Thursday, July 2, 2009

Which High Do You Prefer?

Do you prefer a company with high profitability, high revenue, high income, high dividends, high market share, high cash flow, etc. Aren’t all these highs depicting a good picture about any given company’s state of business? We can find an answer to this in the concept of value investing i.e. wide moat and under pricing. These are the two key ingredients for value investing. Here, the concept of wide moat and under pricing is in the context of its business environment or competition. It is a relative term. Similarly, when we think about any given company’s financial metric, we need to look at it in relative terms. High profitability or high income, or high EPS growth rate as a standalone does not provide a true picture.

We can get a true picture by looking for consistency. Two simple statistical measures of average and standard deviation can help us measure consistency. A standard deviation that is narrow and lower than average is a good observation. The table below shows some examples of randomly selected financial metric for few companies.

  • SYY is showing consistent performance with narrower standard deviations that are lower than averages.
  • WMI has erratic revenue and EPS growth with variations more than averages. Indicating negative performances in past.
  • QCOM has wide moat in its market domain and has consistency but its dividend growth is erratic.
  • INTC is another example of wide moat in its market domain, with no competitor worth a mention. But its growth in dividends, revenue, and EPS is erratic.
For a given financial metric, when we compare the company’s current performance with historical averages (and standard deviation) is provides some insights into which direction the company is heading into. For example, decreasing operating margins and increasing payout factors are signs of trouble; highly varying metric with many ups and downs is also likely sign of trouble, etc.

I don’t like to get high. Companies that continue to strike balance in their year over year performances are the ones that provide long term sustainable returns.

This article was written by Dividend Tree. If you enjoyed this article, please vote for it by clicking the Buzz Up! button below.

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