The Mean Fifth Company Valuation
“As an investor, I want to get my investment back in as few years as possible so I look for a low number of Years to Get Investment Back (Y20) – usually no more than 6“
As indicated by the name, Mean Fifth, I am looking for my investment portfolio to attain an average annual growth of 20%. To achieve this, through a mixture of logic and experience it makes sense to value a company from a critical perspective: i.e. not only how much it would cost to buy all the shares in the company, but also including its committed obligations in the form of debts and lease obligations, less cash.
- Value of Company = Market Capitalisation + (Borrowings + Lease Obligations) – Cash
- Years to Get Investment Back (Y20) = Value of Company / Profit Before Tax
As an investor, I want to get my investment back in as few years as possible so I look for a low number of Years to Get Investment Back (Y20). For me, to consider making an investment in a company, I am most comfortable with a Y20 value of no more than 6. In other words, I look for companies at a current price which means I would make all my money back in no more than 6 years (if I ignore that the company’s profits will be subject to tax). I sometimes purchase shares in companies with a higher Y20 than this, but it certainly won’t be much higher.
The subjective aspect for Y20 is my view as to the sustainability of the company’s currently achieved, or forecast, Profit Before Tax.
For this, I review the company’s Turnover to ensure it is not making either too large a share or achieving too small a share in Profit Before Tax. Too large a share (20+%) means there is a fair risk new competitors will look to “steal” some of this company’s high margin profit, thus reducing its annual profits; too small a share (5-%) means there is a risk of one or two poor or “unlucky” management decisions resulting in the company making a loss.
I also review the Dividend because this is the only way the company directly pays me for my investment. I don’t have a strict view on dividends – some of my most successful investments have annually paid high dividends, whilst others have paid low dividends. Essentially, when a company is in a period of growth it may want to invest its own profits to grow its own business in which case low dividends can be fine. If a company is mature in a stable rather than growth market, they will usually pay a reasonable level of dividend (4% or more).
What I look for in a company’s Financial Results
From the Profit and Loss Statement:
- Sales/Revenue/Turnover – how much money the company has received from it’s customers
- Gross Profit – the profit a company has made after the direct costs of purchasing the items accounted for in Point 1
- Profit Before Tax – the profit a company has made after all costs are deducted except for tax payable on this declared profit
- Net Profit – the profit declared in Profit Before Tax minus the Tax which is payable on this declared profit
From the Balance Sheet:
- Borrowings and Lease Commitments – these will be found under the Liabilities section in both Current Liabilities (those due within 12 months) and Non-Current Liabilities (those due after 12 months)
From the Cash Flow Statement:
- Cash and Cash Equivalents – these indicate the cash available to the company on the date of the results
From the Notes to the Company Accounts:
- Weighted Average Number of Ordinary Shares for Diluted Earnings per Share – this is the total number of shares approved for issue (it includes shares not yet issued such as those commonly approved as part of bonuses or long-term incentive plans for executive directors)
- Dividend – this is the amount per share to be paid to all shareholders by the company and is often used as an incentive for investors to remain shareholders of the company
Where to find a company’s Financial Results
Almost all publicly quoted companies have an area on their website for investors and it is on their own website that it is most appropriate to lookup a company’s financial results. Due to the speed of internet search engines, it is quickest to find a company’s results by doing the following:
- Open a search engine
- Execute a search for “<company name> investor relations” and
- Click on a result found on the company’s own website – ideally for one mentioning results as in the following image:
On the page you open, look for a final or interim results announcement and ideally select the PDF version of the results because I have found it is a good file type to work with. For example, as shown in the following image:
Handle With Care
Please remember, as an investor you are a “customer” of an organisation’s investor news and financial results and therefore company press releases and announcements mostly contain commentary which is written to emphasize important points positively from the organisation’s board’s view, as they want to encourage more investors to purchase their shares.
For me, I rarely read the commentary first – as an investor, it is more appropriate to examine the financial results first and then if the financial numbers make me curious, usually as a potential investment, I will move on to consider the board’s commentary.
As mentioned above, I ignore the headlines and look for the Group/Consolidated Income Statement (also called “Consolidated Statement of Comprehensive Income” or similar). This is usually several pages into the financial results – sometimes more than halfway through large organisation’s annual reports.
Often, especially in larger companies, it is constantly being adapted and this is often apparent in the Income Statement. Alongside statutory or reported results, you will sometimes see terms such as Continuing or Adjusted or similar. Logically, Continuing (Operations) makes sense to use as this only focusses on areas of the business which will remain within the company – parts of a company sometimes are being sold or closed down and so it is logical to ignore these parts of the company as they will not be present in the future. Adjusted values are less clear as to whether to use or not – some companies have adjusted results almost every year, and if those adjustments are similar each year, my view is that you should ignore them as they are likely part of how the company runs. For example, some companies list acquisition costs in adjustments as they are “one-offs” but when those companies are making acquisitions every year with similar costs, I am not sure I agree with ignoring them. As I say above, please Handle With Care what a company is reporting and make your own decision based on the information you have to hand – never forget, the company’s board is trying to sell to you as a potential investor and therefore will usually frame news in as positive frame as possible.