How to invest - part 1. Preparation - How - Sixth Part

Today will be the third item on what to look at, financially: The net profit margin.

Net profit margin is calculated by deducting from your revenue, the following items:
1. cost of goods sold
2. operating expenses aka overheads oka fixed costs
3. depreciation and amortization, interests, and taxes

You may recall from the previous post that gross profit is obtained by deducting your cost of goods sold from your revenue. So, your net profit is really just your gross margins, less all costs other than costs of selling your goods.

Picture this: you sell lemonade for a living, so your revenue is the sales amount from all the cups of lemonade sold. Your gross profit is your sales, less the costs of the lemonades, water, sugar, salt, ice, cups, i.e. all the costs that you need to pay in order to serve that lemonade to your customers. 

Now, other than the costs mentioned, there are other costs you gotta accommodate, in order to operate - these are the costs you would have to incur in running the biz, whether or not you make money - such as the lemonade stand, the icebox, the ice in the icebox to keep whatever in the icebox ice-cool, chair(s) for you to sit on while waiting/tending to customers, a table cloth to place your lemonading equipments, the cash box/register, and the biz license (lol I doubt there needs to be a license for running a lemonade stand but let's just assume the gov is serious about regulating the lemonade business). These are your operating costs - there can be a few variants to this name but the concept is wtv cost you pay to ensure the biz can operate, whether or not you make a sale.

Then there are the truly boring stuff - especially if you run a cash business coz these costs are stuff you don't quite see and feel (for taxes, it's stuff you neither want to see nor feel really). Depreciation and amortization, in a nut shell, is you recognizing your assets this year won't be worth as much the next year - this is because of wear and tear, or the equipment becoming older/obsolete, and because accountants generally need to do something - this recognition is manifested in the real world by deduction against your income. Depreciation is for physical assets like the lemonade stand, jug to store lemonade, chairs etc, while amortization applies to intangible assets like your lemonade stand brand, the website, and trademark of your lemonade stand name.

Think about the car you own - you first got it for say, $100,000.00, then in the 2nd year, you find that the market rate for your car in the second hand market for a two year old car is only $85,000.00 - it's not exactly the same thing but you can think of it as a parallel. This part really becomes useful for tax breaks and for audits.

Interests, well it's pretty straightforward - the interests on any loans you make also need to be deducted against your income. This part also becomes really useful for tax breaks.

Coming to tax, well I don't have much to say other than I wish there wasn't tax but that would mean governments will cease to operate (and is that such a bad idea?). Suffice to say, you make income, there will be a tax on that and there are some steps you can take in an endeavor called tax planning - unfortunately my knowledge, will, and patience for tax matters are as deep as the thickness of an A4 paper and I shall not go any further - just know that tax is always present, and any listed company has to pay tax, and if they don't, they get in big trouble, usually existence-threatening trouble - so any listed company will not or will try their best to keep their taxes in good order, making this an item the least of your worries.

Also, there's a reason why, in the financial statements, the depreciation and amortization, interests and tax are lumped together with income, under a line called EBITDA or earnings before interest, tax, depreciation and amortization.  This is really just taking your gross profit, and deducting your operating expenses to get your total income before considering the effects of depreciation and amortization, and any interests on loans and taxes. 

You can consider this to be your net profit (gross profit after deducting operating expenses), but without the accounting effects of depreciation and amortization - which in theory should give you a "cleaner view of your income"

As a side note,  depreciation and amortization doesn't really affect you in a physical way coz it does not disrupt your cashflow right? You receive cash for selling lemonade (revenue), then you minus of the costs of buying lemons, and preparing & storing the lemonade (cost of goods sold), and after that, you pay for the chairs, banners, and the lemonade stand itself (operating expenses) . No where in this process will you need to pay someone or something the amount you think that your lemonade stand will decrease come next year, or by the amount you estimate your car will be worth less next year. 

