Thursday, March 8, 2012

Know Your Investments

One of the most important aspects of investing is to "know your investments", but what does this phrase actually mean?

I like to think of investing not as the buying and selling of stocks, mutual funds, bonds, etc, but as being long term part owners of a business. In this way, the phrase 'knowing your investments', becomes, 'knowing your business'. All of a sudden, the sentence has a whole different meaning.

Knowing Your Business

What kind of information does a business owner need to know about his or her own business?

Some common things:
- what am I selling
- how will I sell it
- who are my customers
- what are their needs

Some less common things:
- how much money am I making per sale
- how do I grow the business revenues and profits
- what are my fixed costs, and variable costs
- how do I deal with competition

Not by coincidence, these are also questions you must ask when investing in the stock market.
Let's take a look at one of my biggest holdings in my portfolio

Know Your Coca Cola (Ticker: KO)

Q: what does this company sell?
A: The Coca Cola Company is in the business of selling branded beverages. Their beverage products cover  segments such as soft drinks, juices, teas and coffees, sports drinks, energy drinks, and bottled water. Their brand portfolio includes Coke, Sprite, Dasani, Simply Orange, to name a few

Q: how do they sell it?
A: Coca Cola (Coke from here on) sells its products in a variety of different ways. A few examples are: via supermarket (retail), via restaurants (syrup machine / fountain drink), and via vending machine.

Q: who are their customers?
A: Quite literally, everyone. Every consumer is a potential customer of Coke's business. Whereas their business was previously heavily concentrated in developed countries, there are more and more Coke customers in the developing world as each day goes by.

Q: what are their needs
A: Generally people who consume Coca Cola products are looking for a cold, tasty beverage. As people's tastes and preferences change over time, it is important to Coke to keep this in mind in order to continue to meet their customers wants and needs.

Q: how much money are they making per dollar of sales
A: Coke's gross margin has typically been between 60 and 70%. This means for every 1 dollar of sales, 60-70 cents is profit. As you can see, Coke is a very profitable business

Q: how do they grow the business revenues and profits
A: There are typically 3 ways a business can grow revenues and profits. Sell to new markets, increase prices, and take market share in existing markets. Coke is no different. Their long term goal is very clear. They want everyone in the world to consume a Coke product. The developing world consumer consumes on average 10% the amount of the developed world consumer, so there is a lot of growth still available to the company.

Q: what are the business's fixed costs, and variable costs
A: Coke's business model is very good. They sell a low priced product with a very strong brand. Their main variable cost is raw material costs (syrup, aluminium/plastic costs), and their main fixed cost is distribution costs (transport, shipping). But generally these tend to scale very well with increased volume (doesnt cost too much to ship an extra few bottles/cans). The business does have some exposure to commodity costs thru its raw material costs, but the strong pricing power of the brand can offset this easily.

Q: how does the business deal with competition
A: Coke's main competition is Pepsi. Their main weapon against Pepsi is superior brand recognition thru continued spending on advertisements and sponsorships. Unless something drastic happens (like some poisoned Coke drinks), this existing competitive advantage over Pepsi is unlikely to fade.

I hope this quick Q&A on Coca Cola has helped you understand how to approach an investment, and some of the things you should think about, and know about, before investing in a stock (or business).

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