8 Simple Steps for Investment Research in Under 30 Minutes
TL;DR:
Due diligence is relentlessly time-consuming, but doing it is vital to a successful investment strategy. If you are having severe FOMO on a particular stock and don’t have enough hours in the day, that’s okay. Simple quantitative data such as market cap, critical balance sheet figures, and financial/trends, and competitive analysis, can help you determine the health and strength of a company. Qualitative data such as ownership & management, price history and action, expectations, and risks can help you determine the future of a company.
If you think you’re ready to get into investing in specific stocks, I’m gonna provide you some simple steps to get you started - for the love of God, please don’t YOLO options on $GME until you have done your homework.
Due diligence is the difference between gambling in the stock market and making educated money moves. It is, in essence, the process of comprehensively appraising a business’s value and potential. This is achieved through a blended approach of fundamental and technical analysis and is at its core the ‘why’ you would decide to put your money where your mouth is.
Yes, it’s time-consuming and much harder than trusting a friend that just 2x’d their retirement portfolio on the TSLA split or following wall street analysts that are wrong 70-80% of the time. Trust, this investigation is worth every single penny. Here are eight simple steps you can take to start doing your due diligence in under 30 minutes!
Capitalization
Market Cap = # Shares x Outstanding Share Price
Market capitalization alone gives you a basic understanding of the company you are about to invest in. In addition to size, it can give context to expectations around volatility, breadth of ownership, and the size of their consumer base. For example, at the time of this article, $AAPL has a market cap of $2.17T. This can immediately tell an investor that Apple, Inc. is by far the largest company on the planet. It's very likely to be a stable, ‘safe’ bet with broad ownership and that it has a very large end market (anyone that needs a cell phone, computer, or headphones has at least considered an Apple product). On the other end, $NNDM has a market cap of $1.78B - you may have never heard of them. That’s probably because you don’t need to use a 3D printer as often as you would use a cell phone. The market cap would nearly immediately indicate that $NNDM is more volatile, with fewer shares going around, and has a smaller end market than $AAPL.
Balance Sheet
Ew, numbers?! Yes, numbers. A lot of time can be spent on the balance sheet alone but for a more simplistic analysis,
a cursory review of the consolidated document is just fine. The company’s consolidated balance sheet will show you all the levels of assets and liabilities - paying attention to cash levels and the amount of long-term debt held. Cash on hand is like your emergency fund - does your company have enough cash for short term liabilities or for when the fan gets dirty?
On the subject of debt - if a company holds a lot of the horrid d-word, it is not necessarily a bad thing. Some business models or even entire industries are more capital intensive than others. Comparing a company’s liabilities with competitors through their debt-to-equity ratios will help you decide if the debt is problematic or worth investigating.
If total assets, total liabilities, and stockholders' equity change substantially from one year to the next, there should be an explanation. Companies usually include footnotes in their financial statements to help shed light on any inconsistencies or irregularities. The company could be preparing for a new product launch or ramping up R&D to go toe-to-toe with a competitor in an innovative space, or they can just be burning cash like Germany after WWI. What you see should start to give you some perspective on how a company is shaping up as an investment.
Revenue, Margin Trends & Valuation Multiples
More numbers?!🤮 Yes! More numbers. Luckily, these can be found on nearly any financial site with ease, including Google Finance (but there are plenty more).
Revenue and net income trends are strongly correlated to a business’s overall health. Because of this correlation, there are tons of formulas and ratios to extrapolate how the company’s performance relates to its stock price, like earnings per share, price-to-sales ratio, price-to-earnings ratio, price-to-earnings growth... I think you get the picture.
For the quick-and-dirty take, the most important aspects of the trends are revenue, net income, price to earnings (valuation multiple), and price to sales. Take note of fluctuations or consistencies (or lack thereof) - and just as with the balance sheet, any dramatic shifts should be addressed in the financial statements.
Competitors and Industries
To get a full picture of a company, you have to do the same analysis for their competitors - I’m sorry, I don’t make up the rules. But now that you have a sense of how big the company is and its overall perceived health, it’s time to consider the industries it operates in, and how it shapes up to its competitors. Compare the revenues, margins, and valuation multiple to at least two to three other major competitors. You can find this information on most financial sites, or by simply Googling ‘[TICKER SYMBOL] competitors’ - bonus points if you include the product or service line you are analyzing, but that’s getting into the nitty-gritty.