Popularised during a time when leveraged buyouts were the rage, EBITDA became the goto number for evaluating a company coz :
1. leveraged buyouts, as the name implies, made use of leverage or high amounts of debt to buy a company - a profitable one with good cashflow
2. As high amounts of debts were issued, naturally the biggest chunk of expense will be your interests on the debts issued.
3. So, by taking by comparing your EBITDA to your interest ratio cover (basically, how well can your profits cover your interest on debt) - you can sort of tell how well your newly bought biz can meet the loan obligations you incurred to buy it out.

Truthfully speaking, I don't really like looking at net profit margin because at every step of the way, you can change abit, tweak a little, charge more, account for less, increase depreciation/amortization and perform some accounting magic (legal magic mind you) in so many other ways that the initial revenue you get may very well turn out to not be a good indicator of biz performance by the time it is net profit. I believe, more revenue, means good business but that's for another day!

How to invest - part 1. Preparation - How - Fifth Part

 Today we will be touching on the Gross Profit margin:

Simply put, Gross Profit: Revenue - Cost of goods sold

Then, Gross Profit Margin : Gross Profit / Revenue

In other words, you take your sales, and minus off whatever cost you directly incurred to make that sale, and you have your gross profit, in dollar amounts.

Then, you divide this gross profit by the sales amount - this tells you how much profit you make per $1 of sales, percentage wise. 

So, if company A makes $100 in revenue, and spends $20 in promotion, hiring temp staff etc, the gross profit is $80 and its gross profit margin is 80% - which is real damn high, but not unusual.

What this % does is, it tells you a couple of things:

1. If you have a company that is high in gross profit margin, it tells you that the profits it makes in relation the costs it needs to spend to make a sale is quite high, and this also tells you the company manages to keep its selling costs low. 

How does a company keep its costs low? Couple of ways: the company manages to source for material cheaply, which may signal the company has a unique hold/access to its raw material(s) or manages to strike a good deal with its supplier and can keep costs low for a certain amount of time

2. Say, you know this industry really well and the prices of its raw materials are quite standardized/commoditized so any company in this industry faces roughly the same costs. So, based on point 1, you think the gross profit margin should be roughly the same for all - but, you noticed there are one or two companies that seem to have higher than average gross profit margin. 

This probably means the company is able to charge a higher price ie bring in more revenue. Now, if you have a company or a few companies that are able to charge higher than its peers in an industry where the cost of goods are about the same, you may think these companies are doing something different.

Perhaps they have a good brand, strong marketing, excellent after sales, awesome customer retention, constant updates and improvements to their existing and new products/services - in warren buffett's terms, the company has a strong moat(s).

Definitely save a company like this in your watchlist for further study !

So, just with gross profit margin, and revenue, you can do abit of preliminary analysis:

1. Check the revenue growth of company A vs the revenue growth of the industry.
If its higher than the industry, it means A is eating up its competitor's share but also pay attention if the revenue growth of the industry starts to decline - it may signal the beginning of the end. Like Kodak and the digital camera market.

2. Compare the gross profit margins between a group of companies in the same industry, and you can kind of get a sense of which companies has good cost management (this does however warrant a deeper dive to get a full understanding of all the other costs a company incurs), good pricing ability, and in turn, good/strong economic moats.

How to invest - part 1. Preparation - How - Fourth Part

We will be talking about Revenue this time.

What is Revenue?

In short, it is sales or how much you as a company makes from providing a service or product to customer. The more sales you make, the more revenue you generate for the year. 

What is special about Revenue?

Simply put, no revenue, no money in the company. 

And no money, no talk as the saying goes.

No revenue, means there's is profits or cash flow. if a  an organization can't bring in money, it will cease to exist. Heck this is even true for not-for-profit organizations!

But, among other things, revenue also represents the confidence the market has in the business, NOT the price of its stock BUT the amount of sales it makes. 

