Risk, Uncertainty and the Best Strategy for Your Business

A blog post by Dr. Ben Nunnally

The best strategy for your business is one that is well-informed – and the best way to become well-informed is by a true understanding of your company and its competition. The recent history of your company and its competitors is all contained in your financial statements and the operating, financing, and investment data – or cash flow information – from your competitors. Do you know how to read it?

Financial statements help decision makers forecast their firm’s short-term cash needs, understand the components of cash flow, understand and measure their firm’s sustainable rate of growth, and realize the underlying, and very important role, of capital markets.

Knowing your company and industry is certainly essential, so is understanding what is, and is not controlled by management, when alternatives are considered, and decisions made. The successful decision maker will be conversational with the operating, financing, and investing characteristics of the business – insight gained primarily from the analysis of financial statements.

Though benchmarking data is outside your own company, understanding it allows you to put into context the larger implications of internal decisions. The context of information can be just as important as the data itself.

Let’s take a look. Only given the information below, which company’s stock represents the best value, and why?

A given in investing is to “buy low and sell high.” A fine rule. However, it is crucial to understand the meaning of “low” and “high” in this context. The two companies, A and B, should be compared to a reasonable benchmark. In this case, Standard and Poor’s 500 list of common stocks. Again, using only the data shown, Company A is the better choice.

The “market” is valued at 22 times earnings, but Company A is below that level, meaning it is selling low as of the date of the data shown. Moreover, its return on equity is better than the market. Therefore, Company A is performing well in terms of investor return, and is not “overpriced” relative to the benchmark (the S&P 500).

The opposite is the case for Company B. While the foregoing information can be gleaned from financial statements, the statements contain comprehensive company information, allowing for a much deeper valuation analysis than what is described in this example. See, for example, “Financial Reporting and Firm Valuation: Relevance Lost or Relevance Regained?” by Luzi Hail