The hardest part of investing is doing the dirty work – research. Researching a company requires hard work to uncover vital information about a company and using it to determine which stocks to buy or sell.
Let’s go through a few ways to find critical information about a company:
- SEC Filings – Companies have to report to the SEC by law. Searching SEC filings for annual and quarterly reports about a company is an excellent place to start your research.
- Analyst opinion – Brokerage firms and research companies provide research reports to investors that summarize the company and explain the opinion of the brokerage or research company towards a particular investment. One well-known research company is MorningStar. (Read these last, if at all. It does not help to start analyzing a company with biases picked up from another analyst if you are doing your own research.)
- Industry trade magazines – Virtually every industry has a trade magazine – even pizza companies! Trade magazines are a great way to learn about the competitive environment in a particular industry, and also the important trends that affect individual companies in their respective industry.
- Customer due diligence – The internet has made it a lot easier to learn about a company from thousands of miles away. Online forums for a particular interest, and review sites like Yelp make it possible to see what customers think about a company and its products.
- Company news – I like to use Google News to search for news about the company’s operations. I also set up a subscription for email alerts about individual companies to harvest important information about the company over time.
Understand the Company Behind the Stock
I like to start by first breaking a company into pieces. Companies are really nothing more than a group of people (employees), capital (land, buildings, factories, ideas, etc.), inputs (raw materials to be turned into goods) and their customers.
In any business, something goes in, and a product goes out. As an investor, our number one goal should be to understand exactly where a business fits in an industry, and what it does to make money.
Fast food is a great example because it really is a simple business. Chipotle Mexican Grill (CMG) buys unprepared foods, puts it through the “magical money machine” at each location, and then sells it at a profit to their customers.
If one were to analyze Chipotle, he or she would want to know some important information about the company:
- Employees – Who are the chief executives? What is their experience in the food industry? Who else works for the company? Are there any risks to the business from employees like minimum wage increases?
- Capital – How much does it cost to open a store? How much can a new store make each year? What is different about Chipotle’s capital investments from Taco Bell’s?
- Inputs – Chipotle sells burritos and other Mexican foods. How do food prices impact the company? Will rising or falling food prices affect its bottomline profits? Will changing consumer tastes change what inputs the company buys? Will the company realize savings as it grows and buys more and more inputs every day?
- Customer – Why do people eat at Chipotle rather than other Mexican restaurants? Is there room for more customer growth? Is there more room to sell more product to more customers? What are the general trends in Mexican foods? Are customers willing to pay more for Chipotle if it wants to increase prices?
Of all these things to analyze, the customer is so incredibly important. If I could know one thing about a company and one thing only, I would want to know all about its customers and why they choose to buy that company’s products.
For example, handbag makers were on fire in the 2000s because they were selling more product, but they weren’t selling more product to more people. In actuality, the same customers were just buying more purses each, and that trend was only temporary. If you knew the customer, you’d know that growth was not sustainable. If you didn’t, you might have been sucked into an idea based on incorrect explanations for company growth.
Find What’s Knowable
Investing is not about knowing everything. No one can know and predict the future perfectly. It’s impossible. Investing is about making the most educated guess possible, after knowing all possible knowable information – information that you can realistically discover about a company.
Once you break a company into pieces it becomes so much easier to see how the moving parts work, and to find information that is worth knowing about a business.
Once you break down their employees, you can go to the SEC filings to see how management is keeping up with its goals. Once you understand the capital investments necessary to run the business, you can check trade magazines and other sources to find out how much these cost, or how important they are to the business. When you break apart the inputs, you can check to see how the cost or quality of these inputs will affect the business. Finally, when you understand the customer, you can get a very, very good idea of how changes in employees, capital, or inputs will influence a company’s future.
The Bottom Line
The most important information is found where no one else is looking. Anyone can look in annual reports. Not just anyone will do the kind of due diligence to create alpha by finding actionable information about the “softer side” of the business – the stuff that goes beyond finance and into the daily happenings of a company.