10 Questions to Ask Listed Companies

By Derek On February 15, 2012 Under Post


In a recent note we talked about why visiting listed companies is a good idea and how to do it. Let’s take the idea one step further and look at what questions to ask a company during the meeting. 

First, you call the company of your choice. It is best if the company is “investable,” meaning it trades enough a day to make this a commercial proposition for clients. There really is little point to visiting a small cap company with no liquidity and telling large institutions like Fidelity to buy it. They can’t. For larger clients the minimum amount of liquidity will be around $10 mn traded a day. Some may go as low as $5mn in daily turnover. Anything less is really more for smaller funds who are only interested in buying a few million dollars worth of stock, or large clients who are small cap specialists. A large fund, to make it worth their while, will want to build a position of $50 mn or so. If they accumulate the stock of a small cap company every day and keep to the normal 1/3 of daily volume, it would take 150 trading days to build a large position. More importantly, they wouldn’t be able to sell, ever.  

Any stock that trades below $1mn a day is a “PA trade.” The letters “PA” in finance do not mean “Pennsylvania,” or “Public Announcement,” but rather, “Personal Account,” or using your own money. So you may have done your homework, had a great company visit and wrote a wonderful note on the back of it but if there is no liquidity it will be about as useful to clients as a two story outhouse. 

Don’t Be Shy 

Remember, when setting up the meeting, call the IR (Investor Relations) department first. If you are visiting by yourself without a client tell them who you are and who you work for. Then tell them you have clients who are interested in the company and they want you to go see them. Don’t be shy, this always works. 

During the Meeting 

Most likely, you will be sitting across the table from somebody in IR who has a full color presentation to give you. Take it and let them walk you through it. A good example of this is the presentation VTech (303 HK) puts out. You can see their latest investor presentation here. (Have a look, it won’t bite). VTech has a current market cap of US$ 2.6 bn and trades about US$4 mn a day. This makes it a fairly liquid small cap story. 

I pick VTech because it is a manufacturer and relatively easy to understand. VTech makes cordless phones and children’s toys. Tech stocks fall into a similar category as manufacturers while internet and insurance companies would be placed at the opposite end of the “easy to understand” spectrum. 

The purpose of your visit is not only to get an understanding of what the company does (you should have a basic idea before you go) but what the likely outlook for them over the next six to twelve months may be. Is it a “Buy” or a “Sell” right now? 

The Drivers

This is where you need to find the drivers for the stock. We start with the basics: Costs and Profits. 

First, look at the recent trends in revenues and profits. VTech is seeing minimal revenue growth overall: 5.4% in 2011 vs. 2010. Most of that growth came fromEurope. Ouch. What’s happening inEuropenow? Right, it’s falling apart. So there is vulnerability here. What about operating profit? It is down 6%. So revenues were up but profit was down – this usually means costs are rising faster than sales. This is not a good thing and tells us we will have to look at costs more closely. 

Costs 

I always look at what the cost components are: is it labor (vulnerable to wage inflation inChina), is it plastics (vulnerable to oil price shocks) or is it rent (vulnerable to fickle landlords)? 

And where do VTech’s costs come from? Raw materials (plastics), wages and RMB appreciation. So they make ALL their stuff inChinaand sell ALL their stuff outside ofChina. What is the first thing you should think about when you see this? Right, currency vulnerability. If the RMB goes up vs. the USD and the Euro, that will eat into profit margins and might eliminate them entirely. What do they do about this? 

And what about that growing wage bill? The days of arming ten million Chinese with teaspoons to build the Great Wall are over. Exactly what percentage of costs are wages now? What were they a year ago? What will they do to mitigate the increase? Usually, companies have two choices: move the factory to a cheaper location (not always feasible due to component supply issues) or automate. Automating a factory means buying more equipment which means higher capex and less profit this year. 

Revenues 

Next let’s look at the revenue breakdown. Half of it is cordless phones. Is it growing? No, this is a mature product in a mature market (theUSandEurope). While it may be their biggest seller, is it the profit driver? If cordless phones are half of revenues and they are less than half of profit, then this is a lower margin business compared to the company’s other products and given it is a mature market this cannot easily be an area of future growth. Management should look to maintain this business and use the cash flow to invest in higher growth areas. This brings me to the next question: how dominant are they in the cordless phone market? Let’s look at market share. They have 50% market share in theUSand 30% inEurope. That’s pretty dominant. It is not in the presentation; I asked. 

Let’s look at their other divisions: ELP, educational learning products and CMS, contract manufacturing services. This is sort of a weird combination and investors usually shy away from a hodge-podge assortment of businesses under one roof. In VTech’s case they are putting more investment into ELP, maintaining the cordless phones and putting less effort into the CMS division. If the educational learning products are an area of focus then focus your questions here. The company doesn’t provide a breakdown of profit contribution among the three divisions, so you ask. 

Which reminds me of another common error made by junior analysts and sales people: don’t get overly excited about a new product or new market. Focus on the drivers of a company’s earnings, not the hope. Always keeping this in mind will prevent you from claiming how great a new product, division, strategy or market of a company is when it only contributes 8% of profit. Who cares? 

Are there any catalysts for the stock? Are they talking about making an acquisition that you think could happen sooner rather than later? Are the next generation of the founding family a bunch of whoremongerers and crack heads and about to take over? 

Risks? 

Now that you have a deeper understanding of the company, its drivers and their view of the outlook, what are the risks to that view? What could go wrong for them? They won’t usually come out and tell you and may only hint at it in the meeting. In your opinion, are they doing what they should to manage those risks? 

Also, see if there are any other things that could influence an investment decision here. VTech has $243 mn in cash sitting on its balance sheet. Will that be paid out as dividends? Historically, the company has been a high dividend payer and currently the implied dividend yield is 7.4%. That is high and they have the cash and track record to back it up. 

It may a great story but don’t forget about valuations. If the company is already trading at 30 times PER on consensus estimates then the story is well known and perhaps over bought. But maybe the market is wrong and the stock should trade even higher – or lower. You need to decide. 

What Does Your “Gut” Say?


Finally, what is your individual impression and opinion of the company? Clients are always interested in a fresh view. If you think the company is blowing smoke up your ass and something isn’t right – tell clients that. After visiting a company you should go back to the office and call clients to tell them whom you saw and what your conclusions are. Finally, put it together in a coherent and straightforward note. If your opinions are really negative couch those phrases carefully. A good rule to remember is: speak more than you write. 

To sum up, here are the 10 questions you can work with when visiting an investable listed company like VTech: 

  • 1)      Drivers?
  • 2)      Is profit up or down?
  • 3)      Where does profit come from?
  • 4)      Are costs up or down?
  • 5)      What are the cost components?
  • 6)      Catalysts?
  • 7)      Risks?
  • 8)      Anything else important here?
  • 9)      Valuations?
  • 10)    Your opinion? 

Now get out there and go see some companies. Let me know if you have any questions.

Cheers.

Derek Hillen, CAIA

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