Business Analysis:The Scuttlebutt Approach

March 18, 2008

Scuttle butt approach in investment was popularized by Philip A. Fisher.In his book,’Common Stock,Uncommon profit’,Philip explained that an investor can get better view of a company by interviewing its competitors and vice versa. Information about a company should be obtained at from employees, customers and clients.One should not ask its management because the management will paint the outlook with beautiful colors since it involves conflict of interest. To perform scuttlebutt, one must have a good network with many people in various industry.By socialising with these contacts,one can get a better picture before putting his hard earned money into the business. Sources of information are competitors,vendors,customers,professors and employees. Reading news from research houses and newspaper is not adequate because these sources have filtering system. The research houses and media act like the advertisers of public listed companies rather than helping the investors to understand the business.They are paid to do so.Scuttlebutt approach helps investors to obtain confidential information and ‘insiders’ information’.Of course,the investors must be very good with his communication skills to indirectly dig more information from these sources.Remember,knowledge is power!What are the basic information which an investors should look for? I highlight the questions below.

1. Do these companies have products with market potential to increase sales for at least several years? Your target company may be harvesting profits currently, but it may lack long term potential. This question can help you discern the company’s prospects (and yours).

2. How effective is R&D in relation to its size in each company? Looking at the financial ratio between total R&D expenditure and total sales is a popular but crude way of thinking about R&D commitment. Such ratios can be misleading. When evaluating a company’s R&D efforts, it is just as valid to inquire about market research as technology research. So, find out how the company investigates (and develops) its market.

3. Can you describe the sales organizations of these companies? Information about the sales operation is seldom discussed in financial reports of public companies. Fortunately, this information is easily obtained using Scuttlebutt. Of all aspects of a company’s activity, the most well-known to sources outside the company will be the sales organization.

4. How would you compare these companies’ profit margins? Sales are of value only when they lead to profits. You want to find out what the target company is doing to maintain or improve profit margin. Scuttlebutt can give you a glimpse into a company’s profit future.

5. How would you describe the way these companies treat employees? Within an industry, it is generally known that there are “decent” companies. It is also generally known that there are companies that “burn up and discard” people. Senior management is often blind to its own reputation, but others will see it clearly.

6. How would you compare depth of management? A small company can do extremely well under an able autocrat. What would happen if that key person were no longer available?

7. How would you compare these companies’ cost analysis and accounting controls? It is not difficult to churn out reams of accounting information. The tough questions are, how valid and useful is this information, and how effectively does management act on it? The Scuttlebutt method is helpful here in revealing significant problems that won’t necessarily appear on the balance sheets.

8. How would you compare the integrity of management? Without breaking laws, there are ways in which senior managers can benefit themselves at the expense of customers, employees, and stockholders. Such managers are generally known within their professional communities. The only real protection against being abused by such managers is to avoid getting involved with them.

It can be very difficult to obtain the information you need about a privately-held company. Scuttlebutt gives you access to the professional assessments and opinions of people who know a company. It’s not perfect information. However, by cross-referencing the answers you get to the questions we have outlined, you can form a picture of your target company. Scuttlebutt helps you combine your judgment with that of industry insiders to draw reasonable conclusions. 

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What is Value Investing? Part 9

June 12, 2007

There you have it,eight parts on value investing. Part 9 will touch on corporate governance. But this part will be explained by my fellow friend, Ben McClure.Anyway, Who is this guy?

But before we go to that topic,let’s learn about The Basics of Corporate Structure.

In summary,

Step 1: Read ‘Who is this Guy’?

Step 2: Read ‘The Basics of Corporate Structure’

Step 3: Read ‘Corporate Governance’

….continue


What is Value Investing? Part 7

May 27, 2007

Now,you should have calculated annual EPS growth (from Part 4), understood a company’s strength,weakness,opportunity and threats (SWOT) (from Part 5) and analysed financial ratios in financial statements (Part 6). Next is to dig further into the management of the company.

Well, there are cases which companies were investigated by S.C on irregularities in annual report and some CEO are investigated for corruptions.As a value investor, you should put  these companies away from your portfolio. Remember, it is ……(continue)


What is Value Investing? Part 6

May 13, 2007

The 3rd criteria is to recognize ‘EPS Manipulation’ in financial statement.Before buying a share, read the ‘Notes to the financial statement’. Get to know how the company define its sales, expenses, debt and others. Look for irregularities in the financial statements such as extraordinary write off, special expenditure and so on. This means you as an investor must question every ‘weird’ numbers in the financial statement. Each financial statement will go through an artist work (by the accountant) to hide any ugly sides of the company.

For example, a company can declare its sales before the products are sold to the end users. This means the company declares its revenue before it receives the cash or before the cerdit term expires. By doing the ‘art work’, the company can significantly increase revenue, reduce expenses and get a better EPS. 

(continue)


What is Value Investing? Part 4

April 29, 2007

What are the criteria in choosing a public listed company to invest in?These criteria is obtained from the book,”The New Buffetology” which is written by Mary Buffet.I will explain how can you apply those criteria in KLSE.Some criteria might not be suitable and need some modifications.

The first criteria is the EPS pattern over a decade.By observing the EPS pattern for the past 8 to 10 years,an investor will be able to get a sense of a company’s sustainability and reliability in its industry. You should chart the EPS in Excel as linear graph, and observe its EPS fluctuation and direction.If the fluctuation of the EPS is little and the trend is upward,then you are looking at a stable company.You can only predict the future of a company which has shown stable growth over the 10 years.Small fluctuation of EPS is acceptable.

Erase all the companies which does not have …(continue)