Tuesday, August 21, 2007

Pushing the reset button

Regardless of whether the unwinding of credit issues is done or not, and it is probably not, this has been a market event that will have a lasting impact. Equity portfolios will be reshaped significantly in the coming months and regardless of what's happening in the overall averages there will be plenty of activity among the components. Here's what will drive the change in equity analysis:
---The balance sheet will be back in vogue. That boring old part of a financial statement is coming back like hats in winter. Investors will look at those mundane stats of debt to assets, long term debt to equity, and current assets to current liabilities. A new twist will be looking at fixed assets and seeking to determine their viable life first and, given the fact that the dollars five year collapse will likely continue, how valuable those fixed investments are on a world stage. The final ingredient of this balance sheet analysis will be the more intangible networking analysis of financial flexibility, meaning are the credit markets open to this industry and this company.
---After that and only after that comes the income statement and cash flow statement, and the growth that they imply. To use one of the few management buzz words that has meaning, that will lead to an analysis of "sustainable competitive advantage". Does the company have the products, brand, human capital, and financial capital to grow over a reasonable time frame, and as always let's put a number on that amount of time.
---Passing these tests will lead to an examination of the global nature of the firm, given the dollar's ongoing plight. Does it have exports---good, does it depend on overseas suppliers for components or products---maybe not so good, and does it have overseas production and sales operations---possibly good. If a company is primarily U.S. dependent on sales it is likely best that it is in, first, essential items like energy, food, war supplies, and infrastructure maintenance or, second, in luxury goods and services. Anything in the middle will be less profitable on any global measure.
---Only then will come a look at some of the market issues that have been most important in recent years, and remain worth looking at after the above tests. What is the P/E relative to others and historic market data, who owns the stock and why, and what is the market momentum of the company and its industry.

All of the above applies to commercial and industrial companies. Financial companies have their own reset button given that they are structurally more leveraged. They are facing increasing scrutiny on many fronts that could lead to regulation, some of which will inevitably be damaging to the companies and even the economy. They are the easy villians for political rhetoric. But most importantly they are solely dependent on financial capital and human capital. They don't have machines that make dollars and euros and yen, and so when accidents happen they can be devastating. Until the coast is clear on all of the recent credit panic, the whole sector will be discounted heavily and it will take time to recover.

On that cheery note, we start another day.

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