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Your Advanced Homework: Dig into the Details

Editor's note: This was originally published on RealMoney. It is being republished as a bonus for readers. To subscribe to RealMoney, click here

There is more to doing the homework than just running screens and reading filings. Compiling a list is the starting point, not the finish line. You have to read and dig through the financial statements of the companies. You need to review management's thoughts on the business and the outlook for the next few quarters. Publicly traded companies have to file quarterly reports complete with financial statements. As a long-term value investor, I have to read them to know what I am buying.

I start with the balance sheet. I make no secret that I am one of the few remaining book-value-oriented investors on the planet -- a curmudgeon before my time. The first thing I like is intangible assets. Most screeners do not adjust for tangible book value. I back out any and all intangibles such as goodwill. I know this a valuable accounting tool but there is not way to immediately monetize goodwill so I subtract it.

The next question to consider is what are the assets? Is it oil in the ground or oil in a tanker? They are worth substantially different amounts. Is it property owned for decades in a metropolitan area? The value may well be understated. Are the assets primarily inventory, which may be outdated and difficult to sell? Are inventories rising faster than revenues? How much debt is there and what is it as a percentage of total equity and assets? Are the assets liquid?

How much cash per share does the company have? If they have a large portfolio of securities, do I understand what they own? That one single question kept me out of major banks starting in 2007. After better than two decades of trading and researching banks, I simply could not decipher what they owned and what the risks were.
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