When researching companies, it is important in the inital stages to identify what kind of company it is because the company's stock performance can related to the type of firm. There are basically 6 kinds of companies:
These are large and aging companies that are expected to grow slightly faster than the domestic economy (GDP). Laggards are the classic "smoke-stack" companies that were the heart of the economy for most of the 20th Century. They started as fast-growers and eventually pooped out because they had gone as fast as they could or else they exhausted their business opportunities. Laggards pay generous and regular dividends mostly because they can't think up of any other ways to use their investor's cash. These companies often barely generate excess returns on invested capital.
Classic Laggard Companies
Gas and electric firms (BC Gas,TransAlta, TransCanada Pipelines)
Transportation (CN Railways, Canadian Pacific)
- If dividends have always been paid and routinely raised
- What percentage of earnings are being paid out as dividends (ie. Dividend Payout Ratio). If it is low then the company has a cash cushion which will help it get through hard times.If it is high then it is riskier.
- Company has lost market share for several years.
- They're looking for another ad agency.
- No new products are being developed, spending on R&D is reduced and company appears to be resting on its laurels
- Recent acquisitions look like "diworsifications".
- Price is so low that dividend yield will still no attract investors.
The Sturdy Ones
These are large companies with 10-12% profit growth. The stocks can be profitable if held for the long-term (3-5 years). An investor should consider taking profits more readily than with a laggard (ie a 50% price gain is as good as it may get). The Sturdy Ones offer good protection during economic downturns. They produce products that people will always need (eg Corn Flakes, toothpaste etc.) and are unlikely to go out of business.
Classic "Sturdy Ones" Companies
Coca Cola, Proctor and Gamble, Molson's
- Earnings mulitples (P/EVA) to determine if you are paying too much.
- For possible diworsifications that could reduce earnings.
- Long-term growth rate and whether it has kept up the same momentum in recent years.
- See how company has performed in recessions if holding stock long-term.
- New products introduced in the past couple of years has had mixed reviews and other products that are still in phase are a year or so away from market.
- A major division in the firm that contributes a significant portion of the firm's earnings is prone to an economic slump.
- Growth rate has been slowing, though it is maintaining profits by cutting costs, future cost cutting opportunities are limited.
These are small aggressive new enterprises that grow at about 20-25+% per year. They learn to succeed in one place and then attempt to duplicate the formula in more areas. Growth is faciliated through expansion into new markets. They are highly risky in that they are overzealous and often underfinanced. Cashflow can be an issue. Good "Accelerators" carry little debt and have strong Balance Sheets as well as generating high excess returns on invested capital.
Classic "Accelerator" Companies
Technology companies (Microsoft, Cognos, Nortel)
Biotech companies (MDS, BioChem Pharma)
Any "knowledge based" companies
- Growth rate (minimum 20-25%).
- Products that were supposed to enrich the company compose a significant portion of the firms business.
- If company still has room to grow and expand.
- If expansion is speeding up or slowing down.
- If there is high institutional coverage of the company.
- Expansion appears to be slowing.
- 60+% of shares are held by institutional investors and company is getting excessive media exposure.
- Earnings multiples reach ridiculous levels.
- Key executives leave the firm to join a rival or startup.
- Earnings multiples are higher than its growth rates.
These are companies whose sales and profits rise and fall in a regular and predictable fashion. Prices tend to rise as the economy comes out of a recession and fall when the economy begins to slow down. Cyclical companies can also be lumped in with the Sturdy Ones.
Classic Cyclical Companies
Auto Companies (Ford, GM, Chrysler etc.)
Housing (Construction, Furniture, Real Estate)
Commodities(Oil/Gas, Forest Products, Mining, Steel)
- Inventories and supply/demand relationships.
- For new entrants into the market which is bad.
- If the industry is in a slump for a long period, the recovery will be longer and better.
- Reach the end of a business cycle. Ideally this is a year before the decline.
- When something actually goes wrong (eg costs increase, plants operating at full capacity and spends on additional capacity).
- Futures commodity prices begin to fall.
- CRB Index begins to show a downward trend.
- Competition enters forcing price cuts.
- Union contracts are close to expiring. This would cause collective bargaining and a potention for work stoppages which could impact earnings.
- Final demand for products are slowing down.
Turnarounds are companies that have been battered, depressed, and often can barely drag themselves into bankruptcy. They are zero growth companies. They may lobby for government handouts to stay in business.
Classic Turnaround Companies
- If company survives a raid by creditors.
- Cashflow levels.
- Debt levels.
- If company has sold off unprofitable divisions.
- If business environment is improving.
- If costs are being cut.
- If company has a plan/vision for the turnaround.
- If debt level has been increasing.
- Inventories have been rising faster than sales
- Most of the firms business is tied to 1 customer.
The Asset Play
These are companies whose assets are worth more than than price of the stock. Assets include cash, land, buildings, R&D,Patents etc. These values are often unrealized by the market.
Classic Asset Plays
3Com (Palm Pilot)
BCE (Nortel and Bell Affiliate stakes)
- The value of assets. Are there any hidden assets?
- How much debt is there to detract from the assets.
- Is the company taking on more debt?
- Is there a raider or potential takeover candidate that will raise the share price?
- Takeover rumors begin to circulate
- Company issues more shares.
- Division brings in less cash than thought.
- Institutional ownership increases significantly and fast.