Numbers Worth Noticing*

Percent of Sales:
When a company seems of interest because of a particular product/service, the first thing you want to know is what that product/service means in the overall picture of the company in question. What percent of sales does it represent? If the product/service offering is terrific and everyone is buying it, but it represents only a small precentage of the company's sales and earnings, then the company in question should left out as a potential candidate for investment.

The Cash Position:
You have to find out how much cash the company is sitting on (if any). What is the per share figure of the company's bank account? For example, if the company has $10/share of cash and is selling for $15/share with a p/e of 3, it could be a bargain.

More on The Debt Factor:
You have to also find out how much the company owes versus what it owns. The debt-to-equity ratio is commonly used here.

Pay extra attention to the debt factor among turnarounds and troubled companies. More than anything else, it's debt that determins which companies will survive and wich will go bankrupt in a crisis. Young companies with heavy debts are always at risk. There are two major types of debt which can prove to good or bad for a company.

The first is bank debt. This type of debt is usually frowned upon and looked at as being the worst kind of debt a company could have. This is because if the company is having "headaches" the bank can jump in and demand its money back on short notice. This type of aggressive move by banks usually cause many companies to end up in chapter 11.

The second type of debt (the good debt, from a shareholder's point of view) is funded debt. This is labled "good debt" because it is the type of liability that can never be called in no matter how bleak the situation, as long as the borrower continues to pay interest. The principal may not be due fore 15 or 30 years. Funded debt usually takes the form of regular corporate bonds with long maturities. Corporate bonds may be upgraded or downgraded by the rating agencies depending on the financial health of the company, but whatever happens, the bondholders cannot demand immediate repayment of principal the way a bank can. Sometimes even the interest payments can be deferred. Funded debt gives companies time to wiggle out of trouble. The breakdown of the various types of debt the company has can usually be found in the footnotes or notes of its annual report.

Dividends:
An arguement in favour of dividend-paying stocks is that the presence of the dividend can keep the stock price from falling as far as it would if there were no dividend.

However, if a company retains all dividends (assuming it makes profitable use of them) then that would be a bigger plus as it would grow the business' book value faster. Smaller and newer companies are usually the types that do not offer dividends.

If a company cannot find any profitable methods of imploying its retained earnings, then it should either pay a dividend or buy back as much stock as possbile; thus, increasing the value to the shareholders that don't sell.

Hidden Assets:
Look for these! These are the types of assets that are stated at a fraction of their true (intrinsic) worth in a company's books. This may include land - which usually appreciates in value - that is worth more today than what is was recorded on the balance sheet at the time of purchase under the "cost basis" principle stated in the GAAP. Or the company may possess some very powerful intangibles (as brand names) which are usually stated at enormous discounts to true value on the balance sheet. Perhaps the company owens several precious metals which are worth in excess of what their costs were in the past. Drug patents, for example, can also be classified as a company's "hidden gems" - think of Fhyizer's hugely successful "viagra".

The best thing about hidden assets is that they are required to be depreciated on an annual basis as required by GAAP. This can result in a bargain situation, because these are the types of assets you would be getting for free! This could include a fully depreciated piece of valuable land or any of the other elements metioned above.

(Accounting) Goodwill:
Goodwill is the amount paid for an asset over and beyond its orginal cost. This is listed under the asset column in the balance sheet, and must be written off over a period of 40 years under new GAAP regulations. For example, if a tv station sells for $450 million (at fair market price), but is actually worth $2.5 million on paper, the extra $447.5 million paid for the staion has to be classified as "goodwill" and carried on the (new) books as an asset, and eventually it, too, will be written off. This in turn creates a potentaial asset play (#6 above).

Subsidiaries:
There can also be hidden assets in the subsidiary businesses owned wholly or in part by a large parent company. For example, La Senza has large interest in Wet Seal which is carried on La Senza's books at cost, not on the basis of present or future worth.

