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These Seven Variables Can Help You Become A Better Investor

I used to work as a performance analyst in one of the biggest sugar manufacturers in the world. The work was never ending – strategic plans, budgets, and forecasts.

The main lesson that I learned was that every budget or every plan is inevitably wrong. I did, however, learn one thing (or should that be seven things) – the “Seven Variables.”

If you can’t prepare a budget in half an hour by identifying up to a maximum of seven variables, then you do not understand the business“, my finance director and mentor used to say.

He went on to explain how he identifies seven variables in a business with annual sales of about 1 billion pounds and prepares a budget in less than 15 minutes.

As investors, have we asked ourselves whether we really understand the business that we invest in? Can we name the seven key variables that explain up to 90% of the profit of a company?

Let’s take an example of a company such as First Resources Ltd (SGX: EB5).

Established in 1992, and listed on the Singapore Exchange since 2007, First Resources is one of the leading palm-oil producers in the region, managing over 190,000 hectares of oil palm plantations across the Riau, East Kalimantan and West Kalimantan provinces of Indonesia.

The above is a basic introduction of the company. Using the idea of the seven variables, we can identify the following as important metrics to help us understand the company.

  1. Fresh fruit bunches yield (FFB yield) per hectare
  2. Oil extraction rate
  3. Cost of production per tonne of crude palm oil
  4. Average age profile of trees
  5. Price per tonne of crude palm oil
  6. Total land area (planted and unplanted)
  7. Capital expenditure for new plantation

By recognising the seven key variables, we can make better assumptions about the future performance of the company.

Moreover, we can ask better questions such as “Can fresh fruit bunches volume increase?” or “Can we increase the extraction rate through improving technology?

So the next time before you invest in a company, ask yourself this question: “Can I name the seven key variables that drive the profit of this company?

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Lawrence Nga doesn’t own shares in any companies mentioned.