Suppose you came to know about a new home decor mart in the town, and everyone is going crazy because of the heavy discounts it has to offer. Also, the shopping mart has a wide range of collections and unique products compared to its peers in the town. Like the majority, you would be amused to have something unique and offbeat as a décor item for your wardrobe.
Aren’t heavy discounts and a wide range of unique collections enough for the mart to survive in the town? No… not enough, as in the frenzy of discounts, people often ignore the less talked about aspects of a business like:
- How was the behaviour of the staff?
- Was the staff prompt in attending to the customer’s queries?
- What was their expertise about the products?
- Was the billing procedure easy?
- How was the overall experience? Etc.
Without answering all these questions, we can’t say anything about the future of the business. Likewise, people usually overlook some important points while finding an outstanding stock, which will be discussed here in the next section.
Point 1: Does the company have outstanding labour & personnel relations?
Most investors do not take into consideration the profits generated from good labour relations. The impact of bad labour relations can be enormous, as frequent strikes may lead to halted production activities until the demands of labour are met. The direct cost of strikes can be a financial drain for a company with bad labour relations. With good labour relations, a foundation is laid where efficient leadership can improve productivity per worker.
On the other hand, a company having no union is by no means a sign of good labour relations. This company with no strikes is like a henpecked husband. Absence of conflicts may not mean a basically happy relationship as much as fear of the consequences of conflict.
A company with good labour relations can be judged on the basis of labour turnover in one company compared to another in the same area. Another figure to assess is the labour retention ratio. The lower it is, the better the company’s labour relations.
Point 2: How efficient are the company’s cost analysis & accounting controls?
Companies that efficiently cut costs reap higher profit margins as compared to their peers and eventually benefit their shareholders in return. A company which can’t control its selling, general, and administrative expenses ends up in a loop of debt trap. They take debt to run their companies since they are left with no penny to reinvest in their venture. Neither can they spend on research activities to develop their existing product line, which slowly narrows their market and leads to bankruptcy.
Investors should always ponder over the SGA costs; some of them are mentioned below:
- Cost of financing a new project.
- Expenses on employees’ benefits and welfare.
- Cost of sales & marketing.
- Legal fees.
- Transportation & shipping cost.
- Cost of fuel & power consumed.
- Insurance costs of inventories & real estates.
- And many more…
Remember, the SGA costs indicate the companies’ ability in cutting costs and handling the accounting controls efficiently. The lower the costs, the higher the profit margin.
Point 3: Are there any other aspects of business that give the company an edge over its peers?
There are few, but not many, aspects which define the exceptionality of a business. Insurance cost & patents, both of them, show the depth of management’s attitude, ability, confidence & execution towards desired targets. Discussing them one by one will lead to a better understanding.
Insurance costs in many lines of business add up under total expenses, thus affecting the company’s profit margin. A company having 40% lower overall insurance cost will reap a broader profit margin in relation to a company with higher overall insurance cost. Lower insurance cost doesn’t only imply efficient cost cutting but also the degree of management’s ability, understanding & involvement in handling the company’s affairs.
Patents are another hidden haven for enormous wealth creation. A strong patent position is usually a point of additional but not basic strength. It lets a company reap broader profit margins for several years. Large companies do not generally disrupt the market competition with a strong patent position; rather, they sell it for small license fees to their competitors and expect the same from their licensees.
But if any large company relies heavily on its patent, a point of concern arises because once the patent is exploited to its full potential, the company’s profit margin starts to narrow. It shows the company’s weak R&D to bring new products or develop existing products in line.
Studying these two not much talked about aspects of business can help investors make an informed decision.
Point 4: Whether the company needs equity financing in the future, which can cancel existing shareholders’ benefits from this anticipated growth?
Additional shareholders reduce the per-share earnings the existing shareholders were enjoying earlier.
Consider two companies, namely, company A & company B. Company A is debt free, has foreseeable sales growth, broader profit margins, a good R&D arm, an above average sales organisation, and a confident management of unquestionable integrity. Whereas company B fails in some or many other aspects that company A passes. Both will need equity financing in years ahead. Among the two of them, which will be an outstanding investment?
Obviously, Company A, because investors are always more interested in these sorts of ventures since company A has a management which takes strong financial decisions; therefore, equity financing poses no threat to existing shareholders’ benefits. At the same time, company B has poor financials and a management which makes weak financial decisions, leading to repetitive equity financing, which slowly eats up existing shareholders’ benefits in future years ahead
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