Due Diligence In 10 Easy Steps

 Courtesy : Investopedia

You sit down at your computer with a fresh cocktail napkin or sticky note that has a single ticker scribbled across it - it's a ticker you've never researched before, but something (or someone) has piqued your interest. This article will discuss 10 steps you should take on your first tour through a new stock. This due diligence allows you to gain essential information and vet out a possible new investment.

The steps are organized so that each new piece of information will build upon what has been previously learned. In the end, following these steps will give you a balanced view of the pros and cons of your investment idea, and allow you to make a rational, logical decision.

Step 1 - The Capitalization of the Company 

 
It really helps to form a mental picture or diagram of a newly researched company and the first step is to determine just how big the company is. The market capitalization says a lot about how volatile the stock is likely to be, how broad the ownership might be and the potential size of the company's end markets. For example, large cap and mega cap companies tend to have more stable revenue streams and less volatility. Mid cap and small cap companies, meanwhile, may only serve single areas of the market, and may have more fluctuations in their stock price and earnings. No judgments should be made at this step; we are just accumulating information that will set the stage for everything to come. When you start to examine revenue and profit figures, the market cap will give you some perspective.

Step 2 - Revenue, Profit and Margin Trends

 
When beginning to look at the numbers, it may be best to start with the revenue, profit and margin (RPM) trends.Look up the revenue and net income trends for the past two years at a general finance . These should have links to quarterly (for the past 12 months) and annual reports (past three years). A quick calculator check could be done to confirm the price-to-sales (P/S) ratio and the price-to-earnings (P/E) ratio. Look at the recent trends in both sets of figures, noting whether growth is choppy or consistent, or if there any major swings (such as more than 50% in one year) in either direction.

Margins should also be reviewed to see if they are generally rising, falling, or remaining the same. This information will come into play more during the next step. 

Step 3 - Competitors and Industries

 
Now that you have a feel for how big the company is and how much money it earns, it's time to size up the industries it operates in and who it competes with. Compare the margins of two or three competitors. Every company is partially defined by who it competes with. Looking at the major competitors in each line of business (if there is more than one) may help you nail down just how big the end markets for products are.Information about competitors can be found in company profiles on most major research sites, usually along with their ticker or direct comparisons that let you review a list with certain metrics filled in for both the company you're researching and its competitors. If you're still uncertain of how the company's business model works, you should look to fill in any gaps here before moving further along. Sometimes just reading about some of the competitors may help to understand what your target company actually does. 

Step 4 - Valuation Multiples

 
Now it's time to get to the nitty-gritty of P/Es, price/earnings to growth (PEGs) ratio, and the like - for both the company and its competitors. Note any large discrepancies between competitors for further review. It's not uncommon to become more interested in a competitor during this step, which is perfectly fine, but still look to follow through with the original due diligence while noting the other company for further review down the road.

P/E ratios can form the initial basis for looking at valuations. While earnings can and will have some volatility (even at the most stable companies), valuations based on trailing earnings or on current estimates are a yardstick that allows instant comparison to broad market multiples or direct competitors. Basic "growth stock" versus "value stock" distinctions can be made here along with a general sense of how much expectation is built into the company. It's generally a good idea to examine a few years' worth of net earnings figures to make sure most recent earnings figure (and the one used to calculate the P/E) is normalized, and not being thrown off by a large one-time adjustment or charge.

Not to be used in isolation, the P/E should be looked at in conjunction with the price-to-book (P/B) ratio, the enterprise multiple and the price-to-sales (or revenue) ratio. These multiples highlight the valuation of the company as it relates to its debt, annual revenues, and the balance sheet. Because ranges in these values differ from industry to industry, reviewing the same figures for some competitors or peers is a key step. Finally, the PEG ratio brings into account the expectations for future earnings growth, and how it compares to the current earnings multiple. Stocks with PEG ratios close to 1 are considered fairly valued under normal market conditions.

Step 5 - Management and Share Ownership

 
Is the company still run by its founders? Or has management and the board shuffled in a lot of new faces? The age of the company is a big factor here, as younger companies tend to have more of the founding members still around. Look at consolidated bios of top managers to see what kind of broad experiences they have; this information may be found on the company's website or on exchange filings.

