It’s amazing how many comments I receive in a day along the lines of “I have no idea what a yield curve is” or “I only invest in Bitcoin” and even the “I like Apple. It’s a great company”. Though I don’t have a serious issue with the last two, there is an issue among millennials and inexperienced investors alike: they do not know the basics of finance and personal investing, and are highly influenced by those around them. So, I decided to write a post about how you, as someone who probably only knows what the Dow and the S&P 500 are, can invest in strong companies without the need for advanced quantitative models, multi-layer valuations, and head-and-shoulder patterns.
Top-Down: Start by identifying a space you are interested in and can see yourself reading about every day. I’ll choose the food space as an example (I am a huge foodie). You need to be inquisitive! “What’s going on in the space? Are people still eating burgers and fries, or salad and bread? Do meals vary among the day, or do I see myself eating Chipotle twice a day for a week?” Identify the circumstances of select audiences, and apply your perspective to the larger population. Sure, people in a wealthy community may brunch at a middle-eastern restaurant and pay upwards of $30, but what about working individuals in the city? How about in suburbia? Do I switch restaurants daily, or do I have a “spot”?
Then, think about what a company can adopt to propel its success further in the space. The “catalyst” as you may have heard in your Security Analysis class. Maybe Chipotle would do better if they had a breakfast menu (essentially, open at 7am and serve eggs) or expanded their product line. What if Shake Shack offered salads with their signature meats for the more health-conscious customers? The possibilities are infinite, however, it is your perception of what will succeed that will drive the pitch.
Start doing some research. Whether you have a Bloomberg or not, look for some companies who have your vision in mind. Read their mission statement, look at management’s past experience, and even hop on a call with investor relations. You’d be amazed at how willing these individuals and even management members are to speak with potential shareholders. When you find a company whose product, business and strategy are in line with what you see as successful, ask yourself, “Do I trust this company with my money?”.
If the answer is yes, then you might have found your match. And you can apply this elementary, cookie-cutter approach to any industry. I recommend researching industries where you can understand how the company makes money. I made a mistake earlier in my investment journey by trying to value BDCs (not the first choice for someone new to the market).
However, before you hit the “buy” button on Robinhood or your TD Ameritrade account, determine what the inherent risks are of the space and to the specific company. “If X happens, what will that mean for the industry, and ultimately, my company?”. It is imperative you assess the potential downside factors that may cause adverse conditions to the company’s financial health. You can apply anything here, and though it may be difficult to quantify, you can question, “Is there a high probability of this event happening? If so, is it within my investment horizon?”.
Lastly, determine if there is a sustainable source of cash flow. Do you foresee the company making revenue and increasing profits into the future? What about their product differentiates them from the competition and makes them so unique that it’s virtually impossible to mimic? This is key; the stock market is forward looking, i.e. the price of a stock is what an investor will pay for all the future cash flows it will generate. Will the company be there in the long-term, and does it have attractive future prospects?
Those are the very basics of one method of fundamental analysis. In sum, look at the industry and the macroeconomy, assess the direction of the field, and see what company fits your vision. Determine if management’s business strategy is viable and innovative. Evaluate the risks and consider potential competitors and circumstances that might cause the company to lose profitability. Finally, ask yourself if their business model is sustainable for the long term.
This should be a good starting point. Stay tuned for part 2!