Chapter 15
What do owners and investors look for?

Active owner-managers review their company financial statements with a great deal of behind-the-scenes knowledge. Inactive, or silent, investors often don’t have this background, so their perspectives on your company’s financial statements are different.

Would-be trucking entrepreneurs might have technical and managerial knowledge but need financial backing to get loans to start the company. Silent investors, known as “angels,” are rather rare. Experienced business people often back young and promising managers in starting a company, but you must be lucky enough to know them.

Most of this chapter doesn’t directly apply for the vast majority of small trucking companies. Ownership typically is held by a family or one or two individuals; outside equity investment is rare. But it’s interesting and perhaps even useful to think of yourself as an outside investor. It’s an exercise that may lead you to think more critically about your own management performance.

What would investors look for in your company’s reports? One way to find out is to examine the type of reporting that publicly traded trucking companies commonly present. A good summary of this information is available on the Internet at http://biz.yahoo.com/p/trucksconameu.html. Here you’ll find the Yahoo Investments “Research by Industry — Transportation Truck” recap of the top 35 or so transportation stocks, along with price charts, research and current company news.

Investors are interested primarily in:

• Earnings per share
• Value per share
• Dividends
• Return on equity
• Stability and effectiveness of management
• Liquidity or ability to sell the investment
• Outlook for the company’s future

Financial statements typically prepared by local or regional accounting firms rarely spell these items out, so investors must calculate them or determine them in other ways.

Earnings per share
Earnings per share (EPS) is the primary measure of company profitability for investors. It is computed by dividing after-tax net income by the number of shares of common stock. Most smaller companies have only one class of stock, and the balance sheet or footnotes states the number of outstanding shares. If a company’s net income is $350,000 and there were 10,000 shares of stock, earnings per share is $35.

It gets a lot more complicated if there are two classes of stock, if there is preferred stock or if the company uses incentive stock options. In these cases, there may be two calculations: Primary EPS and fully diluted EPS. The primary EPS may be calculated in the manner of the example above. Fully diluted EPS considers the earnings if all the persons who had stock options exercised them.

Accounting standards don’t require privately held companies to publish EPS data, but it’s not a bad idea if the company has several inactive owners. If your company is organized as anything other than a corporation — i.e., a partnership, LLC, etc. — you also must consult your legal documents and agreements between owners to be certain how to divide shares. For these types of entities, it’s not always along ownership percentage lines.

Value per share
Value per share is nowhere to be found in the financial statements of privately held companies. Value is what an investor will pay for shares and what you will take for them. For big trucking company stocks traded on the stock exchanges, the stock value is as close as your Internet connection or the morning paper. For privately held trucking companies, the share value depends on many factors and is almost never known precisely unless and until shares trade.

One of the variables is how much of the company, as a percentage, is being traded. A minority share (less than 51 percent ownership) is worth less than a majority share. Ownership of more than 51 percent is often valued higher than the pro-rata company value per share. This is called a control premium, because the owner of a block this large can control the company, hire and fire management, and approve or reject dividends. Similarly, a minority discount almost always applies to stakes of less than 51 percent, as the owner of this block is at the mercy of majority shareholders.

A rough baseline value is the book value per share, which, in the case of single-class ownership, is total stockholders’ equity divided by the number of shares outstanding. If your balance sheet shows $1.3 million in stockholders equity and there are 10,000 shares, book value per share is $130.

There are many ways to approximate the value of privately held companies, but the only sure way is to obtain a professional valuation study, which might cost between $10,000 and more than $25,000. Companies sometimes retain appraisers to establish values in buy-sell agreements between owners. But even a professional valuation is only an estimate because no one can dictate what someone will pay.

There are several rules of thumb, however. Databases of private business transactions show that closely held companies tend to trade in the range of two to three times book value per share, or around four to seven times earnings. Sometimes, the basis for valuation is a figure called owner’s discretionary cash flow, with common multiples being two to three times owners’ cash flow.

Dividends
Dividends are all-important to investors, because they often are the only cash stockholders receive. Public companies generally pay dividends quarterly, and the dividend yield is computed as the annual dividend divided by the stock price. Common yields for public companies are 1 percent to 2 percent, and investors trade low payouts for a chance to gain on the upside when the stock price climbs. Owners of small companies with limited upside stock price potential will likely not be impressed with such low payouts.

Small companies rarely pay dividends. If they do, dividends are small, as some of the earnings must be reinvested to grow the company. One number investors should watch is the dividend payout ratio, which is the percentage of annual income paid out as distributions. Growing companies often have no dividend, so their payout ratio is zero. Mature companies may pay out between 30 percent and 60 percent of annual earnings. Paying out more than 30 percent to 40 percent, however, leaves little money to keep the company growing, so the stock price suffers in the long run.

Return on equity
Return on equity (ROE) is a percentage obtained by dividing the annual after-tax income by the total stockholders equity. An average of opening and closing stockholder’s equity often is used for this calculation. If the company’s income is $350,000 and the average stockholders’ equity is $1 million, the ROE is 35 percent. That kind of total return rivals even the lofty returns of the recent stock markets. If there are significant owner loans to the company, remember to consider these before you get excited about return on equity.

Other factors
Stability and effectiveness of management, liquidity or ability to sell the investment, or outlook for the company’s future are not specifically presented in most financial reports. The big, glossy reports of public companies often have letters from the president or other documents summarizing these details, but such items almost never appear in reports prepared by local or regional accounting firms.

As we saw in Chapter 14, however, the five-year track record of the company spells that out. And as we saw in Chapter 13, financials give you the tools to evaluate management if you can find the right number for comparison.
It’s up to the investor to stay in touch with the company and other investors to evaluate management’s plans for the future and the merits of continued ownership. That’s one reason to hold an annual shareholders’ meeting — to keep investors happy.

In Summary
Investors look for quantitative information on your company — earnings per share, value per share, dividends and return on equity — as well as qualitative information, such as the stability and effectiveness of management, the liquidity of the investment and the company’s future outlook. It’s in your long-term best interests to provide as much of this information to investors as possible.