My Research Process

My Research Process

Continuing from last week's discussion on my investment philosophy, this week I discuss my investment process. I am a “business first” investor, owning quality businesses by paying a reasonable price. For sure, my style is not the only way to make money (and lose money) in the stock market, but it resonates with me.

Similarly, my research process is not unique – There is no secret formula that works for all stocks so it’s impossible to capture all the nuances in one’s process.

Idea generation and Business Analysis

I only screen for one financial metric: 5-year average ROIC, which gives me a big list of companies to study. By applying Porter’s Five Forces or Hamilton Helmer’s 7 Power framework, I document the traits that enable these businesses to create excess value. I spend bulk of my time on this part of the process.

I also follow what the wide moat investors are buying and selling each quarter. I can borrow their ideas but not their convictions, especially when businesses and their stocks inevitably go through short-term challenges. Therefore, I do my own work to understand what could be the underlying thesis.

Finally, I like to participate in parts of an industry value chain with higher profits. A business is about maximizing profit. There are two ways to achieve that: 1. Increase price 2. Reduce cost.

High profit businesses signal: First, ability to keep cost low because of advantages such as bargain power against suppliers and customers; Second, high value add translating to pricing power.

An example would be in the semiconductor industry:

  • Foundry (eg. TSMC): 40% operating margin
  • Design (eg. Nvidia): 30% operating margin
  • Packing and Testing (eg. Amkor): 7% operating margin

Financials / “The Numbers”

Two ways (technically three) to get paid: earnings growth and multiple expansion. Earnings growth is more predictable (still not easy) than predicting multiple expansion / contraction.

Here are some things I focus on:

  1. Understand how the business makes money, how it is segmented
  2. Understand historical revenue growth
  3. Come up with a growth outlook based on data such as market opportunity, industry growth rate, management expectation, etc.
  4. Based on fixed and variable mix, develop a cost outlook. Understand any opportunity to bridge the gap in margins with the industry leader (if it’s not the leader already)
  5. #1-4 drive a long-term earnings power outlook
  6. I should do more of this: Scenario test #5 to assess see if the upside of the stock is multiples of the downside. If the risk reward is asymmetric, it warrants a deeper look. Otherwise, it goes to watch list and it’s a pass (since I don’t short stocks and life is better that way.)
  7. If the expected annualized return fits my personal hurdle rate, I will buy the stock and continue to underwrite the thesis as quarters and other events move the stock up and down. It’s not buy-and-hold: It’s a buy, reassess and act accordingly profession.

Management Assessment

Public market investing is about entrusting money to capable management who allocates capital appropriately to create value. So I pay attention to incentive alignment and character for management.

  • Skin in the game: Are they founder-operator? Do they own big number of shares? Has there been recent insider buying? Eg. Amazon, Twilio, Interactive Brokers
  • Compensation metrics: ROIC-based vs. inorganic revenue growth based (the latter can be gamed through M&A)
  • Track record for value creation: John Malone vs. sleaze ball marketing guy who does not own stock in the company but is chairman of 3 SPACs or serially executes value-destroying acquisitions. This is hard to assess and comes with experience.

What I use

Company’s SEC filings are RELATIVELY the most unbiased: 10-K/Q, earnings call transcript, investor day materials, recent sell-side conference transcript.

Then comes the sources with opinions: sell-side initiations / deep-dives, expert network call transcripts, fund pitches, Fintwit views, Substack write-ups, etc. The rest is called “use your imagination.”

That’s my toolkit for now – I am sure I forgot something. One area I am working more on nowadays understands the stock trends – what drove big stock moves in past few years, is the company a constant beat-and-raise or chronically miss earnings and guide down. But still a work in progress for me.

Conclusion

Having a high-level process is important for staying organized and saving time, but one must craft a process that suits their philosophical belief. Be sure to read about successful investor's research process and adapt bits and pieces, but remember you don't have to 100% replicate anyone's process because everyone is different.  

Thanks for reading. Leave a comment below to discuss. I'd love to learn from you. 

If you are interested in learning more about professional equity investing (the "buy-side"), I have two other great articles for you:

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