Also look to see if founders and managers hold a high proportion of shares, and what amount of the float is held by institutions. Institutional ownership percentages indicate how much analyst coverage the company is getting as well as factors influencing trade volumes. Consider high personal ownership by top managers as a plus, and low ownership a potential red flag. Shareholders tend to be best served when the people running the company have a stake in the performance of the stock. 

Step 6 - Balance Sheet Exam

 
Many articles could easily be devoted to just the balance sheet, but for our initial due diligence purposes a cursory exam will do. Look up a consolidated balance sheet to see the overall level of assets and liabilities, paying special attention to cash levels (the ability to pay short-term liabilities) and the amount of long-term debt held by the company. A lot of debt is not necessarily a bad thing, and depends more on the business model than anything else. Some companies (and industries as a whole) are very capital intensive, while others require little more than the basics of employees, equipment and a novel idea to get up and running. Look at the debt-to-equity ratio to see how much positive equity the company has going for it; you can then compare this with the competitors to put the metric into better perspective. 

If the "top line" balance sheet figures of total assets, total liabilities and stockholders' equity change substantially from one year to the next, try to determine why. Reading the footnotes that accompany the financial statements and the management's discussion in the quarterly/annual report can shed some light on the situation. The company could be preparing for a new product launch, accumulating retained earnings or simply whittling away at precious capital resources. What you see should start to have some deeper perspective after having reviewed the recent profit trends. 

Step 7 - Stock Price History

 
At this point you'll want to nail down just how long all classes of shares have been trading, and both short-term and long-term price movement. Has the stock price been choppy and volatile, or smooth and steady? This outlines what kind of profit experience the average owner of the stock has seen, which can influence future stock movement. Stocks that are continuously volatile tend to have short-term shareholders, which can add extra risk factors to certain investors.

Step 8 - Stock Options and Dilution Possibilities

 
Next, investors will need to dig into the exchange  filings  to see all outstanding stock options as well as the conversion expectations given a range of future stock prices. Use this to help understand how the share count could change under different price scenarios. While employee stock options are potentially a powerful motivator, watch out for shady practices like re-issuing of "underwater" options or any formal investigations that have been made into illegal practices like options backdating. 

Step 9 - Expectations

 
This is a sort of a "catch all", and requires some extra digging. Investors should find out what the consensus revenue and profit estimates are for the next two to three years, long-term trends affecting the industry and company specific details about partnerships, joint ventures, intellectual property, and new products/services. News about a product or service on the horizon may be what initially turned you on to the stock, and now is the time to examine it more fully with the help of everything you've accumulated thus far.

Step 10 - Risks

 
Setting this vital piece aside for the end makes sure that we're always emphasizing the risks inherent with investing. Make sure to understand both industry-wide risks and company-specific ones. Are there outstanding legal or regulatory matters, or just a spotty history with management? Is the company eco-friendly? And, what kind of long-term risks could result from it embracing/not embracing green initiatives? Investors should keep a healthy devil's advocate going at all times, picturing worst-case scenarios and their potential outcomes on the stock. 

Conclusion

 
Once you've completed these steps you should be able to wrap your mind around what the company has done so far, and how it might fit into a broad portfolio or investment strategy. Inevitably you'll have specifics that you will want to research further, but following these guidelines should save you from missing something that could be vital to your decision. Veteran investors will throw many more investment ideas (and cocktail napkins) into the trash bin than they will keep for further review, so never be afraid to start over with a fresh idea and a new company. There are literally tens of thousands of companies out there to choose from!

