After allocating assets, the investor now has to decide how to diversify the share of the stock.
The concentrated investing we're going to cover here refers to investing in a few companies that you understand best. Investors seeking such investments need only find 4 or 5 companies that they understand. This investor is the ideal investor and also the goal of our investment study.
Let's take a closer look at this investor by 4 steps.
1. Understanding the nature of stocks
This investor understands the nature of stocks and invests in companies that have a business that is easy to understand and have a moat to invest in.
This is the nature of stocks he understands.
Behind stocks are companies, and behind financial statements are business structures. How well a company uses its business structure depends on the capabilities of its management. Both business structure and management skills drive corporate performance.
Stock prices fluctuate due to liquidity in the short term and follow the company's performance in the long term. So, rather than paying attention to the short-term price fluctuations of the stock, the investor chooses to focus on the value of the company he is easy to understand. So, he wants to evaluate the business structure of the company and management skills.
2. Understanding business structure
The business structure of a company varies greatly depending on the characteristics of each industry and the type of business it operates. This investor wants to focus on determining the productivity of the company, knowing that the business structure of the company is ultimately aimed at increasing the productivity of the company. This investor considers several conditions before making a decision.
1) Is there an essential demand for business and is it sustainable?
2) Has the company secured a high market share in the industries it operates?
3) Is it a business with high barriers to entry?
4) Does the company have a high return on net tangible capital?
Even taking these conditions into account, this demanding investor looks at the financial statements and reviews them again.
1) Is the financial soundness excellent without excessive debt?
2) Is the annual net profit growth rate steady increasing?
3) Is long-term debt decreasing?
3. Evaluating management skills
Only after finding a company that satisfies everything, this investor leads to a judgment on the management skills. This investor is too lazy to go directly to management. Nevertheless, he can make a sufficiently accurate judgment considering the following conditions.
1) Does the management actively allocate assets for new product development and R&D investment without retaining excessive cash?
2) Does the company realize shareholder value by reinvesting in the business and paying dividends with free cash?
3) Are executives' salaries measured excessively high even though corporate performance has deteriorated?
The Investor judges management's ability, shareholder value, and honesty based on these three conditions.
In more detail, the best thing for companies and shareholders is to reinvest corporate profits into highly productive businesses. Even so, companies must have enough cash and working capital to run their business.
After that, the free cash can be used to cancel treasury stocks and pay dividends. But even at this time, it is not unintentional. Management is required to buy or cancel treasury stock only when the stock price is much lower than the conservatively calculated value of the company's intrinsic value.
When the bear market continues and the stock price falls absurdly, it is dangerous to buy treasury stock just to support the stock price. Rather, it is important that companies maintain sufficient cash and borrowing capacity to withstand financial shocks. After that, it is wise to decide on the dividend payment.
4. Don't pay too much
After all of this, the investor finally wants to determine if the company's stock price is suitable for investing. This investor, even a great company, has no desire to pay more than the value of the company. He can wait a few months as well as 2-3 years for the right price to come. This investor believes that waiting for these prices to come is also an investment period. He seems to have awful patience.
The issues of corporate value and price are handled differently by investor criteria. If the market growth rate of the business in which a company operates is high and the company is expanding its business in the form of a monopoly, it will be possible to pay the price several dozen times more than the combined tangible capital, working capital, and net income of the company. But for conservative investors, such price valuations can be a burden.
Still, what every investor should keep in mind is 'Don't pay too much'. No matter how fast-growing companies are, paying excessively high prices can lead to lower returns in the future compared to buying cheap, mature blue chips.
Summary
In summary, you can select a company by judging the business structure of the company and the management skills, and then collect stocks at a reasonable or low price. A company's business structure changes over time, even for a single company. In line with the changes in the world, companies must advance one step ahead. These investors should always pay attention and study how the world is changing and where people's demands are moving.
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