Monday 6 July 2015

Good Companies vs Good Investments

This is just to clear the air and differentiate between good companies and good investments. In a nutshell, not all companies are good companies, but almost all companies can be good investments.
Good companies do not necessarily make good investment nor are good investments always good companies.
In my view, good companies are stable, deliver good returns on equity, safe margins, low debt to equity ratios, etc. Basically all of the usual things that belong in the financial statements. Good investments are a different story, here is where the rubber meets the road. A good investment returns a good return on the capital that I have put in (or basically for listed shares, the share price) and are able to deliver a good return to the investor be it in the form of dividends or capital gains (increase in price).

Maybe some examples would be better able to show what I mean. I guess we can all basically agree that SGX is a good company. With virtually no debt, a return on equity in excess of 30% and is the only local bourse, a good economic moat. However, if we look at it as an investment, it may not be as favourable. But it is not a good investment as it is currently trading around a P/B ratio of 10 and P/E above 25. It is also not a spectacular growth stock with an almost limitless upside, so the company may not be able to justify the price at which it is currently trading at and hence would not be considered a good investment.

I can't think off the top of my head any bad companies that would currently make a good investment, but there are good companies that would make good investments such as the banks after the current drop in the STI (more info on picking the best bank share and thoughts on recent fall in STI) These are good companies with strong fundamentals that are reasonably prices and are likely to give a good return to its investors. Usually good investments start to pop up when the market is not doing so well and entered a recession or during a correction in the stock prices.

Hope this helps to shed some light on the difference between good companies and good investments. As investors, we would like to buy into good investments, better yet if they are good companies as well as these usually require less tracking than bad companies. While bad companies may be good investments, we have to be more wary of them and diversify our risk to ensure that we do not lose our pants on the occasion that one of the bad companies fail, as no matter how good a price we bought it at, we are sure to lose.

To find out more on how to find good investments through analyzing financial statements, read on Understanding Financial Statements (Part 1) - Income Statement and Intrinsic Value - Dividend Discount Model

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