Take for example, you launch a new product and people, your friends and family, and about the 1000 people on social media thinks it's a good product and the hype drives up your cred - that's price of a stock. But, when people wanna put their money where there mouth is at, that's revenue. The clearest way the market validates your business + products/services is when it buys them, not when it supports you via likes/follows/retweets. 

How I identify Revenue?

It is the first line item in income statement (or profit and loss statement - same thing). It is also called sales, turnover, or income

It is separate from profits - which is revenue minus your costs involved in selling. 

 

Key points:

Look for growing revenue, whether year over year or quarter over quarter, look for companies with growing revenue. 

But in particular, check to see if the company's revenue growth is equal or more then the revenue growth of the industry it operates in! If it is, the company is growing faster than the market, and by extension, it is eating up its competitors' market share and gaining a stronger foothold in the industry. 

As a corollary, check the industry revenue growth rate too - if you find in the last 3 years the % has been steadily declining, you might be looking at a sunset industry like newspaper, which will eventually shrink in market size and your company, even if it is number 1 will start to see revenue growth slow down and even reduce. 

How to invest - part 1. Preparation - How - Third Part

Hi, hello, and welcome to 2022 !

Apologies for leaving you guys high and dry the last couple of weeks. Much has happened in a personal capacity - of which, 100% of it affected my posting timelines. I shall try to make up for lost time, and hopefully not let the coming CNY affect my postings hehe.

We last left at: 

Part C. The financials 

Yes, the meat of the matter. The language of business. The undisputable facts of what was done vs what was promised. It is that which will tell you what has happened over the years under the leadership(s) of the management.

I will straight up tell you: looking at financials is crucial to understand the path and evolution of the company. It will tell you whether the endeavors of the management has bore fruit or served to produce more manure. The financials will show in the present, results of the management's efforts in the past, and may tell you what to expect in the future BUT it is not crystal ball. 

To do that - to get an idea of how the company will perform in the future, the only way (that I know of so far - if you know other ways feel free to let me know!) is to keep abreast of the company's development, read the earnings calls transcript, stalk the management's social media, read up on news which relates to the company and the industry, and also do the same for its competitors. 

In short, past performance is reflected in the financials while future performance can be clued  from (usually) non-financial data like the above.

Anyway, when it comes to the financials, we want to have a feel for a trend stemming from past performance to give us a year-on-year % change, and also the results from the last 12 months - aka TTM, trailing twelve months). To do that - we will be looking at 7 metrics. 

Yes. You read right. Only 7 metrics to bring you from rags to riches. Or so I am told.

- Revenue
- Gross profit margin
- Net profit margin
- Return on Equity
- Free cash flow margin
- Current and Cash ratio
- Debt to Equity ratio 

In the next post, I will start with Revenue, arguably the most important metric, without which none of the subsequent calculations will be possible.

A thing I have with being open

 In a departure from the how-to-invest series, I want to talk about something else today. Doing the how-to-invest series was harder than I thought, in terms of crystalizing my thoughts and doing so in an orderly manner - I know understand why i sometimes take 2 highways home when I can do without one hmm.

Anyway, I want to talk about being open with how I invest - specifically, the things that say to me don't do it, don't expose myself in public. I mean, expose myself to the public, if there is a difference nowadays.

Well, I was really half and half about starting this blog for a couple of reasons: 

1. I was afraid of judgement and being told I don't know my stuff, and I should go back to where I came from (wait scrap the last part - that's just me reliving some random moments in australia hehe)

2. I was afraid that I might actually not know what I am doing and as a corollary to the above, I would be exposed as a dumbass with only sublime writing (or was it sublime writing dumbass)

3. I was afraid people who have difference viewpoints, will say their way of investing or trading is superior and value investing is dead, which again, is something like a judgment that I am wrong and should stick to playing video games. and sublime writing.

