In this article, you will learn:
What makes a company valuable?
We learned about the different types of stocks that investors look for in Lesson 2: Strategies for Stock Investing, but now we need to start looking at trying to value specific companies. There are a number of factors investors look for when looking for stocks to invest in:
knThis is the factor that people are most familiar with -- what does the company actually sell? This could be a simple range of products, like computers and computer accessories for Dell Inc. (DELL), or a huge range of different products, such as for General Electric (GE), which sells everything from aircraft jet engines to financial products. The product could be a service rather than a good, such as the banking services provided by Bank of America (BAC).
Once you know what a company sells, it is important to understand what kind of people buy that product and what sort of things affect the revenue generated from that product. For example, if Dell Inc. sells most of its computers to businesses rather than consumers, you need to consider what kind of spending decisions companies are going to make. If McDonalds (MCD) provides a nation wide chain of fast food products, you need consider the future eating habits of people in the population. These kinds of intuitive judgements are hard to make, but crucial in determining the long term value in a company.
You need to also consider what makes that product profitable for the business. One thing investors often look for is the scalability of a product - for example, Microsoft (MSFT) develops one version of the Windows operating system once every several years, and then sells millions of copies of the same product for the minimal cost of packaging and pressing a CD. These sorts of product features are the difference between a good company and the next multibillion-dollar company.
While great products generate good profits, there will always inevitably be competitors who pop up and create similar or better products. The true difference between an average company and a hugely successful company is having a competitive advantage, which refers to anything that prevents competitors from simply copying your product and undercutting your prices.
This competitive advantage may simply be economies-of-scale, where companies can produce goods for much lower cost than their competitors due to their size. An example is a company like Intel Corp. (INTC). It takes a production level of thousands of computer chips a day before this business can be profitable. Any small competitor cannot match Intel on price, and so any new competitor would have to invest billions of dollars to scale very quickly and must gain market traction very quickly to be profitable, which leaves Intel as the industry leader.
Another competitive advantage is the power of branding. Nike Inc. (NKE) can consistently charge much higher prices than its competitors because people recognize the Nike brand name and are therefore willing to pay premiums on apparel that they would otherwise not be willing to pay. This leaves Nike as one of the most profitable apparel companies in the industry.