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How to suss out if a company's top quality before investing in shares

by , 07 July 2015

Investing is all about finding great businesses to buy into.

When you buy shares, you become a part owner in a business. So it's vital you pick the best quality business to put your money to work in.

So how can you determine if a company is a great business or not?

Read on to find out…


Find the best shares to buy with this quality measure


A great way to test a business before investing is to look at its return on net tangible assets. This may sound rather complex, but this is a fantastic way of measuring the overall quality of a business.

It’s similar to return on equity (ROE), but has some differences.

By looking at a company’s returns against its net tangible assets, you remove goodwill from the calculation. Companies with large amounts of goodwill tend to show higher returns. Goodwill includes the value of intangible assets like brands.

Also by looking at a company’s returns against its net tangible assets, it rewards those that can borrow most of the capital they need because their results aren’t cyclical, Porter Stansberry in Daily Wealth explains.


How to calculate return on net tangible assets


To find out a company’s net tangible assets, you just need to look at its balance sheet. You need to compare this to the company’s net income, which you’ll find on its income statement.

If you use Coke as an example, it had net tangible assets of $3.9 billion. Its net income was $7 billion. This means it earned a return of 179% (($7 billion/$3.9 billion) x 100) on its net tangible assets.

This is an amazing return.

If you’re looking at a company that has more liabilities than tangible assets, you can’t perform the above calculation. Instead you need to remove the long-term portion of a company’s total liabilities.

This measure is a great way to weigh up the quality of a company. You want to see return on net tangible assets of 20% and above each year.

So there you have it. How to suss out a company’s top quality before investing in shares.

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How to suss out if a company's top quality before investing in shares
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