Well, thanks to a bit (actually, a lot) of Gary Vee, I realised it doesn't pay to care what the internet thinks of whatever I put out as long as I believe, am interested in, and care for it. The judgment of others - from people in my primary, secondary, tertiary, and workplace environments - don't matter as much as what I think of myself. 

It might be obvious to you, but it is only obvious and powerfully true to me now that: as long as I strive to create value or give or help other people with the intention to see that they become better off, I should not give a damn if I am praised for this or condemned for that, only that I receive input into what people need from me. 

To expand on this point, there are billions of people on this planet and I am but one person - if I can help someone else on this planet and made a difference in his/her life, to get them one step close to financial freedom - which I define as being able to choose to work because you want to, not because you need to - then that will make it worthwhile for me to know I have helped to improve someone's life, and in turn they could have improved their family's life. If I kept all this inside me, I would have missed out on potentially touching millions if not billions of people's lives - no matter how small - and all because I worry about what some stranger on the internet says about my not so sublime writing.

So, I guess my sharing today is the Internet is a great enabler for all of us. It has enabled us to get information, services, goods, people, at scale and at speed. It can connect you and I across the globe, and across time (you can read this anytime after I posted this - long into the future!). With this enabler, it is a worthwhile effort for anyone wanting to make a difference in people's lives, to just contribute whatever knowledge, skills, know-how, opinion because you never know how much of an impact you can make in someone else's life.

Like Arnold Schwarzenegger said as one of his rules,
"Tear down that mirror. Tear down that mirror that makes you always look at yourself, and you will be able to look beyond that mirror and you will see the millions of people that need your help." 

How to invest - part 1. Preparation - How - Second Part

 Hello again!

So yesterday we covered using Google + Youtube to gain a bit of background about our company, what does it do to make money, and how does it add value to its customers. I also said, in relation to the things we uncovered, there are things to take note of such as the ongoing trend of everything being more digital, the company being a SaaS business, and the customer portfolio; all which tells me the company is going with the trend, is a type of company I prefer to invest in, and them being able to support some big names in the world gives a degree of credibility I am very comfortable with.

So, going down the list for the main points of reference, I can go on to look at the quarterly and annual reports for a feel of the financial and non-financial details, direct from the company.

By the way, I know I arranged it like so:

1. The quarterly and annual reports.

2. The earnings call + transcript.

3. Google and youtube case studies

4. Other people's research.

But, feel free to go through the list however you want - the order does not matter, what matters is you understand the business and have the facts to build up conviction. Oh but, again be mindful of other people's research - I've said it a number of times yes - it bears to be cautious when reviewing the reviews of other people about a company as it is all too easy to get swept with their narrative.

Moving on, the quarterly and annual report. 

Which one do you start with? 

I start with the latest annual report since it's the one with the latest complete figures for the year, contains the management's discussion and analysis for the year, notes accompanying the accounts, basically it has everything that has happened throughout the year and references stuff from the previous years while providing some guidance for the next year - use the guidance as a benchmark against the quarterly reports in the next financial year to see how well the management is executing.

So in the annual reports, we want to look at several things

A. The chairman's statement

This is basically the chairman of the board giving you a debrief about the company's performance under the management team, the wins and the things that can be improved on, the status about ongoing projects and future endeavors, and also about external events affecting the company like Covid and other stuff.

Did you watch Ted Lasso? yeah think of the chairman's statement as something like the post-match conferences with a truck load of journalists and Ted is there to address their questions and provide commentary on how the match went, what happened, what should have happened, and anything of note. Ted is the chairman, we are the journalists. Too bad, we can't ask questions directly like they can. Oh wait, you can! There's the AGM and depending on circumstances, you might just be able to direct a question to the chairman/CEO.

B. Management Discussion and Analysis (MD&A)

Still on the football analogy, while the chairman's statement is akin to having the team manager giving a debrief at the post-match conferences, the MD&A is like having the captain (CEO) of the team give you a rundown of what happened during the match.

