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
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
- 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)
- View how to analyze a business via the income statement, balance sheet and statement of cash flows.
- You can tell whether management do what they say by analyzing the margins and other performance metrics such as CROIC, FCF, ROE.
- 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.
March 10th, 2009 at 6:13 pm
I’ve always thought about publishing my research process. Now it’s great that I don’t have to since you’ve done an awesome job here!
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March 11th, 2009 at 9:37 pm
I had never planned but now that I have it written down point by point, it’s easier for me to go through.