Private Equity Update
The latest (but not the last) casualty of private equity is Thames Water. The CEO was ejected last week and a debt for equity swap looks likely. Debt upon debt has been piled up with £14bn in the regulated entity alone.
If you own an infrastructure fund, it might be worth taking a look at the portfolio. OMERS Infrastructure has had a representative on Thames’ board since mid-2019. Greg Pestrak of Wren House Infrastructure looks to have resigned as an NED in December, 2021, while a representative from ADIA joined the board in September last year. I don’t know how significant Thames was to OMERS or Wren House and I stress that I do not know the firms and I am not suggesting anything untoward.
Thames raised RPI inflation-linked bonds, but its revenue is tied to CPI, which looks a schoolboy error - the mismatch between costs and revenues is significant. Expect more pain in this industry and in similar fields where debt has been piling up.
Thames Water could yet be rescued by shareholders - the FT reported that the Universities Superannuation Fund owns 20% and wants to inject more equity. But it will certainly become a case study in private equity mismanagement:
Here is a company which sells a product none of its customers can do without; it has no competitors; and its prices are inflation-linked. How could such a business fail?
I want to talk about the research process this week, but first a word from our sponsor.
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A few weeks ago, I wrote a post “Get Serious or Get Out”, where I called out the danger of picking your own stocks without knowing how to read company accounts.
I stand by that post, but today’s piece is a little more positive. Because as long as you master the fundamentals of financial analysis, I remain convinced that most private investors can beat the market over the long term, but they need to stay disciplined.
The advantages that private investors enjoy over institutions have been covered to death. But I do want to highlight one under-rated advantage that private investors enjoy: the luxury of time. As a private investor, there is no client asking you why you have underperformed this week or month or even year.
All you need to do is buy a cheap stock and wait for it to go up.
Obviously, you want to identify one which is truly cheap and without significant associated risk, which isn’t easy. But it’s not that complicated if you have the right roadmap. At the most basic level, this roadmap consists of three main activities:
- Generating potential stock ideas
- Researching these ideas
- Managing your portfolio
Today’s post focuses on the basics of idea research. By the end, you’ll know 8 things you should know about a company before you even think about buying its stock. I can return to the other topics later if there’s interest. Once you’ve read this, reply and let me know!
Minimum Viable Stock Research
I recognise that exhaustive cash flow reconciliations are not for everyone. However, there are a few simple checks you should do before you even think about investing in a company.
First of all, you should check that:
You understand how the company makes money
The company is not over-indebted
The audit report gives the company a clean bill of health
Going a bit deeper, it’s also a good idea to check:
The company’s working capital ratios and cash generation.
That the company’s margins make sense.
That earnings aren’t aggressively stated
It’s also helpful to see who else is involved in the situation. A key and underrated check here is to look at the shareholder register. If you see investors that you know and respect, that’s fine. If you don’t, perhaps you should cast your net wider.
It’s also vital to assess the management team and how they are incentivised.
For the latter, you generally want management to be incentivised on returns rather than earnings per share growth. Incentives don’t always predict the result, but being able to spot unhealthy incentives can certainly keep you out of trouble.
Overwhelmed? Don’t Be.
I appreciate that not everyone is an accountant. But many of these factors are simple to analyse once you know two things:
Where to find the information you need
Key factors to consider for each point
For US companies, most of the information you need will be in the company’s 10-K report. If you’d like a complete guide to reading and studying a 10-K, my online course A Walk Through Apple’s 10-K is here to help.
Learn More
🧠 Learn how to read a 10-K by watching A Walk Through Apple’s 10-K
🧠 Learn how to find and research stock ideas with How To Pick Winning Stocks
📝 Read my earlier post on studying shareholder registers
📝 Read my earlier post on sizing up management
Paying subscribers can read on for that rarest of ideas – a potentially cheap Australian stock, and to see how I got on implementing my own checklist on a stock I didn’t know in an unfamiliar market. And all this in a morning.