What’s an attractive business?

Who amongst these three is a more inspiring leader? - Abraham Lincoln (AL), Mahatma Gandhi (MG) or Alexander (A)

It’s difficult to say… Let’s briefly see what these leaders are remembered for..

AL: Humility, perseverance and practical leadership. Knew the importance of infrastructure to an economy. Fought against racial discrimination. Leadership during civil war. None of the things he did was rocket science. He did small things.. yet he did them consistently and achieved a number of small victories.....

MG: Truth, simplicity, non violence.. Fight against the British and the Indian independence... Father of an entire nation. A leader who did simple things.. Yet had the mettle to inspire millions to follow him.

A: One of the most successful military commanders of all times. Conquered the entire world. He did not do small things. He did great things that continues to inspire us even centuries after his time..

Ok.. What have these leaders got to do with my original question on what is an attractive business? Here you go...

If we agree that shareholder returns is a reasonable measure on evaluating business attractiveness, there are three important components which constitute shareholder returns:

1. Margins

2. Asset Turnover

3. Leverage

 

That’s because

(Net Profit/ Sales) i.e. Margins X (Sales/ Assets) i.e. Asset Turnover X (Assets/ Equity) i.e. Leverage  = (Net Profits/ Equity) i.e. Shareholders Returns

It’s great if a business scores well on all these three counts. But even if it scores extremely well on one of these counts, it can constitute an attractive business..

High Margin businesses are like Alexander. He did great things. It’s almost impossible for a common man to imitate his deeds. High margin businesses are like that.. They do big ticket deals. Small number of deals but great margins. It’s difficult to imitate them.. Eg. Fashion, Jewelry

High turnover businesses are like Abraham Lincoln. He did not do earth shattering feats. He did small things, down to earth deals.. But he did a 1000 small things, consistently over long periods of time, which put together made him a great leader. High turnover industries are like that. They do small things, yet make up these insignificant deals through volumes.. Eg. Retail stores

High leverage industries are like Mahatma Gandhi. Gandhi gained his fame not because of his own feats. He gained it because he could inspire a million others to follow him which ultimately led to the freedom of an entire nation. Would a strategy of non-violence be exactly effective, if people were not ready to follow him? High leverage industries are like that. They use so little of their own money, get others to lend them money and manage to make a neat profit using the entire pool of cash.. Eg. Financial institutions

DuPont Analysis is a great way to look at businesses. Understanding these levers of business can help us identify and profit from opportunities.