Partial Interests:
Sometimes the best way to invest in a company is to buy into a separate owner of it. For example, a company may sell for $8/share, and might have a 25% interest in another profitable company worth an additional $12/share to the business. You'd be getting this hidden asset for minus $4.

Tax Breaks:
Tax breaks turn out to be a wonderful hidden asset in turnaround companies. The tax-loss carryforward allows a company emerging from bankruptcy the ability of not having to pay taxes on profits generated by acquisitions.

Cash Flow:
Cash flow is the amount of money a company takes in as a result of doing business. All companies take in cash, but some have to spend more than others to get it. In cases where you have to spend more cash to make cash, you aren't going to get very far. The hint here is to look for companies that don't have to spend a bundle to make a bundle.

This is easier said than done, but try to find a business that needs very little in the way of capital expendituers - expenses incurred in updating tangible asset basis as plant and equipment. Since the assets of a business are what help it generate revenue and earnings, the less a business has to spend in the way of their maintainence and repair the more it will get to keep in the form of earnings. An example of such a business is Hershey Foods.

A measure which can help determine how much a company is "wasting" as a result of capital expenditures is the "asset-turnover ratio". The smaller the number the lesser the company is having to replace its asset base. If the asset-turnover ratio is 20, that would mean that the company is having to replace (turnover) its tangible asset base 20 times a year - VERY EXPENSIVE!

Inventories:
Look for high-turnover here. If inventories are building up it might mean that no one wants to buy it. This fact would be kept concealed from the average investor, as inventory is listed as an asset under the balance sheet. Therefore, all may look well until the stock plumets in price. The sophisticated investor knows that a buildup of inventory is not neccessarily a good sign unless, of course, the company is headed for rapid expansion and needs to fill up empty shelves in the new centres it plans to open.

The inventory-turnover figure is very helpful here. If this amount to 100+ (as it is with Dell Corp.) then that means the business is having to replenish its warehouse 100 times in the course of a fiscal year - meaning it is selling a lot of its product.

Manufacturing businesses with high-turnover inventory are, however, at a small risk when it comes to delievery of parts or inventory. This as true for Wal-Mart and Dell as it is for Mc Donalds, and General Motars. If delivery of parts doesn't arrive on time, or if the power goes out and the manufacturing equipment stops working as a result then customer's orders wont get filled, and the company will begin to lag behind on them. In the meanwhile, the inventory already present may start to rot. Examples of this include the 9/11 attacks that called for a sieze of all air flights which caused a temporary blow to FedEx's opperations. And when the power grid stoped working.

The bottom line is that if a business has high-inventory-turnover and is relying on heavily on prompt delivery of parts, then it is preferrable that the business be "vertically integrated" in nature (as is Wal-Mart and Dell) as this would allow it to streamline all of its own operations - from delievery to manufacturing. The other side of this could be that if a company heavily relies on quick delivery from a major supplier, and that supplier goes bankrupt, then the business in question will be affected very negatively. Therefore, if the business is not one which is vertically integrated then it should also not be one that solely relies on a single supplier and/or customer.

Pension Plans and Unions:
These tend to be "unnessary expenses" and "dangers" in the opinion of the sophisticated investor. Each of these tends to "eat up" the earnings of a business. Be weary of a business if it has any part of either of these.

If a company does have a pension plan find out whether it is a "defined benefit plan" or a "defined contribution plan" - otherwise known as "DB" and "DC" pension plans. The latter is preferred over the primer.

As for stock options, they are required to be "expensed" by a business under new GAAP in Canada (the US may soon follow).

Growth Rate:
On Wall Street, "growth" and "expansion" are believed to be synonymous, but this is a popular misconception. For example, the cigarette consumption in the U.S. is going down, but its increasing outside the U.S. and this tends to be a major plus for Philip Morris (Altria Group).

One more thing about growth rate: all else being equal, a 20-percent grower selling at 20 times earnings (a p/e of 20) is a much better buy than a 10-percent grower selling at 10 times earnings (a p/e of 10).

*Peter Lynch, "One Up On Wall Street"