SKM EGG PRODUCTS - RESULT UPDATE

Company reported a turnover of Rs.49.37 Cr ( Rs.65.37 Cr in last year same period.) and a net loss of Rs.56 Lac ( Profit of Rs.7.86 Cr ) in March quarter . For the year ended FY 2015-16 , top-line is Rs.300.45 Cr and a net profit of Rs.24.86 Cr . Compared with last March Quarter , other income decreased from Rs.9.64 Cr to Rs.43 Lac. Normally ,major part of  other income of company includes Export subsidy from government , exchange rate fluctuation (gain/loss),sale of by-product ..etc

Result Link HERE

The Essentials Of Corporate Cash Flow

 Courtesy : Investopedia

If a company reports earnings of $1 billion, does this mean it has this amount of cash in the bank? Not necessarily. Financial statements are based on accrual accounting, which takes into account non-cash items. It does this in an effort to best reflect the financial health of a company. However, accrual accounting may create accounting noise, which sometimes needs to be tuned out so that it's clear how much actual cash a company is generating. The statement of cash flow provides this information, and here we look at what cash flow is and how to read the cash flow statement. 

What Is Cash Flow?

 
Business is all about trade, the exchange of value between two or more parties, and cash is the asset needed for participation in the economic system. For this reason - while some industries are more cash intensive than others - no business can survive in the long run without generating positive cash flow per share for its shareholders. To have a positive cash flow, the company's long-term cash inflows need to exceed its long-term cash outflows.

An outflow of cash occurs when a company transfers funds to another party (either physically or electronically). Such a transfer could be made to pay for employees, suppliers and creditors, or to purchase long-term assets and investments, or even pay for legal expenses and lawsuit settlements. It is important to note that legal transfers of value through debt - a purchase made on credit - is not recorded as a cash outflow until the money actually leaves the company's hands.

A cash inflow is of course the exact opposite; it is any transfer of money that comes into the company's possession. Typically, the majority of a company's cash inflows are from customers, lenders (such as banks or bondholders) and investors who purchase company equity from the company. Occasionally cash flows come from sources like legal settlements or the sale of company real estate or equipment. 

Cash Flow vs Income

 
It is important to note the distinction between being profitable and having positive cash flow transactions: just because a company is bringing in cash does not mean it is making a profit (and vice versa).

For example, say a manufacturing company is experiencing low product demand and therefore decides to sell off half its factory equipment at liquidation prices. It will receive cash from the buyer for the used equipment, but the manufacturing company is definitely losing money on the sale: it would prefer to use the equipment to manufacture products and earn an operating profit. But since it cannot, the next best option is to sell off the equipment at prices much lower than the company paid for it. In the year that it sold the equipment, the company would end up with a strong positive cash flow, but its current and future earnings potential would be fairly bleak. Because cash flow can be positive while profitability is negative, investors should analyze income statements as well as cash flow statements, not just one or the other.

What Is the Cash Flow Statement?
There are three important parts of a company's financial statements: the balance sheet, the income statement and the cash flow statement. The balance sheet gives a one-time snapshot of a company's assets and liabilities . And the income statement indicates the business's profitability during a certain period.

The cash flow statement differs from these other financial statements because it acts as a kind of corporate checkbook that reconciles the other two statements. Simply put, the cash flow statement records the company's cash transactions (the inflows and outflows) during the given period. It shows whether all those lovely revenues booked on the income statement have actually been collected. At the same time, however, remember that the cash flow does not necessarily show all the company's expenses: not all expenses the company accrues have to be paid right away. So even though the company may have incurred liabilities it must eventually pay, expenses are not recorded as a cash outflow until they are paid (see the section "What Cash Flow Doesn't Tell Us" below).

The following is a list of the various areas of the cash flow statement and what they mean:

Cash flow from operating activities - This section measures the cash used or provided by a company's normal operations. It shows the company's ability to generate consistently positive cash flow from operations. Think of "normal operations" as the core business of the company. For example, Microsoft's normal operating activity is selling software. Cash flows from investing activities - This area lists all the cash used or provided by the purchase and sale of income-producing assets. If Microsoft, again our example, bought or sold companies for a profit or loss, the resulting figures would be included in this section of the cash flow statement. Cash flows from financing activities - This section measures the flow of cash between a firm and its owners and creditors. Negative numbers can mean the company is servicing debt but can also mean the company is making dividend payments and stock repurchases, which investors might be glad to see.

