Having outlined the context in the previous chapter, we will now create a ‘limited resource’ approach to equity research. The name reflects our position as retail investors having access only to a few resources – the internet, company annual reports and MS Excel.
In contrast, Institutions have the advantage of human resources (analysts) and access to company management plus financial databases such as Bloomberg, Reuters and Factset, in addition to industry reports.
The aim here is to show how one can gain a better understanding of companies and their businesses using these limited resources, always keeping in mind the ultimate goal which is making the decision whether or not to buy a stock.
To conduct a thorough analysis of a company, the following steps are involved:
At each stage, multiple steps must be taken; shortcuts should not even be considered. Every step is necessary in order to succeed.
– What’s the difference between Stock Price & Business Fundamentals
When conducting research on a company, it is important to take the time to understand the business thoroughly. Going straight into a stock price analysis may be useful for short-term investments, but for longer-term success, grasping the company’s operations is key.
You may ask, why is it so essential? The answer is straightforward: the better you know the firm, the stronger your conviction to stay invested in it – particularly during bear markets.
Bear markets cause price reactions unrelated to business fundamentals. If you have a good grasp of the company and its operations, then it implies that keeping your money in it makes sense even when the overall market disagrees. It might sound hard to believe, but bear markets often produce valuable opportunities if you have a strong belief in the company. Mastering this skill requires many years of practice in investing.
To gain insight into the company’s progress, we can check the company website and its annual reports over the last 5 years. Examining these documents should give us an indication of how they have fared in past economic cycles.
– How to understand the business
In order to gain a better insight into the business, we must create a list of inquiries that can be answered by referring to the company’s annual report and website.
These queries, each accompanied by its rationale, should help us in our pursuit of understanding the business.
These thought starters are designed to help you get a better grasp of any business. Asking and then answering these questions will spark new inquiries, each of which must be researched in order to provide the most comprehensive comprehension.
It doesn’t matter which corporation you are scrutinising – if you follow this Q&A approach, it’s nearly certain that your knowledge about it will expand significantly. By inquiring deeply and exploring the details, you will be able to reach a fuller understanding of the enterprise.
Take note of the first step in the equity research process. If any red flags come up while uncovering answers, it’s wise to abandon examining the firm regardless of how appealing it might be. There’s no point continuing to the second phase if something doesn’t feel right.
My experience has shown that it takes around 15 hours to complete the initial stage of equity research – ‘Understanding the Company’. Compiling my thoughts into a concise information sheet helps provide a comprehensive overview of what I have learned – if I cannot do this clearly, then it’s an indicator that more research is required.
Once this step is completed, stage two can commence: “Application of Checklist”. It’s essential to be aware of the respective order and not to move on until each step has been completed.
We will now head to the next phase of equity research: trying out our checklist on a specific firm. Undertaking this should give us a better sense of Stage 2.
Throughout this module, we have worked with Amara Raja Batteries Limited (ARBL), so we should evaluate the checklist on them too. However, although the company might vary, the framework for equity research stays constant.