other companies
- Distribute dividend
- Buying back shares
All interesting options for a happy shareholder
The percentage of this Free Cash Flow on company capitalization gives me a useful measure to understand potential profitability and dividends.
Also, very important is to understand the consistency of this Free Cash Flow. Is it also growing? Those are important factors that I check evaluating FCF
Debt is powerful tool in the hand of a savvy management, but it could be a risky enemy during economic downturns. For this reason, I prefer companies with limited or no debt.
A company with No Debt is company that can only reward shareholders and capture opportunities at the best moments.
A company with no debt can maximize its use of FCF in favor of shareholders.
1,5 Net Debt/EBITDA is a useful measure to evaluate the risk associate with Debt
Skillful Top Management
Business is made of people, people bring ideas, people can make the difference and create new business.
This is, by far, the most important factor in the success of a company and of an investment.
Amazon and Apple success were driven by talented management and shareholder benefited 100x their investment.
Understand a company forces you to understand its Top Management.
Earning Presentations and Business Plans are very useful to understand their talent and vision.
I recommend reading carefully 5-6 earning presentation before investing on a company.
Margin of Safety
Whenever I try to buy momentum stock it was already too late and this brought me to an immediate capital loss.
So, usually, I try to buy when “there is blood on the street” and everybody is talking trash about this company. One example was Target: when Amazon bought Whole Foods, Target lost 20% in one single day, and everybody was prepared for weak future. But operation were very strong, team was very focus and I thought that Amazon would have killed the weakest of the retail distribution not Target or Walmart.
My margin of safety is to buy a company 20-30% lower than their usual evaluation. This could be P/E or EV/EBITDA…, depending on the business.
Once your company or your opportunity responds to all this points, its just a matter of patience and the business will do the rest.
Time will make the difference and good business will turn amazing.
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