When you look at a cash flow statement, the first thing you should look at is the bottom line item that says something like "net increase/decrease in cash and cash equivalents", since this line reports the overall change in the company's cash and its equivalents (the assets that can be immediately converted into cash) over the last period. If you check under current assets on the balance sheet, you will find cash and cash equivalents (CCE or CC&E). If you take the difference between the current CCE and last year's or last quarter's, you'll get this same number found at the bottom of the statement of cash flows.

In the sample Microsoft annual cash flow statement (from June 2004) shown below, we can see that the company ended up with about $9.5 billion more cash at the end of its 2003/04 fiscal year than it had at the beginning of that fiscal year (see "Net Change in Cash and Equivalents"). Digging a little deeper, we see that the company had a negative cash outflow of $2.7 billion from investment activities during the year (see "Net Cash from Investing Activities"); this is likely from the purchase of long-term investments, which have the potential to generate a profit in the future.Generally, a negative cash flow from investing activities are difficult to judge as either good or bad - these cash outflows are investments in future operations of the company (or another company); the outcome plays out over the long term. 

 

The "Net Cash from Operating Activities" reveals that Microsoft generated $14.6 billion in positive cash flow from its usual business operations - a good sign. Notice the company has had similar levels of positive operating cash flow for several years. If this number were to increase or decrease significantly in the upcoming year, it would be a signal of some underlying change in the company's ability to generate cash. 

Digging Deeper into Cash Flow

 
All companies provide cash flow statements as part of their financial statements, but cash flow (net change in cash and equivalents) can also be calculated as net income plus depreciation and other non-cash items.

Generally, a company's principal industry of operation determine what is considered proper cash flow levels; comparing a company's cash flow against its industry peers is a good way to gauge the health of its cash flow situation. A company not generating the same amount of cash as competitors is bound to lose out when times get rough.

Even a company that is shown to be profitable according to accounting standards can go under if there isn't enough cash on hand to pay bills. Comparing amount of cash generated to outstanding debt, known as the operating cash flow ratio, illustrates the company's ability to service its loans and interest payments. If a slight drop in a company's quarterly cash flow would jeopardize its loan payments, that company carries more risk than a company with stronger cash flow levels.

Unlike reported earnings, cash flow allows little room for manipulation. Every company filing reports with the Securities and Exchange Commission (SEC) is required to include a cash flow statement with its quarterly and annual reports. Unless tainted by outright fraud, this statement tells the whole story of cash flow: either the company has cash or it doesn't.

What Cash Flow Doesn't Tell Us
Cash is one of the major lubricants of business activity, but there are certain things that cash flow doesn't shed light on. For example, as we explained above, it doesn't tell us the profit earned or lost during a particular period: profitability is composed also of things that are not cash based. This is true even for numbers on the cash flow statement like "cash increase from sales minus expenses", which may sound like they are indication of profit but are not.

As it doesn't tell the whole profitability story, cash flow doesn't do a very good job of indicating the overall financial well-being of the company. Sure, the statement of cash flow indicates what the company is doing with its cash and where cash is being generated, but these do not reflect the company's entire financial condition. The cash flow statement does not account for liabilities and assets, which are recorded on the balance sheet. Furthermore accounts receivable and accounts payable, each of which can be very large for a company, are also not reflected in the cash flow statement.

In other words, the cash flow statement is a compressed version of the company's checkbook that includes a few other items that affect cash, like the financing section, which shows how much the company spent or collected from the repurchase or sale of stock, the amount of issuance or retirement of debt and the amount the company paid out in dividends.

The Bottom Line
Like so much in the world of finance, the cash flow statement is not straightforward. You must understand the extent to which a company relies on the capital markets and the extent to which it relies on the cash it has itself generated. No matter how profitable a company may be, if it doesn't have the cash to pay its bills, it will be in serious trouble.

At the same time, while investing in a company that shows positive cash flow is desirable, there are also opportunities in companies that aren't yet cash-flow positive. The cash flow statement is simply a piece of the puzzle. So, analyzing it together with the other statements can give you a more overall look at a company' financial health. Remain diligent in your analysis of a company's cash flow statement and you will be well on your way to removing the risk of one of your stocks falling victim to a cash flow crunch.