This post is a continuation from previous post “Episode 1: Can we invest in McDonald business in India?” which involves a conversation between a teenager Guna ‘G’ (who is interested in the stock market) and her dad ‘D’.
G: Dad, I have finished reading “One Up on Wall Street: How to Use What You Already Know to Make Money in the Market” by Peter Lynch. What next?
D: You need to learn more about Westlife Development Limited (WDL) which is the master franchisee for McDonald’s in South and West India. You need to understand – what does the company do, how does it do it, who are the customers, customers’ feedback about the company, competitors, business model, etc.
G: How do you suggest that I gather such information?
D: You can gather such information from people who work at McDonald’s outlets, customers, company’s website, company presentations, news articles about the company, research reports, annual reports, etc.
G: Let me read through their website first and search for news articles related to the company. By the way, where do I get Annual Reports of the company?
D: You can find Annual Reports of WDL on their company website as well as on Bombay Stock Exchange (BSE) website.
Next day, Guna speaks to McDonald’s store manager and reads through information like
G: Dad, I’ve done some amount of analysis on WDL. Peter Lynch, in his book One Up on Wall Street, mentions about analyzing ‘earnings’ of companies apart from looking at various other aspects. In fact, he has a full chapter called “Earnings Earnings Earnings”. Where do I find information on earnings of WDL?
D: You will be able to find financials in Annual Reports and Quarterly Results statements. You can find such information on BSE website and company website. You will also find information like compounded sales growth, compounded profit growth, Price-Earnings ratio, etc on websites like moneycontrol.com and screener.in.
G: I looked into consolidated financials on WDL and I see that Net Profit (Earnings) for the financial year ending March 2015 has been negative. That doesn’t seem good.
D: You are right; the earnings are negative. However, notice that Sales and Operating profits have been increasing year on year. There’s more quantitative analysis that can be done, but I will not get into that.
G: What do you mean by quantitative analysis?
D: A company needs to be analyzed from qualitative as well as quantitative perspectives. While quantitative analysis focuses on the analysis of financials, qualitative analysis involves analysis of unquantifiable information like growth prospects due to cultural shifts, brand image, customer service, innovative measures by the company, management expertise, etc. If the company doesn’t look good qualitatively as well as quantitatively, it would be better not to invest in it. If the company looks good qualitatively but doesn’t look good quantitatively, you will have to take a call on whether to invest in it or not based on your conviction about the company.
G: Hmmm… It’s getting a little complex here. Should I buy Westlife Development Ltd or not?
D: That’s a question I will not answer. Your investment decisions should not be based on borrowed conviction. If you are not convinced about Westlife Development, you can analyze other Restaurant businesses that are listed on stock market. Basant Maheshwari in his book “The Thoughtful Investor“, shares an incident from the year 2003, when he had to choose between investing in Pantaloon (Kishore Biyan’s venture Pantaloon Retail) and Westside (Tata group owned ‘Trent Ltd’). He mentions that the financials of Westside looked better as compared to Pantaloon’s financials. Initially, he had invested more in ‘Trent’ (Westside) as compared to Pantaloon. After making this initial investment, he did some more research. He used to stand outside both Pantaloon and Westside stores, and he noticed that number of people were shopping at Pantaloon as compared to Westside. The more qualitative analysis made him develop conviction about Pantaloon. So, he rectified his mistake and invested more in Pantaloon as compared to Trent (Westside). In the next 3 years, Pantaloon was up 45 times whereas Trent was up 6 times.
G: Okay. Now I understand the importance of developing conviction. I will think about the analysis I have performed and then decide if I want to invest in Westlife Development or not. By the way, you mentioned that there’s more quantitative analysis that can be performed but wouldn’t want to get into it. Can you give me a sense of what kind of more quantitative analysis can be performed?
D: There’s quite an amount of quantitative information you can look for like the change in sales, change in operating profit margin, change in net profit, etc which can be derived from in profit and loss statements over multiple periods of time. You should also analyze balance sheet and cash flow statements. You should study ratios to analyze profitability, returns, leverage, efficiency, etc. You will also have to perform analysis to understand if the stock is overpriced, underpriced or priced fairly. Let’s talk about it some other day.
Episode 3 has been released.