I want to write an investment thesis. How do I even get started?
A while back I noticed this post: https://www.wallstreetoasis.com/forums/on-the-job-with-simple-as-my-research-process which details the research process for investing in stocks. I found it incredible helpful, but one thing I'm wondering now is how to even pick a company to research in the first place. Where should I look? What should I stay up to date on? What articles/reports should I read? How do you guys know which company to pick before you do your "deep dive" analysis? Obviously a novice in this area, so I really appreciate the help!
Here's an example:
I just randomly go on a stock screener (say, Yahoo Finance). Play around with it, and search for American metal fabrication companies. Here's a sample list of companies that popped up with their P/E ratios:
Thyssenkrupp AG - 0.50
Worthington Industries - 4.45
TechPrecision Corporation - 134.00
That's literally three different companies you can analyze, one of which has a very low P/E ratio, one which is more normal, and one which is extremely high. Let's go with Thyssenkrupp.
Now, if the P/E ratio is that low, there's obviously some sort of a reason for it, and the first step has to be to figure out WHY the market is pricing the stock so poorly. Within literally 30 seconds of looking at the financials, you would find that it is a company with very poor profitability - gross margin is close to zero, and operating income is very negative. The only reason the net income is positive is because of $15 billion added into the income statement from "Earnings from Discontinued Operations". This is from the elevator segment that they sold off to bolster their balance sheet, and the market knows that despite this one-off bump in net income, the underlying business is still fundamentally flawed. So, at first glance, it seems that the market isn't pricing the stock based off of net income, which is highly distorted.
Now, armed with that information, dig into any news you can find about the company. Figure out which segments they operate in, and try to research the markets for each of those segments. Dig into the main drivers for the company's profitability. You'll start to get a better feel for the company, and you'll know the right questions to ask after that.
Keep in mind that this is just how to get STARTED - it's obviously a lot more complicated to do a proper deep dive analysis on a company.
Thanks! This is good advice.
This is good advice but make sure not to talk yourself into an idea i.e do the research before deciding what might be good to invest in. Do some top down macro/industry analysis as well as bottom up company analysis.
I work in Rates (dabbling in equities on the side), so a fellow outsider's perspective might be helpful here.
In the terminal state, as a professional covering an industry, you are already familiar with its "big picture" landscape and the dynamics of companies within it. You are already following some names (e.g. read the 10K/Qs, listen to the earnings calls, talk to management, read sell-side research). You will probably come across new names (which can be new entrants, companies that are now big enough to matter, or recently vertically expanding up/down stream into the industry) by hearing them mentioned in the aforementioned channels, and you will develop a backlog of companies to look into.
As someone who is just starting to look at a new space, understanding the "big picture" industry landscape is a must. A company does not exist in vacuum, so you need to understanding the sector trends, what the competitors are doing, who are the clients and suppliers and the dynamics are there.
So, what does that mean for your strategy of choosing a stock to research? You should probably start by picking an industry and understanding it high-level first. Here, having access to sell-side primers would be a valuable resource and first read to understand what is important within an industry, but you can gather this information yourself (besides, doing this exercise manually is instructive).
Step 1) Pick an "entry point" stock in the industry. Do not stress to much about what this is. Why? Almost always the stock you end up pitching / investing in is not your "entry point" stock, perhaps not even a close comp.
Step 2) Grab a few comps' latest 10Ks and look at the qualitative sections describing the business and quantitative sections describing the financials. You will start seeing similarities across these similar companies as to what generates revenue, what are growth areas, what's the gross/EBITDA margin profile, capital intensity, cyclicalities etc. The similarities will define your "industry profile", and the differences are the idiosyncratic company characteristics that will ultimately lead to the "alpha".
Step 3) Now do Step 2 with Earnings Calls ( there's a free app called Quartr that has aggregated Earnings Calls in audio & transcripts). What does management focus on in their prepared remarks, and what are analysts' questions focused on? Again, similar topics that come up across competitors will highlight the industry trends, and differences will define idiosyncratic company strategies and/or reactions to those trends.
Step 4) Now, look vertically across the value creation chain in a space (which can span industries and even sectors): customers, suppliers, of your "entry point". For example, if you are looking in the travel space, no matter if your starting point is DAL or EXPE, you should strive to understand, to a certain extent, both companies, as well as the wider space (Travel suppliers like airlines and hotels, OTAs, GDSs, TMCs, Metasearch etc). How do these companies, sitting in different places in the value creation chain, share the economics? And what are the trends? Answers to these questions will highlight areas within this vertical that are in secular rise/decline, and then the idiosyncratic parts of Step2 & 3 will point you to companies that are most exposed to these trends. And those are the companies you will ultimately pitch/invest in.
TLDR: Picking a starting stock might not be as important. There is no way around understanding the ecosystem around a company. Pick an industry you are interested in, find a quasi-random entry point stock, and start forming a view, horizontally (what defines that industry and what the trends are), as well as vertically (suppliers, customers and how they fit into the ecosystem). The company you end up pitching/investing in, will likely be something that is a few steps removed from your entry point, but the important part is getting that "big-picture" view, which is a fixed cost that you need to pay, but will pay dividends going forward.
Thanks, great input!
Saepe eaque quis minus. Enim reiciendis eos perspiciatis optio occaecati molestias architecto. Non illum omnis est tenetur ratione odit.
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