Last week I posted Terry Smith's line in this sub as a whole [investing strategy](https://www.reddit.com/r/ValueInvesting/comments/1vrpbil/buy_good_companies_dont_overpay_do_nothing/):
Buy good companies. Don't overpay. Do nothing.
And MyotisX asked a good question: "easier said than done, what's a good company?"
MyotisX's right - it is not easy to find a good company. Ask anyone and they'll tell you to look for a moat. Something durable that keeps competitors out. A brand, switching costs, a network effect, a cost advantage nobody can copy. It's fine as a concept. The problem is that it's a judgement call, and two people can read the same business completely differently. And even if you're good at it, you're not doing that work on 3000 stocks. It's difficult to implement.
However, what you can do is that instead of looking for a moat directly, you can look for its signs. Its fingerprints are all over the financial data.
Check margins. Gross margin tells you how much room there is after making the thing. Nvidia runs around 70%. Net margin tells you how much survives everything else. Apple keeps over 25%, which is rare at that revenue.
Check return on invested capital. It tells you whether a dollar put into the business comes back as more than a dollar. If a company earns high returns on capital, it is a sign of a good business. Mastercard earns 48% on invested capital. That's a moat showing up in the numbers.
But it has to be consistent. One year at 30% is a good year. Ten years at 30% is a moat. Pull the last ten years and see how much the margins and returns actually moved. Include 2020 and 2022. A company that held its margins through both had real pricing power.
Check what they do with the money. High returns only compound if they can keep putting more capital in at those returns. A company earning 30% and growing 12% is compounding. One earning 30% and growing 2% is not the same thing.
And watch the debt. Net debt to EBITDA tells you how many years of earnings it would take to pay it off. Interest cover tells you how comfortably they can service it right now.
So I have distilled all of these down to 10 questions of business quality: growth and growth per share, margins, working capital, returns on capital, whether profit becomes cash, and the balance sheet near term and long term. I made a video working through all ten on ten years of data for Microsoft and Kraft Heinz, one chart per question.
[https://youtu.be/u0HefKGt5YU](https://youtu.be/u0HefKGt5YU)
These 10 questions convert a qualitative question into something that can be measured and analysed consistently across all companies.
Not financial advice. Do your own research. It is second in a series of 6 to 8 videos on the basics of value investing. Feedback welcome.
Disclosure: I have been holding MSFT since 2020. This video isn't about MSFT or KHC. They're used as illustrations only.
AI was used in making this video.
