The qualitative characteristics of a company usually go under the radar with analysts focusing on more tangible and easily available financial matrices. While the latter are clearly very important, assessing the long-term fundamentals of companies requires a further understanding of the business model, its key characteristics, risks and other dynamics which can have a bearing on the success or otherwise of an investment.
The first key pillar in evaluating a company qualitatively is management performance. The meaning of such can be described as the actual performance of the management as opposed to their initial expectations. The majority of Maltese listed companies issue a Financial Analysis Summary (FAS), which is a summary of key financial data and forecasts that seeks to provide assistance to investors. It is also important to analyse the management’s reputation in terms of forecasts and expectations and how reliable the management are when projecting or assuming certain results.
An analysis and comparison between the actual and forecasted financial data gives an indication on whether the management is being overconfident in their forecasted valuation. Typically overconfident managers are not actively looking to maximise the market value of the firm’s equity, since they believe they are doing so already. Furthermore, overconfident managers are more likely to take on riskier projects. If management miss their forecasts year-on-year, it is an indication of overconfidence.
On the other hand, management who always underestimate their forecasts might lead to an indication of a cautious approach by the management. A cautious management approach is not necessarily a positive sign since management might refrain from taking on projects which yield a positive Net Present Value, which is the difference between the present value of cash inflows and outflows over a particular period.
One cannot rate the qualitative characteristics of a company without analysing corporate governance. Corporate governance can be interpreted in various ways, however a concise definition is the way and procedures used to direct and control a company. Many Maltese listed companies are family-owned, with most of them being directed and/or managed by family members. Hence, an important issue when analysing corporate governance is the selection process of board members.
A thorough analysis of the appointed board members, both independent and non-independent, is required. The main focus would be determining the relationship of the appointed board members with other board members, as well as their knowledge in the business. If the board mainly consists of family and closely-related members this might suggest a potential conflict of interest between creating wealth for shareholders and the members’ own interest. The role of independent non-executive directors is crucial in this scenario. This is why a thorough analysis on the members in this role is needed.
Although management is a key driver in evaluating a company, the sustainability of the business model is equally important. Albeit to different extents, all companies are affected by external factors, such as GDP growth, demand for property and inbound tourism rates. Case in point, if GDP growth rates are expected to decline then we also expect cyclical companies’ revenues to take a hit. One key area to look into here is to determine how the company’s business model fairs in different economic cycles.
A feasible approach would be to look at the revenue streams over a time period with different economic cycles, the success rate of projects and products developed over the years, as well as the adaptation of the company to sociological demands. Diversification is another key factor in determining the sustainability of the companies’ business model. If a company is focused solely on one area of business it is more susceptible to a specific risk.
On the other hand, if the company branches out in different areas of business, it is minimising the idiosyncratic risks that were typically associated with the company. Having said that, one has to be careful in identifying what type of business the company is entering into. Two important questions that one should bear in mind are whether the company has enough expertise to enter into the area of business and secondly, whether the company is financially capable of branching out into the new area of business.
The latter leads us in analysing a new qualitative aspect: the ability of financing resources. In view of the low interest environment surrounding us, we have seen a significant increase in bond issues. Hence, it is essential to analyse the company from a credit perspective. One key area to look at is whether the company is able to repay back its debt. If the company is already highly geared and incurs even more debt, then a thorough analysis of the company’s future revenues, as well as a qualitative assessment on whether the company will sustain the debt incurred is needed.
A strong and sustainable business model encompassed with a strong and clear management plan and performance is an indication of a positive qualitative assessment towards the company.
Stephen Sammut is an investment specialist at BOV Asset Management Limited.
The writer and the company have obtained the information contained in this document from sources they believe to be reliable but they have not independently verified the information contained herein and therefore its accuracy cannot be guaranteed. The writer and the company make no guarantees, representations or warranties and accept no responsibility or liability as to the accuracy or completeness of the information contained in this document.