ID5-7: Fortune ran an article on Bob Olstein, an investment analyst who was part
ID: 2445775 • Letter: I
Question
ID5-7:
Fortune ran an article on Bob Olstein, an investment analyst who was particularly bullish at the time on several well-known stocks. He said the following indicators were the keys to his success: (1) a recent dramatic drop in the stock price, (2) company reports of positive free cash flow (net cash from operations minus capital expenditures), (3) conservative accounting methods, (4) a buildup in raw materials and partially completed inventory compared to finished inventory, (5) an increase in discretionary expendi- tures such as research and development, (6) undervalued assets on the balance sheet, (7) little or no debt combined with a high return on assets, and (8) consistency between what the president’s letter said and what had actually happened over the past few years.
REQUIRED:
Explain how each of the eight items could provide a positive sign about a company.
Explanation / Answer
1)a recent dramatic drop in the stock price: This means if there is correction happened in the stock price and investors who missed in previous period can start investing in the company right now when there is sudden drop in price of compnany. The reason may not due to fundamentals.
2)If company reports free operating cash flow means it can fund its capital expenditure without need of any external funding and internal money is enought to fund which is very good sign and because of this no need to issu stocks by which dilution can happen
3)Conservative accounting methods if followed will give fruitful results when there is downturn in the economy as a whole which will affect all the companies. By this there is no sudden changes in either balance sheet or Profit & Loss if sum unexpected things happen .Examples are considering bad debt expense and publishing contingent liabilities etc
4)Having higher finished goods is not good for any company , may be because of change in technology the goods can become obsolete and aging of inventory will give bad sign about the demand for the product in markts. A build up in raw material shows that the company is expecting some demand in the economy and making itself ready.
5)An increase in spending on Research and development will show good impact on investors, It will increase the sales in the coming years and while calculting PE ration the expected growth rate will be more.
6)As assets are always valued at book value it will be relatively lower than the fair market value. If some situation comes where the assets have to be liquified then as market value is higher than the actual book value it will assit the comany to generate more cash.
7)Little or No debt means the company is not debt burden and if any downturn in the ecoomy the payment of interest will not create problem for any company. A high Return on Assets means the company is effectively utilizing its assets and generating value to the shareholders.It will be due to two reasons and/or increase in net profit margin , Asset turnover.
ROA= (Net profit/sales)*(Sales/Assets)
8) THe company management is concerned abput investors and they are really giving as per outlook they see based onthe internal operations of the company and are not misguididng the investors which will raise serious concerns in the investors in long term as they will loose trust on the management.