Looking Beyond the Numbers

When analyzing a listed company for investment purposes, its financial statements are obviously a key variable to work through. If you have to ask ‘why’, then I kindly refer to this series of short webinars I did a few years back:

While the two links and their content are far from comprehensive and aspects of them are interpretive and subjective, those that work through them will hopefully conclude–as I have–that company financials are integral in analyzing a listed company for investment purposes (and valuing it).

But are the financials comprehensive?

The short answer is: no.

The long answer and pointers to get around this problem are what follows here.

Why do the ‘numbers’ have their limitations?

Firstly and most relevantly in the South African-context, the numbers could be incorrect or falsified. The reality is that auditors (and even management) have their limitations.

One of the ways to partially mitigate (you can never entirely eliminate) this risk is by seeking third-party or independent verification.

As a fund manager, I spend time meeting management, asking questions, and, importantly, doing so of third-parties. Likewise, I do site visits and even speak to suppliers and customers. With regards to consumer-facing businesses (e.g. retailers, banks & shopping malls), I literally keep my eyes open to see if consumers are using the said services or products and/or in the shops at the tills.

What you are looking for is non-financial data and/or third-party facts that agree with the company-produced financial reports/numbers and lend credibility to their accuracy. Management can distort their financials (because they ultimately control them), but they cannot distort real-world data not produced or handled by them.

Likewise, this approach can sometimes see trends in real-time and, thus, offers a unique leading-edge in perhaps identifying when a company is doing better (or worse) than the market realizes.

This leads me to my second point: financial statement, results and company data is almost always backward looking.

Companies report their financial results after they have happened but investors are only interested in the future results, hence there is a disconnect. While a company’s financial statements create the context of the future (i.e. from what position and point of profitability with what cash flow to utilize) the historical financials are no guaranty of the future results.

Hence, doing your own “primary” research can also offer a key, real-world insight into what you think the future may look like for a certain company.

How do you do ‘primary research’?

I’ve already touched on a number of soft ways that one can do research beyond a company’s financial results, but let me delve into a deeper (but far from comprehensive) range here.

As a general rule, though, the research of any company will benefit from meeting/communicating with management for insights, doing site visits and speaking with customers and suppliers. Even consider Google Trends, checking out HelloPeter and the company’s various social media accounts for followers, likes, customer comments etc.

Getting more specific, though, will require some customization. Your starting point will always be what is the company? Different companies will require or lend themselves to different sources for primary research gathering.

For example, retailers lend themselves to comparison with the retail statistics released by Stats SA (here). Are they doing better or worse than the rest of the market and, if so, why? It is also worth just wandering around the retailers’ shops, seeing how full they are, how many customers are at the tills, what are they buying and do you find yourself buying from them? How do their prices compare on various items against their competitors? How accessible are their shops and so on…

In this way, in my opinion, it appears that Shoprite (SHP) is still trading well while Pick ‘n Pay (PIK) is seeing trading-down from Woolworths (WHL) as high-LSM’s feel pressure but do not want to stoop to shopping at Checkers and OK… Likewise, Spar (SPP) always seems full to me, at least in my little area. I’d be careful of the discretionary retailers, like Truworths (TRU).

When walking around the retailers, keep your eyes open for what’s going on in the rest of the shopping center. This is relevant for building a view on the retail property stocks. How full are they? Are they in good repair or falling apart? Are their store vacancies and, if so, how long have they been vacant? Which shopping centers do you find yourself going to and why?

Once again, anecdotally, I currently see the mid-tier malls are starting to feel immense pressure. I see lots of vacancies popping up in these expensive dinosaurs and few are being filled quickly. The convenience centers (often with Spars in them) appear to be fine while the super-regionals (except Mall of Africa, which seems quite empty!) are holding their own. While many of the retail REITs are reporting softer numbers, I think the numbers are lagging reality and see some nasty impairments, write-downs and even one or three collapsing/forced-bailouts in this sector (see my old notes here for more details: Part 1 and Part 2, which I still think are relevant as generalizations).

Banks and credit-based businesses can likewise be compared with the National Credit Regulator’s own credit market data released (link). Once again, asking the same questions as for retailers. Most of these credit-businesses have a store presence, so while at shopping centers, pop your head in and see if there are customers actually making use of them?

For example, while Capitec (CPI)’s latest loan book growth and provisioning look like a bit of an outlier against the market, if you walk past a Capitec branch (of which there are more and more of them too!), you will notice how busy they often are and how many people of queueing to use their ATMs. This stands in stark contrast to a number of the other banks (most notably, ABSA) where there are almost never queues and some of them are filled with staff (i.e. costs) and few-to-no customers (i.e. revenues).

I can continue with telcos (ask your Uber driver what telco he is using and why?), airlines (which one do you fly? Where are the queues at the airport?), service companies (which ones does your own office use? Keep your eyes open at place for badges on security guards, cleaning staff, and other outsourced services) and so on, but I think you are starting to see the approach to gathering ‘primary data’ and comparing it against company results.

(When you are sick, see who makes the medicine that your doctor prescribes you or which hospital you are referred to? When eating out, consider who owns it and how full the restaurant or fast-food place is? When eating in, who made the ingredients that you are consuming and where did you buy them? And so on…)

Finally, directors of a listed company have a fiduciary duty to reply to investors and potential investors. Do not feel intimidated in dropping them an email with a series of direct questions about their company, industry or competitors. Even if they do not answer you directly, their investor relations should supply some input. You can often get at least a basic IR-email address off their websites.

In the absence of any reply, well, consider that a red flag that goes well beyond the numbers as they obviously do not care for minority shareholders or potential investors.

It is all just shifting the odds in your favour

Investing is always inherently risky. You cannot get away from this but you can try to mitigate it.

In fact, good investing is merely shifting the odds more and more in your favor. Don’t forget, we are all paying the same share price on the stock market but that does not mean that we all have the same perception of the risk or realization of the value/upside.

Knowing that there is a much higher probability that a company is doing well and should keep doing better may make a share that appears fairly-valued or expensive, actually cheap. Likewise, this can shift a stock from what appears to be risky to one that is relatively safe.

People give bargains away all day long on the stock markets because they do not believe that they are bargains at all. If you have done the work–both with the numbers and with the primary research to back them up–then your conviction becomes your greatest single asset here.

That is gold. No. Actually, that is far more valuable than gold.

That is looking beyond the numbers and shifting the odds in your favor.

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