Friday, April 17, 2015

Getting conviction: Fundamental Factors #3

This post is a continuation of the following posts:
Lets continue on the list of things to watch out for:
6.        Options dilution - Many companies give stock options to management in order to motivate them to perform better. Companies with too many stock options typically are not great to invest in – in my experience. A small amount of stock options can be a good tool although I must say no options is better than some options. 

Stock options given out today can dilute future earnings per share (EPS) and thus impact your share of the earnings. You need to study this carefully thing about it as lower growth for the non-management shareholders. If the option accounting is too complex you should be worried. Typically if you think the business is going to grow well all options should expire in the money. What needs to be seen is whether the options being given out don't skew the scales of management compensation - this has been covered in detail in the Getting Conviction: Management Quality Factors article.

7.        Margin consistency – Sometimes during the upcycle of a cyclical business the margins of a company are at an all-time high. It is very easy to extrapolate to that assume that the margins will either increase or stay constant – as you probably already know that expanding margins are not always sustainable. You need to understand the value chain of the business before making a judgement on the margin – many a flash in the pan years or quarters have belied investors into value traps.