What makes a "good or bad" company?

If own a good stock, you basically own a good company (or a little piece of it). As mentioned in the last post, some of the most important characteristics are the age, size and value of the company, profitability, long term growth potential, cash on hand, low debt load, etc.

As we are not experts, it is almost impossible for most of us to understand financial statements of any company. That job is better left to investment and mutual fund managers. That is just one of the things they are trained for. They also talk to management about investment strategy, management style, future plans and an entire host of things that we do not have access to.

Having said that, there are some things that make sense to us without any training. What can we look for in order to determine other things that constitute a good company:

• VERY LARGE COMPANIES – you may not make the biggest money here, but you will probably make the safest and most consistent money buying into the largest companies.

• COMPETITOR PROOF – If you think about our Canadian chartered banks that fall under the Bank of Canada Act, it’s not hard to figure out that NOBODY will be starting another chartered bank in Canada. Then there’s the rail lines – Do you see anyone building another rail line across the country? What about the large insurance companies – they are massive and impossible to compete with. Can you think of other companies that fit in this category?

• THEY HAVE AN EASY TIME MAKING MONEY – I hate to dwell on banks, but its almost mandatory that you deal with one; they take your deposits and lend out money – there is nothing complicated about that. They aren’t spending tons of money on research and development or trying to invent something new. Insurance – we all need insurance of some kind. Whether its your car, your house, your life, your travel plans, your health and dental plans, liability, disability . . . . . Like the banks, the insurance business is not very complicated. You buy insurance, they pay out if you have a valid claim.

• ITS EASY TO FIGURE OUT WHAT THEY DO – If you have to research for days to just figure out what the company is about, it might not be that easy to figure out how they make their money. Besides the banks and insurance companies in the last bullet, think about some of the other companies you deal with. Nike sells sneakers; McDonald’s sells fast food; Disney sells entertainment. . .

• EMPLOYEE OWNERSHIP – A quick Google search will tell you if there is a management/employee share ownership program. If you own shares of the company you work for, you have a vested interest in the success of the company. The better the company does, the better you will do personally.

• DIVIDENDS THAT INCREASE YEAR AFTER YEAR – if a company is doing well and paying a dividend, it typically means it’s making money, and if the dividend increases every year, it becomes very attractive to shareholders. The dividend they pay is typically just a portion of the profits. The rest of the profit is used to grow the company, thereby increasing the profit which helps increase the dividend. This doesn’t necessarily mean that companies aren’t making money if they are not paying dividends; it may be using that money to further grow the business increasing their share value that way.

IF we were to only buy companies with all of those features, it would eliminate a large number of the 1500 companies listed in the TSX alone. And you don’t necessarily want to eliminate every other company because it doesn’t meet the above criteria. Keep in mind, that most companies started small and have taken many years to become companies that meet this criteria. I’m just suggesting you make the majority of your investments in the larger, more stable companies AND you start there as you learn more about investing and become more comfortable with the ups and downs of the stock market.

The UPS AND DOWNS? the BULLS and the BEARS – what do you mean? Come back next week for more on that!