FOOL'S EYE VIEW
How Much Is That Business Worth?

By David Kuo (TMFDragon)
March 7, 2002

Carburton Street, London -- Call me an old-fashioned investor. But I still like to think that buying shares in a company is like owning a piece of that business. For that reason, I don't treat share-buying lightly and I want to know as much about the business as possible. Of course, the advantage of buying just a share of a business instead of the whole caboodle means that I don't need to get too involved in the day-to-day running of that business. And as a shareholder, I can simply pack up and sell out if I'm not happy with the way that the business is going.

There are some very simple rules that have stood the test of time which help to determine whether a business represents a good buy. And here are a few that I find useful:

Is The Line Of Business Solid?

This is the first question you should ask and unfortunately, you won't find the answer in a share price graph. You will need to roll up your sleeves and dig around for some background on the industry. Thankfully, the Internet is a wonderful source of information. But don't get too bogged down with the details at this stage. What you want is an overall feel for the industry and whether it offers any prospects.

Is The Business A Sound Proposition?

After you have decided that the industry is sound, you can then move on to investigating the company itself. From the first part of your study, you should have identified some of the players within the sector. Send off for the annual reports for these companies. You can get hold of most annual reports by contacting the company direct or you could use our free annual reports service. Try and pay particular attention to the managers' reports. Learn about their strategy for coping with a competitive environment. Remember, you are still building up a picture of the industry and there is no such thing as too much information. Learn as much about the sector as possible because you are, after all, going to be a part owner in that business. 

The Ranking Game

Ranking will not make you go blind, but it can be a very good way of testing your knowledge of an industry. After you have identified the various players within the industry, try and rank them in order of size. Use your own judgment from what you have garnered thus far to decide which ones you think are more valuable and which should be worth less. But don't be too concerned about getting it absolutely right at this stage. When you have compiled your list, check the actual market capitalisations for each company. You will find market capitalisation numbers in the financial press. Compare your list with what the market believes each of those companies is worth. Incidentally, you have taken your first important step in looking for undervalued businesses.

The Track Record

The numbers that are included in the company's annual report should be your next focus of attention. Our quick guide on "How to read an Annual Report in 5 minutes" will show you how to extract the important bits of financial information that you need. When you have finished, you should have a list of simple ratios for the company. These are the vital signs that will point to either the health or ailments of that company. Compare those numbers with the others in the industry.

Be very critical; and remember, these are historical numbers. The numbers tell you what the company has done in the past; they don't tell you what is going to happen in the future. For that, you will need to put together some growth projections and consider how that growth could be achieved. Go back to the company reports and take a look again at how the managers plan to grow the business. Decide if their strategy stacks up. Would you do things differently if you were in charge?

Taking The Plunge

This is the moment of truth. If you keep in mind that you are buying an interest in a business, you won't go too far wrong. Before you plunge in, you should be convinced that the line of business is solid. You should also be confident that your chosen company has the right management and products to make a significant contribution to the industry. It matters little that it is not the biggest in the sector in terms of market capitalisation. But revisit your calculations to make sure that you are not overpaying for your part of the company, and its future.