Determining the value of a company

Every year, Nigerians invest billions of Naira in the stock market, but only a few people consistently make money in the long term. The difference between those who make money and those who don't is rarely luck; it's understanding what to look for before you decide to buy a company's stock.

Buying a stock based solely on its price or on tips from social media gurus is not a reliable investmentAn asset or commitment of money made with the expectation of future income, growth, or both. strategy. A stock can appear cheap or popular while having underlying problems in its company's business model. Over time, these weaknesses can affect demand, reduce revenue and cause its market valueThe price at which an asset could trade in the market at a given time. to decline sharply.

Before investing in any stock, it is important to analyze the company behind it.

This is the first part of a three-part series on evaluating stocks before buying. In this part, we'll focus on understanding the company offering the stock. By the end of this article, you should be able to:

• Analyze a company's business model
• Examine the company management's experience and track record
• Use its market cap to set growth expectations

#Analyzing a Company's Business Model

A company worth investing in sells something people want, collects payment reliably, and has leadership that keeps it growing. Analyzing the company behind a stock helps you set realistic expectations. A company's size, industryA more specific group of companies with closely related products or services. and management all influence how fast it can grow.

#Understanding What Drives the Company's Revenue

You are betting on the future revenue of a company when you buy its stock. You need to understand what the company sells, who pays for it, and why they choose it over alternatives.

Understanding the company's history and current operations can help you predict where it is headed and if you want to be a part of it.

Let's assume we want to buy Okomu Oil stock. To help us understand the company, we would analyze:

i. Product/Service

We'll get this information from the Okomu website. There is a 'Product and Sales' option at the top of the page. This leads to a drop-down list of its products (oil and rubber). If you select any product on the list, you'll be led to a page that explains what the product is about, where it is extracted from, what it can be used for, and the company's 2024 production rate.

ii. Customer Retention

Most companies do not directly provide their customer retention rate, so to get this, we will be analyzing its growth in revenue from the sales of its products (this gives us insight on its demand) and cash flow (to see if its customers are struggling to pay). These metrics provide clues on the company's retention.

To get the financial statement of any company on the Nigerian ExchangeNigeria's principal securities exchange, where listed shares, bonds, ETFs, and other instruments trade., go to NGX Group.

From the list of stocks provided, search for the specific stock you want to research.

When you click on the name, a page containing its company profile, trading information and financial statements will appear.

Scroll to the section on financial statements and search for the document you want.

You can also get OKOMUOIL's financial statements from its website under the 'Corporate GovernanceThe system of rules, oversight, incentives, and accountability through which a company is directed and controlled.' section. Some companies like Presco Plc have its statement listed under the 'Financial Report' section.

Let us look at the Annual Reports and Accounts for 2024.

In OKOMUOIL's statement of profit and loss, there is a row for 'revenue from contract with customers.'

This gives us the amount the company made from selling its core products to customers. From the data provided above, we see that Okomu made almost two times more money from sales in 2024 than in the previous year. This means that the demand for the product increased. To get an accurate grasp of this, it is better to compare data from at least 3-5 years.

Next, we will check its statement of cash-flow.

A positive net cash-flow from operating activities generally indicates that customers are paying for the products they order. If an increase in revenue from customers is not accompanied by an increase in net cash-flow from operating activities, it means that the customers may be getting the products on credit or delaying payments.

From the data provided by Okomu, we see that the net cash-flow from operating activities also increased by almost two times when compared to the previous year. This means that customers are not struggling to pay, which is a good sign.

Not all companies give good signals on their customer retention rate. Let's look at the 2022 annual reportA yearly publication containing financial statements, management discussion, governance information, and other disclosures. of Pharma Deko PLC, a pharmaceutical brand.

Under its statement of profit and loss, we see a revenue decrease recorded in 2022. The total comprehensive income for the year also ended in loss. This means that the demand for its product dropped.

Let's look at its cashflow statement.

The net cash from operating activities also ended in loss. This means that sales do not cover its production cost. This is not a good sign.

If you are buying a stock where the company's sole offerings are subscriptionThe process of buying new units in a fund by submitting money and a valid instruction. services (for instance, buying HubSpot stock), you can assess its customer retention by looking for the growth in customer base. Some of these subscription-based companies may even give data on revenue retention rate.

From the data provided, you see that HubSpot's customer base has been growing steadily for the last 3 years while the average revenue generated from subscription per customer increased in 2023 but decreased slightly in 2024. Its net revenue retentionRecurring revenue retained from existing customers after upgrades, downgrades, and churn. (which is the percentage of recurring revenueRevenue expected to repeat under subscriptions, contracts, or ongoing customer relationships. retained from customers) dipped slightly.

Overall, the data tells us that HubSpot has been growing their customer base and increasing the revenue they generate per customer, meaning that customers were willing to pay more for the services.

Let's look closer at its retention rate.

Net Retention Rate is the amount the company made from their existing customers. If it is 100%, it means that the company made exactly the same revenue from their existing customers as the previous year. If it is below 100%, then the existing customers either downgraded their subscriptions or cancelled out entirely.

From the data, we see that HubSpot made 10.3% more revenue from existing customers in 2022, 3.9% more in 2023, and 2.2% more in 2024. This means that while it retains customers, the amount these customers spend is decreasing slowly.

iii. How Customers Perceive the Company

One way to check customers' perception is to get their reviews from third-party sites like Trustpilot and Google Business Profile. But this method only works if the business is an app, e-commerce, or sells to consumers directly.

For businesses like Okomu which sell to manufacturers and export traders, a better way to assess its value is to check its inventoryGoods held for sale, production, or consumption in the production process. movement.

