The First Thing I look For…
Have you ever struggled to put together a toy or game for a kid? I had the pleasure of recently assembling a trampoline for a 6 year old. And this young lady couldn’t wait to get to her new toy!
Of course, assembling a 10 foot trampoline isn’t such an easy task.
You know the rule of assembling things… read the instructions all the way through before starting anything. The assembly should go smoothly. Of course, when it came to the trampoline I simply glanced at the instructions then started screwing parts together.
We were 70% finished before our problem came to light…
The netting wasn’t aligned properly with the frame. If I’d have paid closer attention to the directions I would have noticed the importance of aligning everything. The simple act of looking at the instructions first would have saved me an hour of disassembling… and then reassembling the great new toy.
It’s a horrible lesson to learn. And if you ever find yourself assembling a trampoline for an anxious 6 year old, read the directions front to back. The extra 10 minutes will save you hours of tedious work.
So what’s my story have to do with investing?
The first thing you should do when assembling a new toy is read the instructions. The same rule applies to investing.
There’s one thing I always look at well before starting any analysis or research. It may seem funny to point to one significant data point… but I’ve learned this lesson the hard way too.
What’s the one thing to look at before analyzing financials, reading about management, studying the industry, or researching valuations?
I look at this one thing before I look at the value of the stock, or how it’s trading in the markets.
The first thing I always check for is simply – REVENUE!
It sounds simple I know, but it’s not.
Why such a focus on revenue?
This one number – revenue – will tell you a lot of information about a company. The first thing to notice is if the company has any revenue at all. Often management is so focused on the future… new products… recent joint venture deals… and all the hype of running a public company they forget the number one goal is to sell something.
If a company has no revenue it means they have no customers… and more importantly, they have yet to prove they can sell anything.
Now I know in certain situations some companies won’t have revenue… for example a drug development company or a business focused on commodities exploration. In that case, you know right off the bat these businesses are high risk… and what will drive their business isn’t operational excellence, but outside influences.
Here’s the deal.
If you want to take a risk, go ahead. But understand what you’re getting into. A new biotech company might have the cure for cancer… but it will take years of testing and study to get through FDA trials.
As a result, the company stock price won’t move higher on news from the business. Instead, short term news and events will impact the stock price. Signing up a big drug development partner, or seeing the drug pass form one phase of testing to another will often lift the price of a drug company.
So will the CEO speaking at an important industry conference.
News of mergers and acquisitions in the industry could also drive the stock price higher.
Believe it or not, if you find a small biotech company without any revenue, a big driver of their stock price could be a competitor’s product getting FDA approval. Many investors assume if one drug is approved, other similar drugs will also get approval.
You see how this simple indicator… revenue… changes how you should look at a company!
So what about companies showing revenue?
This presents an opportunity to look for good and bad influences on a company… before investing.
Let me give you an example…
Back to the drug industry. We all have friends and family who take medication regularly. Some use it to reduce the risk of a heart attack… others lower their cholesterol levels… still others take drugs for calming mood swings, or eliminating stomach problems.
These are often lifetime issues that just don’t go away.
The drugs don’t cure the disease… they make the symptoms manageable. As a result, week after week, month after month, year after year, the users of these drugs fill and refill their prescriptions. It’s known simply as recurring revenue!
And recurring revenue is a very good thing.
You’ll see this in a number of industries. Just think about all the recurring bills you pay… your cell phone bill, the electric utility, the magazine subscription, even the cable bill arrives every month and you pay like clockwork.
Nobody has to sell you anything. Nobody forces or cajoles you into paying with a credit card or writing a check. We often pay these bills without even thinking about it… and that’s the best kind of revenue there is!
Recurring revenue is often a very good sign for a business… and also a good sign of just how happy customers are.
Now, I don’t have much more room, but there are a few other things you want to look at when examining a company’s revenue.
I always like to focus on sources…
For example, does the company get 40% of its revenue from one customer? Read the 10-K they file with the SEC. Every company has to list their top customers… and how much they buy.
If a company has a big percentage of sales from one customer it’s a red flag. It’s worth taking a little extra time to find out why… and what the company is doing to find more customers.
The other thing I like to focus on is Growth Rate.
Is the company growing revenue, or is it stagnant? Or worse… is revenue falling? This is a big factor not to be overlooked. Did they raise prices? Did they introduce a new product? Or did a competitor steal market share from them?
There are a lot of other things to focus on when it comes to revenue, and I’ve just touched on a few key issues today
What you really need to keep in mind is simple… look closely at revenue first. If that looks strong, then spend some more time on your research and analysis. If the revenues look weak, take a pass… there’ll always be another company vying for your attention and investment dollars.