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5 Things Investors Shouldn’t Forget

When examining the financials and health of a company before investing, the sheer amount of information and stones to kick over can make even Atlas shrug. It is difficult to know where to start. Most investors have no trouble with looking at earnings, growth rates, revenue, and the ever popular P/E ratio, but they tend to overlook other important indicators
The following factors are often neglected, even ignored, by investors. Paying attention to these things when looking at a company can make the difference between success and losses.
Management
These highfaluting people can make all the difference in a company. Think of them as members of a sports team. But don’t forget, you need a whole team in order to play but it is the superstars that can push and pull the team to consistent victory. How do the Lakers play without Shack or Kobe Bryant? They suck. The rest of the Lakers are important, but undoubtedly Shack and Kobe are huge contributing factors to winning. The same works with the management at a company.
Good management doesn't do everything, but it certainly is an essential part of the company’s success. Sam Walton (of Wal-mart) and Jack Welch (of General Electric) typify management who led their firms through all manner of times, good and bad, to amazing gains. I’m not advocating that you should buy a stock based purely on management, but absolutely consider the significant value in proven, long-standing leadership when you invest.
Cash Flow
This is often technically calculated as net income plus depreciation and other non-cash items. I think of it as the constant flow of money into and out of a company: the outflow of cash is the money paid every month to salaries, suppliers, and creditors and the inflow is the money received from customers, lenders, and investors. It is crucial to companies, because through cash they pay their bills.
Don’t expect companies in different industries to have similar cash flows. Each industry works according to its own cycle. However, if a company within a particular industry is not generating the same amount of cash as competitors, then you should begin to worry—especially if it is lower. A company that can’t generate sufficient cash to pay bills will be in real trouble even if it’s profitable.
To judge the amount of cash flow, examine the cash-to-debt ratio, and look to see if a company is generating more cash than debt. If the debt is higher, the company will have to tap into other areas—usually a bad sign. If the flow is healthy, the company will be able to service their loan and interest payments. Think of it this way, you make payments to your credit cards; what starts to happen if you put off paying the balance. It grows, and grows, and grows until you begin to have nightmares. Should a company begin down this road, detour away from it.
Inventory
Inventory is exactly what it sounds like, the finished products available for sale. The term also covers the components and parts needed to make the final product. When a company has high inventory, they have to pay to store it, and a growing inventory can suggest that a company is producing more than it can sell. Low inventory is also a problem. It does not matter if a company is producing the hottest new product if they cannot make enough. It is a fine balance, but generally inventory should increase at a rate similar to that of sales.
Inventory is best thought of as a long term indicator, so don’t worry if a few months before Christmas a company begins to have higher inventory. Worry if in February, the company still has several million unsold gizmos left.
AR: Accounts Receivable
Accounts Receivable represents sales or services for which the company has yet to be paid for and is still outstanding. It is related to inventory in that it is concerned with the moving of product. Here, the numbers are driven by sales. The more sales, the more AR grows, and the growth between the two should be at a similar rate. You should become concerned if a gap begins to open between the two, especially if the AR is growing faster than the sales. At that point, the company is not receiving payment for its sales, leaving itself short to cover the costs associated with producing those sales.
Furthermore, AR allows us to see if a company is “stuffing the channels,” which is when a company sends excess goods to retailers and records those shipments as sales on the books. Eventually the excess goods will be sent back, but in the interim it will appear as if sales are increasing. This distorts the books and an investor’s ability to see a true picture of performance; and will in the long run implode the stock.
The Big Picture
When you can’t see the forest for the trees you might miss something important. This is often referred to as fundamental or qualitative analysis. What you should do here is look at the company as a whole. Examine the overall company and its future and just look for big trends. For example if you start seeing mention of a company in odd, unrelated places, in newspapers, in magazines, it might be on to something. Another example is the power of a brand name and its ability to push the market. Don’t discount the financial value in a name.
The hard cold reality of real life cannot be argued with and you should not forget to use this perspective when applying your investment strategies. It is just as important as sales and earnings.
These five areas are by no means definitive indicators of stock performance. Rather they provide a deeper, more thoughtful analysis of performance and outlook. Being able to see beyond what others are looking at is what gives you an edge over the pack. Everyone looks at earnings because they are important, but they are not the only indicator. By having an edge, you can slice through all the bull to a real and accurate look of a company. Look deep and do solid research and you’ll be far ahead of everyone else.