By Rob Lawson, Editor, Credit Today
This article originally appeared in Credit Today, the leading publication for the credit professional.
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In most of my conversations with CreditRiskMonitor CEO Jerry Flum, we talk about markets and stocks. Jerry is an unabashed bear. He thinks the debt levels (measured as a percent of GDP, at all levels of government world-wide, as well as on individual levels) are at totally unsustainable levels. No living human has ever experienced what’s going on now, so no one has any idea what’s about to happen (hint: “watch out below!”).
At heart, Flum is a securities analyst and was something of a “boy wonder” of hedge funds long before they were common on Wall Street. He lectures at MIT and has close relationships with many of the top analysts on Wall Street. So we pay attention to his views.
In a recent conversation, the idea of “perfect company” came up.
He noted that in CreditRiskMonitor’s annual report, he cites 6 characteristics of the perfect business (which, we’ll forgive him for thinking he’s managing something fitting those characteristics). After checking out their list (which he says he wrote himself), we concur with his assessment and think it’s a list worth sharing:
- Low price – Is the price of their product service low relative to its value? Is the price of the product or service low relative to its competitors?
- Non-cyclical – Is the business immune to business cycle changes? (Think of an electric utility on one extreme vs. housing-related businesses on the other end of the spectrum).
- Recurring revenue stream – Is the product or service something needed just one time (a TV for example), or do customers need to continue to purchase the product (razors or food, as examples)?
- Profit multiplier – Does the business benefit from economies of scale as it gets larger (most software, cable TV or a railroad as examples)? Or do variable costs rise along with volume (anything labor-intensive, such as hospitals or hair salons, as examples)? Obviously, the latter is not as good as the former.
- Self-financing – Does the business require outside financing (even if only occasionally) to stay afloat? (some auto dealerships and mortgage companies fit this description) If so, it’s dependent on the “kindness of others” and, from a long-term perspective, that always raises risks.
- Management – as any credit pro will tell you, integrity is the first and most important thing to focus on here. But of course, competence is critical. You really do need both.
As a credit pro, you won’t go wrong if you keep these principles in mind when thinking about and analyzing your customers and your portfolio as a whole.