Value Investing – Principle #3: Financial Analysis (Lesson 8)

Value Investing

Changing the direction of a large company is like trying to turn an aircraft carrier. It takes a mile before anything happens. And if it was a wrong turn, getting back on course takes even longer. – Al Ries

Large behemoth corporations are like aircraft carriers, given their enormous size, it takes tremendous amounts of resources to stop or even slow them down. In addition, if you want to change their trajectory even slightly, it still takes significant energy to implement this course correction. This is why highly stable organizations such as the top 2,000 companies can maintain their profitability. Their missions are figuratively set in stone. Any desire to add or delete product lines or implement new processes must go through a rigorous review by multiple levels of management before implementation. The thinking is simple, ‘Why change a good thing?’.

Thus, the number one overall force that impacts the stock price of large corporations is the economy as a whole. The DOW companies are greatly effected by the economy and rarely are their stocks’ price directly tied to a failure within their overall corporate organization. This was covered to some extent in Lesson 3 about market fluctuations. In addition, industry wide issues impact a company’s stock price more so than company financial results. A perfect example is the oil industry. Middle Eastern political actions often affect an oil company’s stock price to a greater degree than the company’s own internal financial results when reported.

This leads into the usefulness financial analysis generates for value investors. It sets up a predictable and reasonable market price for the respective stock. This becomes the sell price point or what is often referred to in this series of lessons as the recovery point. If all three forces (economic, industry and company level) are performing reasonably, then the stock price for the company will recover to this sell point. Therefore,

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