Tuesday, December 14, 2021

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 

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