Business Model and Environment Analysis
(This is part 3a of the Stock Investment Research Process series. We will discuss Business Models in this post and discuss Environment analysis in next post – part 3b)
There are ‘Sprinters’ as well as ‘ Marathon runners’ among businesses.
If our objective is to find someone who can run for a long time (durability) and cover a great distance (large profits), we would obviously pick a marathon runner. Hence it is important for us to distinguish which type of a runner our company is.
Remember, we are in the look out for long term ‘compounders’ of wealth.
How do we find out whether our short listed candidate is a marathon runner??
For that we need to find out the Business Model of the company.
It is very easy to understand the business model of the company. Just answer these three questions:
- What is the company Selling?
- Businesses exist because they are satisfying some wants/needs of customers. We need to understand what exactly is the company selling.
- Is it a ‘product’ company or is it a ‘Services’ company?
- What are the products or services that the company sells?
- Are they ‘branded’ or ‘un-branded’ or made for some other brand (white-labelled)?
- Is it a ‘commodity’ type product or a ‘value-added’ product?
- Is it a highly recognized brand? How well known is the product?
- Is it a finished end-user product or is it a component?
- Is it selling to end users or to other businesses? Who are its customers?
- Why are customers Buying it?
- Is it because it is the cheapest?
- Is it because of its quality?
- Is it because of its premium image?
- Is it because of the easy availability?
- Is it because of brand awareness and loyalty?
- Is it because there are no alternatives?
- Is it because it is too complicated/difficult to switch to another product?
- Is it because of addiction/habit?
- How is the company making money?
- How does it make a profit? What determines the profit margins?
- Is it a low cost producer? Does it have access to cheap raw material/ resources/better processes?
- Does it make money from one-time sales or from recurring sales (subscriptions)?
- Is it a high volume low margin business Vs low volume high margin business?
- Does it need constant addition of capital to remain in business and grow or does it sustain itself from profits?
- When will it get money from customers? Do they pay in advance? Do they pay at point of sale? Do they pay after a period of time?
- When will it pay money to its suppliers? Does it pay in advance? Does it pay at point of purchase? Does it pay after a period of time?
- How much debt does it have? How much interest does it pay? What percentage of profit is spent in paying interests? Will it be able to pay off debt from its profits?
- Can it increase prices without affecting sales? Can it pass on raw material price increases to end users? How has price increases in the past affected its sales and profit?
- (Feel free to expand the list of questions in each of these three areas and try to answer them.)
You get a big picture view of the company, right?
Once you asked and answered all these questions, we should be able to describe the business model of the company in a couple of paragraphs.
It is a good idea to write it down.
The business model will underpin the investment rational.
By this point, in your investment study workbook, you have noted the following.
- A list of areas you will focus on to find out suitable investment opportunities, within your circle of competence. (a list of sectors/industries)
- A short list of companies from the above sectors. Couple of lines on why you think each of them is the strongest candidate in their sector (concentrate on the strongest candidates)
- Describe the business model of each. It is a good idea to open an excel sheet for each of the shortlisted companies at this point.
Now grab a cup of coffee and think about the Strengths and Weaknesses of the Businesses you have shortlisted. These are Internal factors affecting the success and durability of the business.
We will also look into the Opportunities and Threats, in other words, the external actors affecting the business in the next post, as part of Environment Analysis.