Deciding to invest in a company

You have capital. How do you decide how to allocate it to a company or not?

You may be out of college and have plenty of time but no experience or money. You may have some time and some money. Or maybe you don’t have much time but have money. Having no time is the worst, as it means you’re dead. You can use this framework even if you don’t have money.

Disclaimer: This is not investment advice, just educational.

Investing vs. Speculating

An investor looks for the safety of principal with adequate returns.

When risking your principal, no matter the returns, you are speculating.

Don’t speculate more than you can afford to lose. This cannot be overemphasized.

Safety of principal

When investing in a company, how do you protect your principal? You protect it by buying at an adequate price and by maintaining liquidity. Buying a stock is more liquid than a private company. Nowadays, you can trade stock in a matter of minutes.

On the other hand, you expect the company to be around in the next 5-10 years. You do this by investing in companies with the following:

Adequate size: a company traded in the most important stock exchanges can be considered adequately sized.

Strong Financials

Can the company generate wealth and weather a financial storm?

• Current assets are twice the current liabilities. 
• Long-term debt shouldn’t exceed working capital (current assets - current liabilities)
• Profitability in the last ten years

Moderately priced

A company is priced on a multiple of its earnings, usually EBITDA, which stands for Earnings Before Interest Tax Depreciation and Amortization. Some people like to price companies over projections. I also love to do it when selling, but when buying, it is best to stick to past earnings when calculating a price multiple.

There are many reasons to use past performance. The most important is that the past is the only way to adequately compare prices, as each company will have its way of making projections, which will likely be off anyway in the long term. Looking at the past will allow you to compare P/E (price over earnings or earnings multiple). 

Price will vary widely on the stage of a company:

• Owner-operated with under 10M in revenue and 2M in profits averages a multiple of 2,5.
• The same company but professionally managed will average a multiple of 4,5.
• A company with over 10M in revenue and 2M in profits will sell for an average multiple of 15.

At current prices, you can find stocks of large corporations from as low as 3x its profits to as high as 627x (AMD). I’m not saying AMD is not a solid company, but buying it a 627 PE is speculation.

Benjamin Graham recommends a multiple of 15 as a reference for stock-traded companies. Any company that will take more than 15 years to repay the initial investment can be risky, and I prefer to stay clear.

Adequate Returns

I think that dividends are my actual return, and capital gains are a bonus. I want to own a company and get an ROI for life. For me, adequate returns are 4% or higher. This allows me to use the 300x monthly expenses to calculate how big of a portfolio I need to be set for life.

If you are growing your portfolio, you might need a more significant return. Would you like a tool to help you calculate your desired return on investment? Let me know in the comments below.

Bottom Line

Deciding whether to invest or not in a company takes time and effort. Don’t invest in anything because some guru says an investment is hot. More likely than not, there’s something in for him and not for you. Don’t speculate more than you can afford to lose.

You don’t need to take big risks to get more significant rewards; you need time and effort to research where to invest.

How about small companies?

Know there’s a much higher risk, and you are most likely on the speculation side.

The most significant difference lies in principal safety. If you can guarantee the safety of the principal and get a return, you are investing. Otherwise, you are not.

If you can, avoid investing your money—that way, principal safety is guaranteed. You can only do this when bringing capital to the table in other forms: experience, network, knowledge, or any other way of wealth generation. You will be using that capital to fund your purchase because sellers, rightfully so, expect money in their pockets. There are many ways to get it, and increasing profits or wealth generation is one of them.

Another form of investment is with our time.

If nothing else, what I would like you to take from this newsletter is that you don’t trade hours for dollars, euros, gold, or whatever currency you can think of.

Let me repeat this, never trade hours for payment.

Why do I say this? Because this is a trap. If your work more hours, you will get more money and might trade your most precious asset for a number in a computer. You will find plenty of people in your life and media that have plenty of money but are deeply unhappy. Some even take their own lives. It’s a disgrace.

We all have 24h a day for how many days we live. Living well will likely extend your life. Living miserably will, most likely, cut your life short.

As I see it, a part of the day needs to be used to care for myself and my family: sleeping, eating, moving, connecting and spirituality, and enjoying the days on this Earth. Without this, you’re setting yourself up for failure.

The rest should mostly be invested in growth and service through our life mission. Yes, we all have one.

We must make daily decisions on how we invest our limited time. If we don’t, life will decide for us, which tends to be a bad investment. Be very aware of how you use your time.

So how to choose whether to invest in a company or not?

If investing money, preserve its value and get adequate returns. You preserve the value by investing in strong and profitable companies at a reasonable price.

If investing in other forms of capital, be clear on how you will create wealth to assess an adequate return.

When investing time, don’t sacrifice your basic needs (principal), and be clear on what you’re getting in return.

How do you approach your investments? I’d love to hear your perspective.

Peace and Goodness my friend,

Lourenço Czernin