Fundamental Business Valuation Process

Everybody has a method of researching and analyzing companies. Whether we abide to our own set rules or not, the more important point is that we have a process that we adhere to. Whether you day trade, look at technicals or do it mechanically, a process which you can follow and continually improve is a definite requirement.

The following is a process I (usually) stick to except for special situations such as arbitrage, spinoffs and net nets.

Finding Investment Ideas

Business Valuation process

Business Valuation process

Business Valuation Process | Flickr: donekyhotey

There are many sources of finding investment ideas. Ideas may come from the following:

  • screens
  • blogs and quality sites
  • newspapers
  • books
  • magazines
  • performing everyday duties (Smuckers, Midas, Safeway etc)

I’ve previously written about ways to find ideas.

Rundown of the Business

Once I’ve found a company of interest, I perform the following actions and try to answer a series of questions.

  • What does the company do?
  • Go through the latest 10-Q or 10-K statement and quickly review the financial statements. Can determine whether to pass or go on after 30sec -1 min.
  • Quickly estimate an intrinsic value via DCF, Graham, PE, NNWC methods to get an idea of the buy price range

If the above information leans towards a favorable investment, the next step is to read up on the company.

Researching the Business – Business Valuation Process

  • Competitive advantage (moat) to determine whether it is a short term, mid term or long term investment
  • Management (compensation, company perks, previous performance)
  • Business model
  • Strategy compared to competitors
  • Growth (I don’t place a heavy emphasis on growth)
  • Risk (the company knows its risk better than anyone. 10-k’s provide a detailed list)

At this point, I know what the company does and how it intends to go about do it. The next step is to see whether they are doing it properly.

Analyzing the Business

  • Detailed look at the financial statements line by line for the past 2 or 3 years of 10-K filings and then 10 years with the spreadsheet)
  • Competitor numbers (compare with spreadsheet)
  • Come up with a buy price with conservative and realistic figures

Management can always talk the talk, but the numbers prove whether they have been walking it as well.


Psychological Questions

I’ve recently added a psychological section after some recent bad mistakes. I must admit this is by far the hardest section to answer but one has to be brutally honest.

  • Am I giving more weight to recent data and events?
  • Did I think a fact was obvious beforehand?
  • Have I looked at the situation from different scenarios? (Company loses money, no growth, growth etc)
  • Am I influenced by the way the data is presented preventing me to perform the required work?
  • Am I overconfident in the analysis because I work in the industry or otherwise?
  • Have I reviewed the negative factors?
  • Am I over-weighing the negative factors creating too much loss aversion?
  • Am I buying just to average down?
  • Am I slow in changing my opinion?
  • Am I ignoring potential risks because of the reward?
  • Am I willing to purchase because I spent the time researching? Obligated to buy?
  • Is there a bias because everyone else is recommending to buy?
  • Am I refusing to sell for any reason? Attached?
  • Is the information I am using a consensus that can be false?
  • Do I have an exit plan?

How Much Data?

  • 10 years of statements from spreadsheet to get an idea
  • Detailed reading of annual reports – 2 or 3 years worth. Mostly going through the risks and management discussions and footnotes.
  • Quarterly Reports – 1 or 2 quarters. Looking for any new changes. e.g. off balance sheet obligations, footnotes.
  • Latest Proxy – looking at compensation, stock options, the board members, company perks such as jets or cruise ships.

This is how you do the proper Business Valuation Process. Do you have a process of your own?

Ready to try Old School Value?