Main principle behind investing
How do we make value investing relatively easy? When I say easy, I do not want to take away the effort that needs to be put in to get the conviction level to invest in an opportunity. How many times has one wondered whether to invest in a property in suburbs and whether that suburb will get a development focus from the city’s council for the property to grow in value over the years? One still has to go out and figure out few variables like – whether the city does need to grow more, will there be more demand for houses, what other areas can come up, how long would it take for the value to grow etc. But once you have done the homework of finding out answers to these questions, you go in and wait it out till the investment plays out as expected.
Similarly, for investing in stocks, there are few things that need to be checked, but main principle is this:
IT’S ALL ABOUT THE CASH GENERATION CAPABILITY OF THE UNDERLYING BUSINESS
When we own a stock, we own a business. When we own a business, we want to understand whether it can, year after year, generate cash which is greater than the return we get when the cash just sits in the bank or is earning coupons from government bonds.
For example, let’s say we are interested in opening up a franchise (say Subway). We will have to understand the number of people who may come to eat (source of revenues); and how many people we employ + cost of the ingredients + the fee paid for franchise + rent (sources of costs).
If we estimate that our profit as a percentage of investment will be greater, year after year, than the potential interest earned on cash sitting in the bank, we probably will invest in the franchise.
Chapter 1: Financial Statements
Chapter 2: Income Statement – basics
Chapter 3: Revenues, Cost of Goods Sold and Gross Margins
Chapter 4: Operating expenses (SG&A; R&D; Depreciation)
Chapter 5: Operating Profit/Operating Margin
Chapter 7: Other items (Income Statement)
Chapter 8: Income before tax, Tax expense and Net Profit
Chapter 9: Balance Sheet basics
Chapter 11: Non-current assets
Chapter 12: Current liabilities
Chapter 14: Long term debt and other liabilities
Chapter 15: Shareholders’ equity
Chapter 18: Cash flow statement (1)
Chapter 19: Cash flow statement (2)
Chapter 20: Valuation concept (P/E ratio)