Wednesday, February 17, 2010

Making Sense Of The Business

Occasionally, companies will appear to have terrific business models, but for some reason the profits just aren't forthcoming. On the other hand, a company's business model may seem downright silly, but it may continue to show profits. Venture capitalists may take interest in the former, while speculators may be interested in the latter. On the other hand, long-term investors should limit themselves to situations where the business model makes sense and the company shows profits.

As an example, consider Money4Gold (MFGD), a company based out of Florida. With the run-up in the price of gold over the last several years, many companies have popped up looking to profit from this trend, from mining companies looking to re-open shutdown mines to new gold and precious metals funds looking for a larger share of the investor's dollar. One company taking an interesting approach to profiting from the high gold price is Money4Gold.

Money4Gold has taken out a substantial marketing campaign to convince individuals to mail-in their unwanted gold in return for cash back based on what was mailed in. No details are given to the mailers as to how the amount of cash they receive will be determined, and so it appears unlikely at first glance that anyone of sound mind would willingly mail away their valuables in this way.

Nevertheless, the company exists and shows a market cap of over $50 million! Is this bewildering business model actually profitable? The financials suggest that it may very well be profitable in the near future. The company's income statement is improving, and in the last quarter the company actually managed to turn a profit in its Canadian operations!

However, a company that shows profits without a business model that makes sense may trade at a valuation that appears attractive, but could turn out to be a value trap. It is for this reason that it is of the utmost importance that investors understand the business, so that there are no negative surprises. While Money4Gold might continue to improve its profitability in the near-term, it seems unlikely that it can continue to do this over the long haul. The company appears to pay its "suppliers" less than 30% of the market value of their gold, which hardly seems sustainable! Long-term investors should beware of such situations and only invest in companies with easy-to-understand, time-tested, profitable business models.

Disclosure: None

This article was written by Saj Karsan of Barel Karsan. If you enjoyed this article, please vote for it by clicking the Buzz Up! button below.

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