Security Analysis and Business Valuation on Wall Street,: A ... - lib

Company-Specific <strong>Analysis</strong> 117customer, product, <strong>and</strong> market diversification. In addition, because optimal financingis achieved through size, smaller companies suffer from cost h<strong>and</strong>icaps vis-à-vis theirlarger competitors.Many small to medium-size public companies are family-controlled. Since familysuccession is frequently a higher priority than professional management at theseconcerns, family control is a negative for outside shareholders. Furthermore, keepingthe business in the family stifles a firm’s growth potential, as the equity financingneeded to finance new projects is frequently rejected due to the family’s worries overownership dilution.The analyst makes judgments about management’s integrity. Self-dealing, lavishperks, <strong>and</strong> huge salaries are not evidence of a management whose interests arealigned with those of the shareholders. Prior legal problems of executives are atip-off to investors in the integrity area.Board of DirectorsOccasionally, the board of directors is reviewed in the management section. For mostpublic companies, the board is not worth mentioning because the average directorhas so little input into the business. The primary qualification of a director is beingone of the CEO’s golfing buddies, <strong>and</strong> the chief responsibility is rubber-stamping theCEO’s initiatives <strong>and</strong> pay packages. The new SEC rules on director independenceintend to reverse this situation, but progress is slow.Board evaluation plays a meaningful role in investment selection in two situations:a speculative stock <strong>and</strong> a distressed company. In the first instance, a prominentdirector lends a patina of respectability to the stock, giving the analyst another reasonto lend his own confidence. In the distressed company, the directors hopefullyplay a true watchdog role. In some instances, they fire the CEO <strong>and</strong> bring in a replacement.Experienced <strong>and</strong> independent directors are an obvious asset to a troubledbusiness.SUMMARYThe proper evaluation of a corporate investment requires a thorough assessment ofthe business fundamentals, <strong>and</strong> security analysis provides a methodical, step-by-stepframework promoting this objective. For each principal aspect of the company’soperations, the practitioner gathers data, furnishes a description, <strong>and</strong> forms a judgmentabout the firm’s sustained competitive advantage (SCA). The basis for industrysuccess determines which factors are emphasized for a particular business.For any given company, one or more factors can hold special significance, evenif that factor is not common to the industry. For example, a strong market sharein a specific geographic hub is a huge asset in the airline industry. In other sectors,such as paper <strong>and</strong> pulp, below-average production costs at one or two facilitiescan spell the difference between superior profitability <strong>and</strong> mediocre results. Relianceon one product line, like Croc’s dependence on its signature shoe line, is fine whenproduct dem<strong>and</strong> is hot, but the business needs replacement products for the inevitablecooling-off period. Similarly, a focus on one customer is a corporate vulnerabilitysince relationships can change through no fault of the management.