Classification

Categories:

• Too Hard Pile
• Speculation
• Bad Business
• Average Business
• Good Business
• Excellent Business
• Generational Business

The classification is inspired by DIY Investing Podcast.

Too Hard Pile🔗

Businesses that I can not or do not understand. I must NEVER INVEST in such companies.

Here goes all financial companies, except asset management firms.

Speculation🔗

Traits:

• Fraud potential
  • Countries with bad reputation: China, Russia, etc...
• Untrustworthy Management
  • If I don't like management, it is sufficient reason (without searching for proof)
• Unprofitable (zero or negative earnings)
• Earnings are very unpredictable
• Cyclical companies (unpredictable profitability)
• Serious Bankruptcy risk (high debt, questionable profitability..)
• With earnings history less than 5 years

Examples:

• NTWK: fraud potential (Pakistan), untrustworthy management (dubious investments)
• TLRD: bankruptcy risk
• BTU: unprofitable, unpredictable earnings

Bad Business🔗

• Is profitable with positive free cash flow
• Return on Equity >= 10%
• Capital intensive
• Declining business (getting smaller, liquidating, closing shops...)
• With earnings history less than 8 years

Invest on short term.

Example: Net Net

Examples:

• CHTR: ROE = 4.5%

Average Business🔗

Lack of exceptional financial characteristics.

• Earnings history is 8 years or longer
• Operating Cash Flow > Earnings
• Is profitable with positive free cash flow
• Can potentially reinvest earnings
• Return on Equity 10%-15%
• Less capital intensive than bad business
• Can be dependent-commodity business
• They face a lot of competition
• Lack pricing power

Good Business🔗

• Has pricing power
• They do not compete on price
  • They may compete on product/service quality, etc...
  • not a commodity-dependent business

Examples: consumer package companies, companies with brand (e.g. Colgate)

Examples:

• IRBT (or average?)

Excellent Business🔗

• Competitive Advantage (moat or monopoly)
• History of share-friendly capital allocations
  • Rising dividends
  • Buying back stocks when they're too cheap
• Non-cyclical (stay profitable in recession years)

Generational Business🔗

• Extreme long-term durability (> 30 years)

So reliable and predictable that you don't worry to allocate big part of portfolio.

Examples:

• Disney (own brands like Star Wars, Marvel heros, Mikky Mause, Cinderella, Lion King, etc..)
• Coca-Cola (currently it has too high debt)
• Microsoft