Looking at OKOMUOIL financials, we see three items under its stock section:

• a. General stock and agricultural consumables:- These are products that support operation. They include tools, fertilizers, etc. They are not sold.

• b. Finished goods — Palm and Rubber products:- These are the company's products that have not been sold. It indicates demand. If it increases, it means that its customers are reducing demand and the company is stocking more products.

From the above data, we see that Okomu's stock on finished goods decreased in 2024. This means that demand is good.

• c. Goods-in-transit:- These are products that have been ordered but have not gotten to the customers. It gives us an idea of its shipment. From the data, we see a 3,617% increase in shipment in 2024.

From this financial statement, we see that Okomu is converting its stock of finished goods into sales. The demand rises as its customers continue to find the company valuable.

#Market Capitalization

Market capitalization is the current market value of a company's outstanding stocks. It shows how much the market believes a company is worth, calculated by multiplying the total number of outstanding shares (all issued sharesShares that a company has formally created and allocated to shareholders. held by investors, insiders, and institutions) by the current stock price.

Market cap tells you how fast a stock can realistically grow and how much volatilityThe degree and frequency of price or return fluctuations. to expect. Large-cap companies are more stable because high trading volume means it takes significant capital to move the price in any direction, resulting in slower but more predictable price growth. These should be approached with lower growth expectations but higher stability. Mid-cap companies offer moderate growth potential and stability. Small-cap companies may deliver faster growth but come with higher volatility and risk.

To determine if a company is a large, mid, or small cap stock, you have to:

• i.- Check the current equity market cap (which is the combined value of all listed company shares on the stock market) on NGN Market.

• ii.- Assess if the market cap of the stock you want to buy is in the upper, mid or lower range in relation to the equity market cap. For instance, the market cap of Okomu Oil is 1.2 trillion Naira, but the equity market cap is 105.9 trillion Naira at the time of writing.

This means that Okomu Oil is a mid-cap stock as the current stock with the highest market cap is 14.4 Trillion.

Mid-cap stocks like OKOMUOIL often grow faster in price than large-cap stocks like BUAFOOD. This is because a smaller company requires less growth in revenue and investor demand to significantly increase in market value. This means that while you can expect faster growth in mid-cap stocks, you also need to accept that it comes with more price fluctuations.

#Management and Ownership

A company's financials can look strong and still deteriorate under poor leadership. When you buy stock, you are betting on the decisions of the people running the company. Three metrics help you assess whether that bet is sound.

#i. Track Record

The track record of a company's management team shows you a history of their professional performance and qualifications. It can be used to predict the future performance of the team.

Some companies like Okomu have a list of their directors on their website. For other companies where it is not listed, you can get this information from the company's profile on investing.com.

The data above shows the list of directors of Wema Bank provided on investing.com as an example of how this information is displayed on the platform. We will now apply the same approach to Okomu Oil.

One-third of Okomu's directors have spent over 10 years on the board, with the chairman spending 33 years.

The chairman, Gbenga Oyeboye, was the chairman of Access Bank Plc and MTN Nigeria Plc between 2005-2015 and 2001-2019 respectively. He is also currently the chairman of Nestle Nigeria and Lafarge Africa Plc, all of whose market caps exceed 1 trillion naira.

The managing director, Dr. Graham Hefer, has a Ph.D in Agriculture and has over 25 years experience in the industry.

This shows that the company's directors have industry experience and have led other successful companies. This history gives us a positive signal on what Okomu's future performance may look like.

#ii. Do They Own the Company's Shares?

When directors own their company's shares, their personal wealth is tied to the company's stock price. This discourages short-term decisions that may increase their bonuses but harm the company's long-term growth.

From the data above, you see that the chairman and two other members of the board own shares in the company, though none of these positions exceeds 5%. A stake below 5% is relatively small, meaning the directors have some skin in the game but their personal financial exposure to the company's performance is limited. This is not necessarily a red flag, but a higher ownership percentage would provide stronger alignment between management decisions and shareholder interests.

This information is gotten from the 2022 Annual Reports and Accounts.

#iii. Transparency and Capital Discipline

To assess how the board manages the company's capital, check the balance sheet (statement of financial position) and cash-flow statement.

In the 'current liabilities' section, we see trade payables increase slightly. This means that the company is funding part of its operations using credit from suppliers. Unlike bank loans, supplier credit is typically interest-free and short-term. Relying on it instead of debt is good capital management because the company gets the benefit of deferred payment without paying interest.

In the 'amount falling due after one year' section, we see the long-term loan decrease. This confirms what the trade payables tell us: instead of accumulating debt, the company is paying it down and relying on interest-free credits from suppliers.

The total net asset also increases.

From its cash-flow statement, we see that the net cash inflow from operating activities increased slightly above two times the previous year.

From the cash-flow from investing section, we see the company has been spending money on assets (PPE and biological assets) that can increase production. We also see that instead of keeping money idle, the company has been investing in interest-bearing instruments (noted as finance income received). This return on the investment increased almost two times compared to the previous year.

#Final Thoughts

Investment mistakes often happen before a stock is ever purchased, when investors skip the work of understanding the company behind it. Without examining how a company makes money, who runs it, and how large it already is, investors are left setting unrealistic expectations.

By learning how to evaluate stocks based on a company's business model rather than hype or popularity, you reduce the risk of costly mistakes.

But this first step alone cannot help you make an informed decision. In the next part of this series, we'll cover how to examine the stock itself and how liquidity, debt level and revenue should affect your investment decision.