10 factors to judge the quality of a business
From an investing point of view, “high quality” is subjective. Subjective to your risk appetite, time horizon and your own biases. But it would be fair to say that, a company that can assure a certain amount of return over a period of time can be considered as high quality. The quality coming from the certainty to which we can look into the future.
That said, there are countless ways in which the future can unravel. Hence, we need to have a margin of safety in our thesis about a company and it’s future.
The analysis can be divided into a qualitative and quantitative parts.
The 5 main qualitative perspective are
- How does the business make money? What is it’s business model? What are the core features of the business that customers are paying continually paying for?
- Does it have a competitive advantage? Will that advantage strengthen or weaken as the business expands?
- Are they innovating with changing times? This shouldn’t be read as, are they jumping on the hype wagon every couple of years to prop up investor sentiment. Rather, is the business having a good balance of exploring new avenues and maintaining it’s core business.
- What are the major risks for the business? Are there any other businesses that can take its place easily?
- How are the people running the business? This is hard to judge without having any kind of contact with the management. Have they been on the news lately? And was it for a good or a bad reason?
The 5 main quantitative aspects to figure out are
- How has the returns been historically? What drove them over the years?
- What are the costs for running the business? Are the costs growing or dropping and why? How will the costs change as the business expands?
- How much debt does the company have? Is it good debt or bad debt? Will it be able to payoff most of it’s debt if an adversity occurs?
- What are the margins in the business? How much pricing power do they have?
- These metrics alone are not that helpful in itself. The key step here is to compare it with that of it’s competitors and against the backdrop of the industry the business is in.