The Best Questions To Ask When Investing: Part 5
Over the past 10 years, I have probably read about a hundred books or so on investing. However, I have found it hard to retain much of the content in most of the books.
That’s because after I had gone through 10 books on investing, I realised that most investing books seem to be repeating the same concepts and ideas.
However, there is one book that is embedded in my mind like how a sticky chewing gum gets stuck to the sole of a shoe. This book is one of the first I ever read and the best investment I’ve made so far. It is Common Stocks and Uncommon Profits by Philip A. Fisher.
One of the most valuable insights I got from the book are the 15 questions that Fisher himself asked when analyzing a company. Till this day, I continue to ask the same questions about every investment I’m making. So far, the 15 questions have been very profitable for me. That is why I want to share the questions, along with my thoughts on them, in a series.
Now let’s explore the next two questions.
Question 10: How good are the company’s cost analysis and accounting controls?
A great company would be able to price its products and services at the perfect price point that would maximize both its profits and the value received by its customers. Knowing what those price points are require strong cost analysis and accounting controls by the company.
After all, if a company is unable to breakdown how much it costs to manufacture a product or deliver a service, and where those costs are coming from, how can it effectively pinpoint the right prices?
Unfortunately, this question is not easily answerable by individual investors. But, here are some ways to dig out the information you would need to make an intelligent guess:
1. Compare certain financial ratios of the company – such as its return on equity, gross margins, and operating margins – against its peers.
2. Compare the revenue per employee figures for the company and its competitors.
Question: 11 Are there other aspects of the business, somewhat peculiar to the industry involved, which will give the investor important clues as to how outstanding the company may be in relation to its competition?
In a similar vein to Question 10, this is a question that can’t be easily answered by the investor. This is because it requires a deep understanding of the company and the industries it operates in. Without the knowledge, the investor may not know what to look for within the company that makes it unique to others. Here are some possible way to investigate for answers to Question 11:
1. If possible, speak to customers, suppliers, competitors, and employees of the company on how they view the company and its positioning in the market.
2. To find out if the company is a leader at innovation, check whether competitors are copying them.
3. Does the company have higher margins than its peers? A company with a stronger competitive advantage tends to enjoy fatter margins than its competitors.
Fisher’s 15 questions are essentially a checklist for us to think about when analysing a company.
The first six questions focus on a company’s future potential and how well a company can generate profits for its shareholders. The seventh question reminds us of the important idea that a company will only thrive if great people are working in it. Meanwhile, the eighth and ninth questions touch on the importance of the need to learn how to assess a company’s management.
The two questions featured above help us find out if a company has a unique competitive advantage. Often, companies with strong competitive advantages can earn outsized profits in relation to their peers, or in relation to the value chain of the industries that they are in.