6 Essential Clues to Finding Good Stocks

Warren Buffet like franchises which are able to dig deep economic moats around their castles that become increasingly impregnable to competition and market pressures. These moats bring either pricing power or cost reductions which help sustain very high returns on capital, leading to higher cash flows and thus ‘satisfactory’ returns for investors.  
 
Warren Buffet found more often than not that once a bargain always a bargain. Instead of just looking for any company selling for a cheap price he started to look for great companies at fair prices. 

If you can recognize a company with a consistent operating history and good historic business model, you’ll be better placed to ascertain when a stock has simply fallen out of favor, or come upon temporary hard times and therefore profit handsomely when it overcomes the glitch and returns to prior glories.

3 financial clues of a good company

1.  High sustainable Free Cash Flow
• Great company need to make a lot of cash - the lifeblood of any business.
• If company can't make cash from its own operations, it will have to raise cash from owners (dilutes the stake) or creditors (raise the risk of financial distress).
• FCF >= 5% of Revenue can be sure it's a "cash cow"
2. High sutainable ROE
• How much profit a company makes as a proportion of the money (equity) invested in?
• Sustainable ROE > 12% is the engine from which fortunes are made.
• Company can reinvest its profit back into the company at the same rate or return and it can do this indefinitely.
• Company can articially inflate the ROE by just taking a lots of debt. And, it's wby many investor look at another ratio called ROCE and ROIC.
3. High sustainalbe margin
• Great companies are the kings of their domain and as a result, they often have significant pricing power (the ability to set higher prices than their peers).
• The best reflection of this power is in the margin numbers.
• It is very sector specific - food retailing (3% - 4%), pharmaceutical (> 25%); what is constant is great companies have the top ranked margins in their domain.

3 qualitative clues of a good company

Warren Buffet alway make sure he's buying franchises with a sustainable moat. When buying cheaply you don’t want to be caught with a commodity business. Some of the questions to ask whenever you are evaluating a business include:

1. Has it gor impregnable intangible assets?
• It is thing that you can't see - i.e. Brands, Patents and Regulatory approvals.
• It can be unique to companies and deliver fantastic pricing power.
2. Does customer have high switching cots?
• E..g bank can charge nosebleed fees to customers because people just can't be bothered with the hassle of switching banks.
• E.g. integrated software - data procsseing, tax or accounting.
• A unique kind of switching cost comes when companies benefit from network effects in the use of their products which are immensely sticky.
3. Does the company have cost or scale advantages?
• E.g. cheap processes, better location, unique assets or scale benefits (e.g. distribution or manufacturing scale.)

“When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.”  - Warren Buffett

 
References:-

• Six essential clues to finding good stocks  kcchongnz (private)