When we started doing analysis. We were always bombarded with data.
Even though when we had a framework we focussed on almost everything in
a company. Be it whether you are trading or investing, over time we have
realised through experience that very few things matter and knowing which
are those things can make hell lot of difference. Similar is the experience of
other experienced people be it management, investors, traders, key decision
makers. Let’s discuss from the point of view of making an investment in a
company.
While one is investing, one needs to have a framework of tools/mental
models to do analysis. First thing important while doing any research is to
formulate a question and then derive some qualitative and quantitative
indicators which answer that question. If indicators more than 3-5 all point in
the same direction probability is high you are doing the right work (This we
learnt from statistics and data analysis. The marginal benefit after 3-5 indicators
drops massively. Its no use finding more to prove your point). Next, try to go
backward and forward on your thesis.
Though the above mentioned questions come later, first important point is
where to put your energy on.
A) Let’s take an example of Motorcycle companies in India. First you want
to understand the basic business model. You will come to know that they
outsource almost everything in manufacturing.
RESEARCH QUESTION: If you want to invest in them, basic question
you need to answer is Where is the competitive advantage? As once you are
making an investment you are doing it in a business for a long period of time
and you want it to be immune from competition or at least the company
should be working in that direction. So if everything is outsourced what does
the company make itself? Generally its mainly the engine.
INDICATORS: Now you want to find a company which has the best R&D to produce engines. Now answering this question is tough. However, you can
use past data to see how many companies have successfully produced good
engines again and again. You may use annual reports, internet, concalls,
industry people, etc. Basically you are trying to find companies which have a
track record of producing engines successfully. You try to develop indicators
for the same. Hardly anyone will give this you in a platter? If you find a
company which is better and circumstances haven’t change majorly then odds
are in your favour in such an investment (after considering the price). Some
people may invest in companies where R&D is still young but here allocation
should be less and tracking should be more intense. Once you go through this,
make a basic checklist to track company for fraud, accounts or other basic
stuff. This make sures you have gone through basically almost everything and
not missing anything important.
But majorly R&D matters, and no one will ever ask this question or hardly
tell you. This way you have organised a clutter of information and focussed
on what really matters. You can then do your valuation by this in viewpoint.
Obviously further steps are needed. One needs to think about growth,
valuation. But you are majorly on the point.
B) Lets take another example think about IT companies in India – If we
think from competitive advantage viewpoint and if the basic thesis is cost
arbitrage from US (Indian labour is talented and cheap) – Then you need to
find companies which can hire the best employees at cheapest price and pass
on the benefit to clients – Some indicators for the same can be attrition rate,
cost per employee, Fixed asset per employee, sales per employee, layoffs in
recessions – Now this is only valid if cost arbitrage thesis is valid. The focus of
the company should be on the same. This is the thing one needs to track to
improve odds of investment.
C) Thinking about Hospitals – Similarly in Hospitals – One needs the
ecosystem to hire best doctors at cheapest price? Passing the benefit to
patients.You can think about same.
Most of the time these days we are bombarded with lot of information.
However, what really matters are few things and one needs to focus on
them. There is no guarantee more information makes us better decision
makers, in fact its usually the opposite. One needs to think and shift focus on
what really matters and what really matters hardly changes fast on minute
to minute basis particularly in companies. We have observed most traders/
investors use few important things rest all is clutter. Because trading or
investing or business, nothing is new and we had equally good decision
makers before the information manic age. We don’t mean information is bad,
analysing and identifying few important things is important – rest all is clutter.
Think about news, one news headlines and there is too much blah blah
blah everywhere, however usually what is thought important by everyone,
hardly is.
What is noise and what is real information- Really depends on what
question one is answering and what is the framework used? But one thing
is for sure important things are few – not everything or every detail is
important. Spending more time on what really matters – increases the odds
of a good decision. Though one needs to use a checklist to make sure he is
not missing anything very important.
Argha Investment Advisers 