Top 3 Things Investors Look for in a Company

One of the best things about value investing is the evergreen nature of its principles.

A great company is great and worth investing in because of several core elements that, when met, give the investor peace of mind, knowing that his/her funds are well-deployed.

These principles are evergreen plainly because they withstand the test of time -- no matter when, no matter what the “flavour of the month,” no matter which hot new instrument people are talking about. If you apply value investing principles diligently, you can’t help but grow your money and have a healthy, sizeable investment portfolio.

Now, these principles aren’t just for pointing out what’s good about a company. It’s great for flagging out potential pitfalls and traps, which can lead to a severe dent in your investment portfolio if you aren’t careful.

Here are the top three things investors look for in a company before deciding to invest:

1. Investors should look at the company's CFO

How long has the current CFO been around? Did the company’s CFO quit recently? Why?

Does there seem to be a pattern of CFOs quitting the company?

If so, that’s not usually a good sign.

For example, a survey from last year found that 80 CFOs from S&P 500 or Fortune 500 companies have left their positions since August 2020. While this might have been a direct impact of the pandemic, we can’t dismiss the fact that pre-pandemic times, the CFO turnover rate was equally concerning.

In 2016, the US retail industry saw a CFO turnover rate of 17.4% compared to 15.4% for all industries. The year after, about one-fifth of new CFOs were appointed compared to 15% for all industries.

The CFO, more so than others in the company, literally has first-hand information about how the finances of the company are panning out.

They see where revenues are generated, where the outflows are, what the ROI is, and what the plans for funds consist of.

If the CFO quits, why? Was there something amiss in the company beyond the superficial “difference in opinion”? Is the company headed for disaster, or doing something behind the scenes that deserve some scrutiny?

Now, staff leaving is part and parcel of every company’s legacy. But if CFOs are coming and going, especially frequently, that’s a red flag right there.

This is why the CFO turnover is one of the top three things investors look at in a company before investing.

So do your scuttlebutt, dig deep, attend the AGMs, and start asking questions.

It could turn out you’ve been worrying for nothing, or it could have saved you a lot of heartaches.

2. Investors should look at profits and cash flow

Oh, who wouldn’t love a profitable company? Profitable means the company is making money, right?

Well, that is a common misconception.

Dive straight into their cash flow statement and read between the lines.

A profitable business with insufficient cash flow can put the company at risk of bankruptcy.

What? Bankruptcy for a profitable business? Yes, it’s a common oversight.

Take Toys R Us for example, an initially profitable business. However, in 2016, the staggering debt became an issue. Every year, $450 million cash outflow was needed to service its interest payments. It became a huge source of burden. As a result, the company did not have the necessary resources to remain competitive.

The landscape was changing with e-commerce. The shift was rapid and Toys R Us simply could not keep up. Faced with lower sales but huge interest payments, Toy R Us was forced into bankruptcy.

If your cash isn’t coming in in time to pay off your suppliers, meet payroll and other operating expenses, your creditors may force you into bankruptcy at a period when sales are growing rapidly.

So don’t jump for joy just because sales are up. See where the money is flowing.

3. Investors should look at gains (or losses)

Gains and losses must be part of an investor's checklist of things to look at before investing in a company.

Non-recurring gains and losses are, well, by their very nature, not supposed to occur frequently.

These happen because they do not relate to normal business operations.

What types of one-off events is the company posting? How frequently do they engage in such transactions?

If it seems habitual, then the company may be regularly finding ways to write off or write down transactions to make the business look a certain way, or the management doesn’t really know what it’s doing.

It’s your responsibility as an investor

Yes, the law provides a set of guidelines companies are supposed to operate within. And we, as investors, have no control whether they do so with integrity or not.

Having said that, look at the above three things that investors look for in a company. It is your responsibility to do research before deciding to invest in a company. Stay within your circle of competence, educate yourself, avoid shiny objects, and stay the course.

Value investing has proven to be a sustainable, profitable investment strategy that has withstood the test of time. The rewards are yours to reap if you learn, apply, and remain diligent.

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