How to find the winning formula

In recent months, for reasons I will explain in a future Diary, I have been examining companies with a view to investing large amounts of money, usually hundreds of thousands of pounds. Needless to say these big bucks are not all mine and the fact that other folk place faith in my ability to sort wheat from chaff certainly focuses the mind. (Before the Financial Services Authority comes knocking at my door I hasten to point out that I am not a qualified adviser and therefore the final investment decision on this research is not made solely by me, neither do I receive any commission or similar remuneration for my efforts.)

In recent months, for reasons I will explain in a future Diary, I have been examining companies with a view to investing large amounts of money, usually hundreds of thousands of pounds. Needless to say these big bucks are not all mine and the fact that other folk place faith in my ability to sort wheat from chaff certainly focuses the mind. (Before the Financial Services Authority comes knocking at my door I hasten to point out that I am not a qualified adviser and therefore the final investment decision on this research is not made solely by me, neither do I receive any commission or similar remuneration for my efforts.)

Each company under my microscope presents its own set of circumstances, which makes it difficult to come up with a standard list of questions. But here is my guide to deciding whether or not to invest in a company.

The company

Hopefully there is a company history going back several years because this means we can base decisions on facts rather than hopes. In a perfect world it will be an established leader in its sector with a good profit record. One of the truest sayings is: "Yesterday's winners are tomorrow's winners. Yesterday's losers are tomorrow's losers."

In the comfort of my own home I get the financial facts down to a level I can understand by drawing little graphs of turnover, profits and earnings-per-share. If they show a steady increase I go to bed and sleep soundly. If there are blips I sit up half the night trying to find out why.

Bigger companies often have a variety of income streams so I want to know that each source is properly profitable and if not, why not?

If it is a start-up business it must have a good business plan and I will examine this in great detail and with a deal of scepticism. Because columns of figures are not my forte, I arrange for an experienced accountant to do a detailed analysis and if appropriate I will retain the services of an independent expert in the relevant area of business to produce his or her realistic assessment of the new company's hopes.

The product's USP

When I was a copywriter with an advertising agency and we secured a new client we always started our creative head-banging sessions by trying to identify the new product's unique selling point or USP. What made it different? Was it cheaper, more sophisticated, smaller, bigger, or more powerful? As a potential investor I am comforted if a business has an outstanding USP.

The market

It must be big, no point in having a product or service which is wonderful but for which there is limited demand. And is the market saturated or is there some way to go? If the market is expanding how is the company going to secure more than its fair share, and if its potential is fully realised how is the company going to steal business from its competitors?

Customers

The number of customers matters. A wide customer base usually means greater management and sales effort but the risk is reduced. A company is exposed if it relies on a single-figure list of customers. I learned the lesson many years ago when I investigated a West Midlands engineering company that deliberately chose small suppliers, filled their production capacity by giving them big orders, then squeezed them dry by dictating price and paying late. I talk to the customers to gauge their satisfaction.

Suppliers

When a company has a product it invariably buys in materials. I talk to the company's suppliers because this is an effective way to assess how the company does business.

Competitors

This is one of the best ways to establish the standing and potential of a business. First, I draw up a list of competitive companies. Then, based on information I glean from talking with customers, end users, suppliers and independent sources such as analysts and journalists, I create a league table based on turnover, profitability and market perception. If the company under the spotlight is the league leader how is it going to retain the position? If it is not ahead of the field I want to know why other businesses are better and how we can topple them.

Management

Experience. That's the essential ingredient in any management team and, make no mistake, teamwork is what it is all about. Certainly the man or woman at the top must be seen to be the leader but a chief executive is only as good as those who work below him or her. CEOs tend to fall into two categories, those who are professional businesspeople, guiding the company through a business jungle of wheels and deals, and those who are there because they know the company and its products. A combination of both is ideal but a rarity so I prefer the latter. I like a leader who knows the product, its customers and its competitors and has been around for a reasonable length of time. In other words he has a feel for the environment in which the company operates.

Of equal importance is the finance director, particularly if the chief executive is a product rather than a figures person. The money man or woman need not necessarily have been with the company long but his or her track record must stand careful scrutiny. We are considering giving our money to this outfit and we must be sure it will be nurtured efficiently.

I check the salaries, the shareholdings and the warrants because I want to know the senior personnel are well paid and that their carrots, in the form of bonuses, options and/or warrants, are attractive enough to make them want to stay. I cannot over-emphasise the importance of a settled and reliable management. It can make or break a company.

I take a look too at the non-executive directors. Why are they on the board? If they are able to contribute opinion and expertise, fine. If they are there simply because they will say "yes" and not make waves I get suspicious.

Achilles heel

There has to be a snag, there always is. I don't kid myself, saints are not appointed CEOs, so they cannot be blamed for sticking to the good news. On the other hand it is my job to get the full picture so I have to discover the warts and all. Looking under all the stones takes time but it is imperative. Here are just a few of the things to look out for: a shortage of skilled workers, high borrowings, an outstanding court case, unsecured patents, currency exposure, a poor order book, vulnerability to an unwanted takeover.

There are, of course, many other yardsticks by which to measure a company's worth. Dividends, liquidity, City opinion, interest being paid, gearing, they all play a part in painting the finished picture. It is an interesting and sometimes frustrating exercise but I enjoy doing the detective work because I know that if, in the end, we take a stake in the company it will be money well spent.