When evaluating value investing opportunities, we begin with the balance sheet, as opposed to the Wall Street approach that has a primary focus on the income statement. The balance sheet tells the story of a company’s liquidity, and it filters out the quality of both its assets and liabilities. This is where we begin to find answers to our biggest questions about the company’s capital structure and, potentially, its liquidation value. We evaluate inventories and company-owned real estate to determine an appropriate net asset value, helping establish a clear view of the business’s worth for its owners.
Deep Value Investing: Our Philosophy & Methodology
Next, we look at the statements of cash flow. This allows us to gauge the quality of earnings the company is generating. We believe it is imperative to follow the cash to see the true value of a company without running the risk of depending on earnings data on the income statement, which could easily be manipulated by various factors. Companies that are generating strong free cash flows tend to have a higher quality earnings stream.
On the income statement, we look for revenue and earnings trends. We recognize that some companies may show growth, but that the growth may not actually be profitable. Other companies may be shrinking, but becoming a more profitable and viable operation in the process – an attractive position, in our opinion. Also taking into account a company’s tax situation and accounting practices, we endeavor to acquire a deep understanding of both the company’s financial circumstances and management structure prior to making any investments.
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