I know that this is the most tedious step on the list - but I cannot stress this enough: DO NOT SKIP THIS STEP. Every company is defined and shaped by its competitors. Price wars in ride-sharing, innovation races in computer chip technologies, EV efficiency in the automobile industry, 5-freaking-G; in order to stay competitive, your company has to compete. It has to be better than - or, at the very least, it has to be expanding into new markets and plans for generating more revenue with different products and services.
Management & Ownership
Knowing who is running the company is, well, absolutely critical. To put this bluntly, I wouldn’t hand the keys of a Ferrari to someone that has a track record of crashing cars.
Who is running the company? If it’s a young company, it could very well be the original founders. For older companies, it's important to be aware of changes in management, including the board. If there is a change in key executives or the board is shuffled, try to determine why. Look at the bios of the key executives and any new faces to see what experience they bring to the table, and how that experience can help the business (read: if someone's experience seems irrelevant, it very well may indicate that the company is about to embark on a journey to a new, revenue-driving frontier).
While you're at it, take a peek into the ownership of the company as it compares to total float - the number of total regular shares available for trading. If the managers’ and founding partners’ slice of the pie is large and the institutional ownership is substantial, that’s a good sign because it means that management is confident in their own product, and so are institutional investors. If these types of ownership are low with respect to the company’s size, that can be a massive red flag.
Price History and Action
You're probably thinking 'FINALLY - the chart!' This is normally the very first thing that new investors look at, and they’ll make assumptions based on price action. While this is actually a form of analysis used in day trading, it's also important to understand how a stock moves for investing. Without the information from the above steps, price action can lack a lot of much-needed context.
Here, you will want to determine how long shares have been trading, short term and long term price movement, and how volatile the stock has been - generally, getting a grasp for what ownership is like for investors. If a stock price is smooth and consistent, an investor can probably just sit back and see the stock creep up over time. If there are big spikes and dips in the share price, this level of volatility normally attracts short-term shareholders like day and swing traders, which presents different risk factors and overall a different profit experience as an actively traded stock. While past performance is not indicative of future success, and can (and normally does) indicate future price movement and volatility.
Expectations
This is perhaps one of the easiest steps, and it's a sweeping category that can capture any missed details from the above analysis or predictions. Many investors take the news about the economy, industries, or a specific company and they extrapolate to predict an organization's future - this creates an expectation.
The perfect example of this is $TSLA. Tesla has disrupted an industry left untouched for decades, and only now are the largest motor companies revving their electric engines. It’s likely too little too late, as Tesla is destined to eclipse the entire automobile industry in years to come, as legislation and consumer trends push the agenda for the pioneer in electric vehicles. The stock is currently trading at 1,636 times its earnings. Compared to the average PE ratio of 34, this is not just high expectations - this is arguably clinically insane expectations for growth. It has left investors scratching their heads as they are waiting for the stock to come back down from its, again, clinically insane run.
This is not to be confused with anticipation. The most common form of anticipation is upcoming earnings reports - investors and traders are anticipating price movement, either position or negative which creates volatility. But rumors, news, and much weirder things can create investor anticipation. For example on January 7th, 2021, Elon Musk tweeted 'Use Signal.' What happened next? $SIGL jumped from $7.19 to $38.70 in one day. The anticipation of an increase in active Signal users drove investors to get in on Elon's next big thing, and the response was dramatic. So dramatic, that many investors didn't do their own DD, and jumped into a stock that had nothing to do with the messaging app the playboy billionaire was even referring to.
Risks
Don’t be razzle-dazzled by all the opportunity and potential returns your perceived unicorn has to offer. Instead, put your ear to the ground and listen to the reasons people are going short on the company. Some examples could be legal or regulatory issues, sustainability or reputation issues, or unhealthy levels of competition such as burning through a moat of cash to compete in a price war (and especially, if losing that said price war).
In addition to this form of risk analysis, you have to be aware that every investment has a catch. If it is a high growth stock, you can expect volatility, but a higher potential return. If it’s a value stock, you can expect consistency but a lower potential return. This alone might help you come to your decision, as you may want to take on more or less risk relative to your current investment portfolio.
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