Company A vs. Company B
Before finishing the restaurants, let’s look a little deeper into the methodology of comparative analysis. This is only an outline. We will primarily learn this skill using live examples. Each of these issues could be an entire chapter in a book, but we will start with very brief descriptions:
Can I understand this company? This is the constant battle of the generalist. It is ok to say - “I don’t know”. In the comparison of A and B, it is often the case that A wins because B is too difficult to understand. The concept of “understandability” was discussed in Ben Graham’s Classic 1962 Security Analysis, and has seldom been mentioned since.
We must agree of our time horizon before beginning our analysis. We will use 2-5 years. For 90%+ of the investment world the most commonly used time horizon is 6 months or less.
One of the most complex issues is how to integrate concerns about “future economic conditions” into your stock selections. This is an very important subject that we will discuss constantly. Most textbooks ignore this subject, but we will not.
Every good stock selection is based on some type of valuation analysis. The majority of the time a simple PE comparisons is enough, but sometimes alternative valuation methods are needed. Knowing when to use additional measures is a critical skill.
In general our approach will focus on companies with average future growth prospects selling at below average valuations. We are almost never looking for the best or fastest growing companies, we are looking for decent companies that are misperceived by Wall Street.
In our effort to reduce risk, we are usually looking for above average balance sheets, but there can be exceptions here if valuations are extremely depressed.
In general, we will focus on companies with below average expectations. The fewer buy recommendations, the better we like the stock. Properly defining low expectations can be a tricky business.
To reduce risk we prefer to select stocks that have underperformed the market averages for the last 1,3, 5, or 10 years. We will almost never select a stock with “momentum”. Stocks that done well recently are frequently “toss outs” in our analysis.
Our approach will focus on reducing the downside risk of our selections. We will attempt to use Graham’s “margin of safety” concept in our analysis. We are attempting to limit risk, not eliminate it.
We prefer companies with above average management teams, but we can settle for average if our other criteria are met.
We are not overly concerned with “catalysts”. We are happy to select a stock with an average dividend yield, but it is NEVER our primary concern.
In a perfect world we would find a simple to understand company selling for a PE of 12 or less with the ability to grow earnings 10% annually for the next 5 years. This growth could be achieved with the general economy growing at 1-2% in real terms. The stock would have more hold/sell recommendations than buy recommendations, and in market that has been up about 100% over the last 5 years, our ideal stock would only have returned 50%.
The problem is there are no perfect stocks.
*****The effort to compare Stock A with Stock B is a CREATIVE PROCESS. There is no one answer. In the real world, balancing the 10 issues discussed above is incredibly difficult, but not impossible.
The only way to learn, is to get started.
Do you like Evergy or Dominion? Why?
Do you like Ruth Hospitality or Bloomin Brands? Why?
Rinse, repeat.