Part 1: How to define a good business?

Recently after my strategic management class, with some readings in investing in a company, a few thoughts came to my mind. How to define a good company to invest?

Maybe I start off with a systematic breakdown of analyzing the company. Let's start with financial analysis on some of the key factors:

1. Revenue increase (at least of 6-7% increase every year)
Why do I consider this? With the increase in revenue, either the company is increasing its selling price of its products/services or consumers are buying more of this products/services.

2. Control of expenses (this is determined by profit after expenses, tax etc)
Even though companies can tell you their revenue increased by 100% compared to its previous year, if its expenses is 99%, it simply does not mean anything at all. Companies typically like to highlight its revenue but not its net profit (profit after all expenses, tax, interest and amortization)

3. Inventory turnover
This is a very subjective item, as some companies may have low turnover but high profit margin, while some companies need high turnover to gain average profit margin. Take Hour Glass as an example of low turnover/high profit margin while Cold Storage is high turnover/average profit margin. You need to know the nature of the company to determine this.

4. Return on Equity (ROE, Return on average common equity, return on net worth) This measures the rate of return on the ownership interest (shareholders' equity) of the common stock owners. It measures a firm's efficiency at generating profits from every dollar of shareholders' equity (also known as net assets or assets minus liabilities). - Simple explanation from wiki directly. On a average scale over 10 years, the company should post consistant ROE that is above average returns (which is more than 12%).

5. Earnings per share
EPS are the earnings returned on the initial investment amount. For EPS, it should be reflecting an increase in every year to show consistency in its earnings. When there is a fall in EPS for a certain year, it is important to see what exactly happen. It could be an industry wide occurance or it could be due to some bad news within the company.

That's pretty much all for financials although there's many more indicators to take note of. I will go into the fundamentals of a company in my next post.