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Navigating the Numbers: A Deep Dive into Financial Valuation

  • Writer: Edoardo Porciani
    Edoardo Porciani
  • Dec 20, 2023
  • 3 min read

Welcome back, fellow investors! In our ongoing exploration of value investing, we've reached the second step of our five-part series. After filtering through the global stock market to identify potential investment opportunities, it's time to roll up our sleeves and delve into the heart of financial valuation. This step is where the rubber meets the road, and we get to the core of what makes a company truly valuable.


Step Two: The Financial Deep Dive

In this phase, our focus shifts to a detailed analysis of the company's financial performance over the last decade. This historical perspective is crucial in understanding not just where a company has been, but where it's potentially headed.


Key Financial Metrics

The metrics I scrutinize are carefully chosen to shed light on the company's profitability, cash flow, and financial health. These include:

  1. Industrial Margin: This tells us the company's operational efficiency and pricing power.

  2. Earnings Incidence on Revenues: It's essential to see how much of the revenue is actually translating into profits.

  3. Earnings Per Share (EPS) and Dividend Per Share Growth: These metrics indicate the company's profitability and its ability to reward shareholders.

  4. Free Cash Flow to the Firm (FCFO) Over Earnings: A higher ratio here suggests efficient cash generation.

  5. FCFO Over Free Cash Flow to Investment (FCFI): This ratio helps in understanding how well the company is managing its investments.

  6. FCFO on Debt: It's crucial to know how the company's cash flow can support debt.

  7. Cash on Debt: This ratio provides insight into the company's liquidity and ability to meet short-term obligations.

  8. Debt Growth Over Time: A look at how the company's debt has evolved gives us a sense of its financial stability.

The Threefold Objective

The analysis aims to ensure three key aspects:

  1. Strong Marginality and Earning Power: We want to invest in companies that not only make money but do so efficiently.

  2. Robust Cash Generation: It's not just about profits on paper; we need to see real cash flowing in, enough to cover long-term investments.

  3. Solid Financial Structure: The company should be well-prepared for tough times, with prudent debt management.

My Rule of Thumb

As a personal guideline, I look for opportunities where the sum of a conservative estimate of future earnings growth plus the average dividend yield over the last three years equals or exceeds 11%. This threshold helps in identifying stocks that offer a balanced blend of growth and income potential.


Beyond Industry Focus

While industry analysis is important, it's crucial to remember that there's often more variance within the same industry than across different industries. Our goal is to invest in a specific company, not a market or sector. Therefore, after conducting a thorough analysis of our target company, we should compare it with its peers. This comparison adds depth to our valuation but should not overshadow the importance of the company's individual performance.


A Word of Caution

As we conclude this second step, I reiterate that I am not a professional investor. My blog is a platform for sharing my personal experiences and insights into value investing, born out of a deep passion for this field. This article is not an investment recommendation but a reflection of my approach and philosophy. It's a hobby, shared with no economic interest or business ties.

Investing involves risks, and it's essential to conduct your own research and consult with a financial advisor before making any investment decisions.

Thank you for joining me in this second step of our value investing journey. Stay tuned for the next article, where we'll continue to unravel the complexities of stock valuation.

 
 
 

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