Investing, for many, can feel like a daunting task. It’s not only a question of where to invest but how. However, one particular approach to investing is gaining popularity. Accounting-based investing, which was brought to us by financial expert Joel Litman. This strategy emphasizes the importance of a company’s financial statements and accounting practices. This article will delve into the art and science behind this investment strategy.
What Is Accounting-Based Investing?
Accounting-based investing is a strategy that Joel Litman perfected. It focuses on aspects of a company’s financial statements that traditional approaches ignore, such as free cash flow and return on invested capital. From those metrics, you can uncover what Joel might consider to be “hidden gems.” Companies that are undervalued according to other lenses of investing. This provides a unique opportunity for investors to win big. There are clear examples of how this has played out for him regarding his most recent stock picks and recommendations.
The Origin of Account-Based Investing
Account-based investing is nothing new. It’s actually been around for decades. However, it wasn’t until Joel Litman developed a more strategic approach to this strategy that it rose in popularity. His company, Valens Research, provides investment research using this exact approach.
KPIs Account-Based Investors Monitor
As mentioned, account-based investors measure non-traditional metrics to evaluate potential investments.
Free Cash Flow
Free cash flow measures a company’s ability to generate cash from its operations after accounting for capital expenditures. Accounting-based investing emphasizes the importance of free cash flow because it provides a more accurate picture of a company’s financial health than metrics other investors use, like earnings per share. Free cash flow alludes to a company’s ability to pay dividends, buy back shares, and invest in growth opportunities.
Return on Invested Capital
Return on invested capital (ROIC) measures a company’s ability to generate returns from its investments. Accounting-based investing considers ROIC a crucial metric because it provides insight into a company’s ability to earn a return on its invested capital. A company with a high ROIC generates significant investment returns, indicating a potentially profitable investment opportunity.
Management quality is the effectiveness and competence of a company’s leadership team. Accounting-based investing highlights the importance of management quality because effective management can crucially impact a company’s financial performance. A strong management team can make a world of difference, including making better strategic decisions, improving operational efficiency, and driving growth opportunities.
Market position is a company’s competitive position in its industry. Accounting-based investing considers market position an essential metric because a company’s competitive advantage can drive long-term growth and profitability. A company with a strong market position has a greater chance of generating higher returns on invested capital and sustaining growth over time.
How Account-Based Investing Compares To Traditional Investing Methods
Traditional investing methods rely heavily on surface-level metrics such as a company’s stock price and other market factors to determine the best investments. Accounting-based investing relies heavily on what other investors are ignoring, the underlying financial data of a company. This allows investors to get a clearer picture of the company’s financial health and potential for growth.
The Underlying Benefits of an Account-Based Investing Strategy
There are two main benefits for investors regarding this strategic approach. Let’s dive into them.
Uncovers Hidden Growth Opportunities
By diving into a company’s financial statements, accounting-based investing can uncover hidden growth opportunities that may not be immediately evident through a traditional approach. A company may have undervalued assets or hidden revenue streams that this type of accounting analysis can reveal.
Provides an Accurate Picture of a Company’s Financial Standing
By analyzing a company’s financial statements, investors can determine whether a company’s earnings are sustainable and whether it has a solid financial foundation. This makes investors feel more confident and know the future of the companies they wish to invest in.
How You Can Benefit From Joel Litman’s Investment Strategy
You may not have decades of experience like Litman, but luckily you don’t need to in order to reap the benefits of his game-changing approach to investing. Joel Litman’s Hidden Alpha research allows investors like you to make strategic investment decisions and profit from them. Not sure? Read our recent review of what Hidden Alpha has to offer.
All in all, Joel Litman has paved the way for investors to make more informed investment decisions that have the potential to yield more prominent and better returns.