To become a savvy stock evaluator, you must master a multitude of skills. It's undeniably important to hone your quantitative kung fu by familiarizing yourself with financial statements such as the balance sheet, the income statement, and the statement of cash flows. But the qualitative side of the business -- the strengths and weaknesses that lie beyond the numbers it reports -- are no less crucial.
So what should I look for?
Good management is the first virtue Fools should seek in a business. How up-front and honest are a company's leaders? How much faith do you have in them? In good times and bad, look for a company whose earnings reports are free from hype or excuses, and whose managers are equally candid about their business's strengths and weaknesses.
Competitive advantages are also critical; some of the best companies have a sustainable edge over their competition. eBay (Nasdaq: EBAY ) , for example, has such a huge base of users that it would be incredibly difficult for an upstart rival to attract eBay-sized amounts of traffic. If you want to buy or sell something in an online auction, why go to smaller sites when you can use eBay or other huge, established venues? Thanks to their size, they're likely to have the most buyers if you want to sell, and the widest selection if you want to buy.
A model business's business model
Lastly, and no less importantly, investors should examine a company's business model -- how it goes about making money. Amazon.com (Nasdaq: AMZN ) , for example, bases its business model on its ability to sell books, music, and other goods online, without the costly inventory, property, payroll, and other expenses of bricks-and-mortar rivals Barnes & Noble (NYSE: BKS ) and Borders (NYSE: BGP ) . eBay's business model is lighter still; while even Amazon must maintain warehouses of goods, eBay has no inventory at all, merely taking a cut of every transaction between the buyers and sellers it brings together.
The lighter the business model, the more profitable the business generally is. Bricks-and-mortar stores can dominate rivals and make gobs of money, as Wal-Mart (NYSE: WMT ) amply demonstrates, but they generally must sell vast volumes of goods to do so.
The razor-and-blade model
King Gillette, inventor of the disposable safety razor, pioneered one of the most profitable business models around. A safety razor might just seem like a convenience to you, but savvy business observers see dollar signs.
Gillette shrewdly realized that once a consumer bought a razor, he would keep buying blades for it, generating lots of regular repeat sales. Therefore, the razor's pricing became far less important than that of the blades. Indeed, in World War I, many soldiers received free razors from Gillette -- an altruistic gesture, yes, but also a canny and profitable one. Procter & Gamble (NYSE: PG ) clearly appreciated the beauty of this model, since it bought Gillette's self-named company in 2005.
Today's inkjet printers owe a clear debt to Gillette's clever model. You can buy a printer for your computer from Hewlett-Packard (NYSE: HPQ ) for a pittance -- less than $100 in many cases, and sometimes as little as $50. But to refill its ink cartridges, you'll need to shell out $15 apiece, again and again, with multiple cartridges needed for proper printing. Over the life of the printer, you'll spend more on the ink than you paid for the printer itself. And which do you think carries a plumper profit margin -- the high-tech printer, with all its parts and circuitry, or the little plastic box of ink?
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