What is the difference between good and bad analysis? That is a question I have been struggling with for the longest of time. The best investors are the ones with the clearest framework. There is a difference between being clear and being simple. The perspective of a frog in a well is simple, but that’s the last thing we investors want to be.
The “So What?” Test
The framework that I have in distinguishing good and bad analysis is a simple litmus test that I would like to call the “so what?” test. I have previously written about it briefly, but I think that it deserves further elaboration. The most common pitfall of analysis is that people take it as an information dump. This is a huge waste of time, not only for the potential investor, but also for the author. More importantly, it does not convey a sense of investment framework and thought process. It would be akin to reading an encyclopedia of the company.
To avoid this, always ask yourself ‘so what?’ Fact becomes redundant information (noise) if its implication on the company cannot be conveyed. I would go so far as to say a write up of redundant information can hardly be considered as analysis.
The best analysis one where the answers to a series of ‘so whats’ leads to a conclusion which supports the investment decision.
Key Questions in Analyzing a Company
For budding investors, these are some of the key questions that should be addressed in any analysis. Of course, this is just my humble opinion and I have no professional investing experience.
- What are the demand drivers of the industry? This can be further broken down into:
- Price drivers
- Volume drivers – How is the total addressable market expected to perform?
- What are the cost drivers of the industry?
- How are they expected to perform?
- Within the industry, how is the competitive intensity between companies and how is it going to change?
- How is your company different from the others within the same industry?
- Taking into consideration the demand/cost dynamics and the competitive intensity, how is your company expected to fare?
What is Less Important?
- Valuations are important, but should not be misconstrued as analysis, especially if it’s a straightforward valuation. Any monkey or machine can read off ratios. Valuations are typically left to the last because it is meaningless if unaccompanied by a good understanding of company fundamentals
- Statements involving historical performance are not the most useful if they are made without context, or implications on the future. This fails the ‘so what’ test.
I hope this article will aid aspiring investors in developing their investment framework. These are just my personal opinion, feel free to disagree or comment.