As an investor, whether going for growth or dividends, we like to own companies that are near-monopolistic, or at least having a wide moat, as they are seen to be financially stable and strong given their steady or growing user base of their products and services. However, due to some poor management decisions and foresight, a great company may devolve into good, then bad, and then gone, either being bought over by someone (partially or fully) or doing business in some other fields. There are a few classic examples of these companies; the oft-reported stories would be Kodak and Nokia, where they had lost their dominance in their main products.
While it is easy to point out the causes of past declines due to hindsight, at present we do not know if a company and/or its product and/or service is facing obsolescence. While there are many potentials out there now, sometimes a change in management team, product or service range, or “white knight” investors, may save the situation.
The Bedokian’s View
As mentioned, it is not easy to identify such companies especially when things are still in a flux. The good thing is, except for companies that engage in financial fraud and/or suffering from a huge unmitigated public relations disaster, this decay generally would take several months to years to develop, so observant investors could see the writings on the wall and get the hint that it is time to say farewell.
The first thing an investor must know is not to fall in love with any counter, and not to harbour any hope given the known not-so-good circumstances surrounding the company. Love and hope, though good attributes in a personal sense, are not to be brought into investing, where staying objective and rationale is key.
Next up, we shall look at the numbers, in particular revenue and free cash flow. A profitable company would minimally have a slight growth in revenue and a not-so-volatile free cash flow. There are other metrics such as return on investment (ROI) and return on equity (ROE), but these are sector/industrial specific and cannot be applied in general. Though typically I tend to look at over two to three years, if the situation deteriorates faster than it should be, then I may set up an exit sooner.
As for how to tell whether the company is getting worse in a short time, I would look at what I call trends and fads (mentioned here). Though this method of mine is to look out for the next big (profitable) thing, it could be adapted for use in guesstimating negative outcomes.
The final word here is that, even after a thorough analysis conducted and yet you still feel queasy on a counter (that unexplainable “gut feel”), then prudently it is better to just let it go. Having a good sleep is good for your physical and mental health.
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