Know What You Own

Know What You Own

In lieu of the recent sell-off, the DIY investor at home often panics and sells off a lot of his holdings impulsively as the fear in the marketplace gets the better of him. To help protect an investor from himself it’s usually wise to understand the companies he owns and why he bought them in the first place. That in fact might be a better way to achieve a margin of safety than to just blindly diversify his holdings into a lot of companies he doesn’t understand.

The first step in building a margin of safety is to research the company.

There is a plethora of literature available for anyone who is interested in learning how to analyze a company…Read the financial statements. Since the passing of the Safe Harbor Act in 1995, U.S. companies have been incented to provide timely and accurate financial statements in their 10-K, 10-Q, and proxy statements. The 10-K and 10-Q (annual and quarterly reports) each provide three financial statements: income statement, cash flow statement, and balance sheet. There is plenty of information available in these three statements to allow an investor to thoroughly understand how the company operates. The proxy statement discusses management compensation. A brief examination of the proxy statement will offer great insights into how top management compensates itself.

For investors who are seeking a deeper understanding of the company, there are many more questions to pose. Has the company increased its earnings, revenue, and cash flow consistently over the long term? Is it in an industry that has long-term growth potential? Is the management team stable and experienced? Has management laid out its goals and milestones? Has it delivered on those milestones? Has it been successful in expanding its services or its product line? Has the company treated its shareholders fairly?

Recent changes in the disclosure laws plus the ubiquitous Internet have given individual investors the ability to easily access and read transcripts of quarterly management conference calls and corporate presentations to institutional shareholders. These transcripts often give investors valuable clues into the mindset of top management. There is no excuse today for any investor, large or small, to be insufficiently informed on any public company.

Benjamin Graham and the Power of Growth Stocks,

Frederick K. Martin