Failure of a Stock to Perform - some questions to ask

My reason for making this post was prompted by the following article:

The 12 Signs a Cheap Stock is a Value Trap

I thought, why not explore the use of the "12 signs" as avenues of inquiry when assessing potential investments?

In reading the article, you will note that most of the important signs do not address financial metrics directly.  It accords with lessons I have learned in thirty years of investing. 

When considering a potential investment, I look at a few key financials:

• various measures of indebtedness and the financial fitness of an enterprise to survive hard times
• trends in income
• expenditures and returns for various categories of expenditures

I spend more time on "non-financial" metrics. Why?  Because creative accounting can hide a lot.  Financial analysis constitutes the bulk of most analyst reports.  Why?  Because analysts are time pressed.  It's easier, faster, and safer to take the conventional route of going through the mechanical routines of standard financial analysis.  In my view, it is akin to creating a picture by using a "paint by numbers" approach.  There is also an element of "financial alchemy" to this process; namely, "forward earnings estimates".  At best, these estimates are based on hopes and wishes.  At worst, they are the products of shills.  As such, I hardly ever read reports by financial analysts.  And when I do, I always ask the questions: Why is the report being written?  Who stands to benefit?  There is no such thing as "altruism" in the equities management business.  

I am far more interested in investigating other aspects of an enterprise:

• the quality of its management (track record, governance and the make-up of the board, honesty, experience in the field of business)
• strategic plan (is it clear, concise, and purposeful?)
• positioning of the company's products/services relative to its competitors
• customer reaction to products/services
• quality of the workforce and worker assessment of the enterprise as a good place to work

I have written about this at length in earlier postings.  

In the end, businesses are all about people.  Financials are only a second-hand indicator of performance over the longer term.  That is why I maintain my positions with Clean Seed Capital and Questor (see earlier postings).  At one point, the stock price of Questor fell by more than 50 percent.  I ignored the charts because the sustaining power of the businesses rests on a few key attributes:

• seasoned management with a real understanding of the businesss
• sound  financials (no debt)
• agility and ability to adapt to a changing market
• products/services which meet a real need and confer a benefit to customers

The headline article is worth reading several times.  Make sure to read other articles by Nicolas Colas. He is a thoughtful writer.

For example, read his slightly different take on the sustainability of the stock market:

The Real Threats to the Equity Bull Market

It lead me to think about a few investment themes:

• businesses based on domestic markets which are likely to be sustainable in the face of global competition
• the potential of disruptive technologies/business models to yield handsome returns in the future
• "rebound kings" - enterprises which are likely to rebound nicely after the stock market tanks e.g. natural resource-based companies where product substitution is unlikely in the short to intermediate term

I have have reduced my exposure to equities significantly in light of my concerns about the stability of the equities markets.  And yet, I have never been busier with my research.  The "window of opportunity" will open again - entry points when most investors are discouraged and fearful.  The investment cycle will repeat.  It will pay to be prepared.