You might thinking - why? what's the point? Isn't having the bigger dude (chairman) explain what has happened good enough? 

Well no, you see, both the CEO and chairman sit at difference ends of the table - while both want what's good for the company, one is sat at the top (Chairman) looking over what the other (CEO) is doing, giving input, and also acts as a control/checks and balance to make sure le CEO is doing what is right for the company and in turn, the shareholders. 

So, you can see the chairman has a more principal like role, while the CEO is like the teacher, in a highschool setting. One is on the ground doing the work while the other is up above watching those who work to make sure they work and do the right work.

As a result, both will have different lenses and difference ways of looking at things as they unfold over the year - the CEO who is on the ground will be able to tell you the challenges the company faces at an operational, tactical and strategic level as well details what he/she is looking to achieve over the next few quarters or years (Jeff famously says what they are analyzing this quarter, is a result of what they were focusing on a few years ago and by this time, they are already looking at what results they will be generating a few years ahead - by Jeff, I mean Jeff Bezos the extraordinaire at Amazon, who is well good at business. I'll leave it at that).

So the point about reading the MD&A is to know what went well, what projects the management has in the pipeline, the status of initiatives and projects from previous periods, the challenges they face and what you can expect the company to do in the coming quarters. Of course, it's always what they hope to achieve and the proof is always in the pudding - results speak for themselves. 

In short, read the MD&A - take note of the:

1. status of the initiatives & projects the company embarked on quarters/years ago

2. the challenges which the management highlighted - you wanna see if these challenges become a big problem over the following quarters and more importantly, how the management deals with them. Adversity breeds tenacity or it doesn't.

3. the things which the CEO says they company will be doing in the coming quarters especially about new projects or initiatives. Beware the person who comes up with new ideas/things to overshadow what didn't happen as promised.

Really, it's just like football - all teams want to be numero uno; win the EPL, Champions League, FIFA Club World Cup. Some teams talk bigger than they play and it shows. Some teams talk less but play the best game and it shows. You just gotta see what they are actually doing vs what they say they are going to do/are doing.

Alright, I have to log out now but in the next part, still on the annual report,I shall talk about:  

C. The financials (look at year-on-year % change, or 12 months to date):

- Revenue 

- Gross profit margin
- Net profit margin 
- Return on Equity  
- Free cash flow margin

- Current and Cash ratio

- Debt to Equity ratio

D. Risks to the business 

How to invest - part 1. Preparation - How - First Part

Hello guys!

In this post I shall be taking about the How of it all.

This will probably make up the bulk of Part 1. Preparation, since it's all about the actual steps you will need to do. So, Imma break this section into a several parts (yes, I know I need to have a better way to name different sections other than 'parts').

Ok, before we get into it, we've so far covered:

What is needed in the preparation for investing

You need to form your own investment statement; these 3 questions will greatly help you to do just that:

A. What does this company do to provide value to its customers? 

B. What is the company doing right that translates into more revenue, more profits, more cash flow and ever growing market cap? 

C. What needs to happen in the future, for the company to continue growing? What would cause the opposite to happen?

When 

When do you need to prepare and review the investment statement?

Before investing and after each quarterly earnings/annual report is out.

Where

The main points of reference would be:

1. The quarterly and annual reports.

2. The earnings call + transcript.

3. Google and youtube case studies

4. Other people's research.

Right, so we're ready with the How. Christ, here we go with the snapshots - I'll be using PagerDuty (PD) as my case study since it's been a do-gooder in my books. I'll assume this is the first time I'm researching about PD, having heard about it somewhere in the Internet.

At this stage, I'm just a blank slate

So, first step: Google and Youtube PD. I know nuts about the company, and I only want to know what does this company do and how does it make money doing whatever it is doing. 

Youtube

I usually go youtube first because chances are there is someone who has already done the research legwork or better yet, a video from the company itself about itself and its products/services. 

Remember: Don't get suckered into the story/narrative - try as best to be objective and look at the facts of the company!

Awesome, first result on Youtube and right there is a primer on the PD platform by the company itself.

I've included that video here too so that you can also watch, try to absorb and understand what PD does:

So, from the video, I gather they help organisations to resolve issues in their operations, which used to be quite manual since an issue would have to be manually reported by either customer or someone using the service/product, then that issue will have to be looked at by someone and then he/she will have to manually assign the right person(s) to resolve that issue. 

Think of the times when you had to submit a support ticket (if you ever did) and the wait times between each interaction with the support staff - I remember in the 2010s that could take up to days! In today's landscape, time is a scarce commodity and this is where PD adds value.

So, PD steps in by automating the above process quickly, and also:

1. provides 24/7 support - being always online

2. connects individuals and teams across the organization so that issues can be resolved quicker, findings of an incident can be shared with everyone, best practices can prevail because of this collaboration.

3. collects signals from all points of the organisation - that means, whatever the device, app, program, service that is being used in the organisation, a data point from that will flow into the PD platform where it will be aggregated with all other signals to detect if there is an incidence and better yet,

4. to predict if any incident may occur, and direct resources there before it happens or as soon as it happens - this possible with them using machine learnings, collecting all those signals and having a good analytics to make sense

So just by looking up youtube, we've gotten this much of a background! And there are more videos out there we have not touched yet !

Next, Google. I'll usually google *Company Name* + Wikipedia coz Wikipedia does a good job at summarizing stuff !

PagerDuty - Wikipedia (Click the link for the actual wiki page)

Clicking on the link will bring me to this page:

Ok so we can see PD is in the business of "SaaS incident response platform for IT departments." Great, cool, awesome, nice but wtf does that all mean?

Well, we'll just have to google incident response:

Another google result gave me another one:

Right, so the definition we get from googling it is that an incident an attack or breach of a company's systems which is likely to be its networks and everything inside it; an incident response then is how the company handles said incident.

So, with this preliminary research, we can safely say:

PD is a SaaS company which provides an incident response platform for IT departments. Copy pasting from earlier, PD provides automation for incident response and also:

1. provides 24/7 support - being always online

2. connects individuals and teams across the organization so that issues can be resolved quicker, findings of an incident can be shared with everyone, best practices can prevail because of this collaboration.

3. collects signals from all points of the organisation - that means, whatever the device, app, program, service that is being used in the organisation, a data point from that will flow into the PD platform where it will be aggregated with all other signals to detect if there is an incidence and better yet,

4. to predict if any incident may occur, and direct resources there before it happens or as soon as it happens - this possible with them using machine learnings, collecting all those signals and having a good analytics to make sense

Ok, so we now know what the company does (incident response) and how does it add value (automation, predictive analytics, greater collaboration between teams for better outcomes).

At this stage, I already have some thoughts:

1. As the worldwide trend is moving towards digitalisation, that will mean more parts of a company will be online for more and longer - which means there will be increased number of incidences or events. So, the IT department will be more crucial now ergo PD will shine here.

2. SaaS companies are high growth, and share singular characteristics like high FCF margin, high GPM, increasing revenue growth % - for me, I have been investing in these companies so these metrics are something I am familiar with and know what to look for; it is within my - as Buffett says - circle of competence, and I feel comfortable knowing what to look for and look out for.

3. I did not include a snapshot above, but there are some notable customers in PD's stable (is it right to call your customers as part of your stable? Hmm) like Zoom, priceline, DropBox, Yelp, Evernote, Okta, Shopify and even Xero - some of these you may have heard or even used them and all of them are pretty big names.

Ok, you shouldn't solely just go with name drops but think about it, these are big HUGE companies with elaborate operations spanning the globe and across many industries, and they trust PD with the sanctity of their operations. That's some food for thought there.

Ok, so you now have some background info to go by and some facts you can use too. Alright, I shall continue with the other 4 methods next!