One of the most frequent queries I get is around how should one go about researching a stock? And this is one of the most time-consuming parts in the overall investing process, and thus having a good structured approach here holds a lot of value for investors.
In this blog, I will lay out some key insights that investors can use to carry out their research on a particular stock. Here I am assuming that investors have already carried out their initial screening and zeroed in on a particular idea for further research (initial screening itself is a gruesome process and should be part of a separate discussion).
Now, the end goals of the whole research are two-fold, first is around figuring out what is the play or say the future possibilities in the stock and second is building conviction around the probability of such future play materializing.
And herein lies one of the best hacks in the research process. In my initial days as an analyst/investor, I used to start from something like 5-years back resources (Annual Reports, Results, Concalls etc) and then build up to the most recent ones. However, this is a very inefficient process given that a lot of times the past might look good, but by the time you reach the most recent resources, you might see that the way things are stacked currently, future does not look that interesting. And thus, the entire efforts that you have put in going through these last 5-years of resources does not yield any result.
I realized this back in 2018 when I was doing my research on CCL Products. I started my research from 2012-2013 period and progressed to mid-FY19, only to realize that the business growth would taper off materially from its past growth rates as the company has reached a saturation level in its business. Company’s management in most recent concalls was talking about how their B2B business will slow down due to scale issue and because of this issue they had started focussing on B2C business, which itself will not contribute much to profits over next 4-5 years.
If I would have read the most recent concalls first before digging into the history, I could have saved a lot of efforts. This is not to say that the whole effort was wasted, I obviously built a good research bank around the stock which is helpful in the future, but I could have used that time working on something that might be useful in near term. (Have discussed the importance of creating a research bank in the later sections of the blog)
So, the right way to do this is to start by reading the latest annual report and most recent 3-4 quarters results, concalls etc. This way you get a good understanding of what is happening in the stock and what could be the possibilities in the future. And if that looks interesting & something worth investing into, only then you go for building conviction & understanding the risks.
Now, building conviction & understanding the risks requires one to go back into history of the company as far back as possible, but a 5-year lookback period on the qualitative side of things is decent enough. (For financial numbers, one can have a much longer lookback period)
One important thing to keep in mind here is that, one should start with the earliest period of your lookback period and then sequentially progress towards the recent periods. This is because if you go backwards, it becomes difficult to connect the dots. Going from earlier years to latest years allows you to get a sense of what was happening in a business in a particular year and how it progressed into the next year, you can see what the management was saying in one year and what it was delivering in the next year.
Another important thing that investors should follow during their research process is to build a research bank. By research bank, I mean an excel sheet wherein you store important aspects of the business & stock that you discover during your research process.
Some of the important aspects that I like to cover in my research bank includes-
1. A timeseries of important understanding & developments around the business with their source.
Snippets from my research bank on Syngene-
Surge’s members can access our research bank on Syngene here- https://www.surgecapital.in/syngene-researchbank
2. A section wherein I store some qualitative aspects like how the business or industry operates.
3. Quantitative data in a time series format containing a host of relevant data points.
4. Financials
I personally like to have a financial data set built manually from annual reports & results rather than exporting the same from other databases like screeners etc; especially for smaller companies.
And there are couple of benefits of doing so-
A. When you enter the financials manually from primary sources like Annual reports, it pushes you to go through the notes of accounts and various heads of P&L and Balancesheet. And a lot of times one might discover some data points that are not readily available, some inconsistencies with accounting, and various other useful things.
In one of the companies that I was researching on recently, I found that the company was taking loans against its inventory and was classifying the same as trade payables and thus the overall debt in the company was much higher than what balancesheet was showing and that the operating cashflows was higher due to this.
In case of Vadilal Industries (Research Report on Vadilal) , by creating three different research banks with financials of Consolidated, Standalone and US Subsidiary, we were able to figure out how profitability was being captured separately in Standalone entity as well as in US Entity; with increasing share of US Business, the consolidated gross margins were expanding while Standalone gross margins were stable and US entity itself was booking similar gross margins as Standalone, indicating that realizations in US business are 2x the domestic business.
B. It allows one to play with the numbers in a lot of ways & improves comparability across stocks & businesses. One can look to build some important ratios in a way that you want to calculate them and that would be comparable across various stocks that you will research on as you are entering the financials manually and ensuring that classification of various items is similar across the board.
5. Other things like the risks that needs to be kept in mind, questions related to areas wherein you need to develop more understanding.
And there are clear advantages of building a research bank-
1.It significantly improves understanding & retention of what you are reading. It has been scientifically proven multiple times that writing something provides a much better clarity of things than a plain reading.
2.It helps connect the dots much better given that you have things noted down and you can quickly compare them across timeframes rather than having to look & search them again.
3. It also provides you with an ability to quickly recap things around a stock that you might have read about many years ago and build on top of it without having to go through the process all over again.
In case of CCL Products which I researched on in 2018, recently they had announced a large capex and I was able to figure out things here in no time given that I had the research bank built till 2018 with all the data around capacities across types of coffee and geographies.
Over last 5-years or so, I have been able to build such research banks for >150 companies, which holds a tremendous future value.
One more suggestion I will give is to not read initiation reports first and then do your own research. Reason being that if you read an initiation report first, it cultivates your mind with some opinion & biases based on what the report is highlighting and then when you do your own research your mind focuses on those aspects only. So, if the report on a stock is positive, you start your research with a positive impression on the stock and would ignore a lot of negatives in a subtle way. First impression is very important and thus it is better to build it on your own rather than relying on someone else’s opinion on it.
Once you have done your own research, only then you should read these reports and compare your opinions with what the other guys have.
Also, going through the thread of the company in ValuePickr is very useful as in some cases the thread could go back as far as 10 years into the history of the company and thus you can quickly pick up some additional qualitative aspects which might not get covered through company’s resources like Annual reports, concall etc
Some of the areas that investors should look to cover in their research process should be-
1. Company level resources like Annual Reports, Concalls, Presentations, AGM notes etc
2. DRHP, Offer Documents, M&A documents including that of recently listed peers as it contains a lot of useful info that might not be available so easily.
Back in 2020, I was working on Jubilant Foods and Burger King had recently filed for its IPO. The offer document contained a lot of insights around store level economics of all the players including unlisted entities like Subway; and that was very helpful in understanding the strength of Jubilant’s store level economics.
3.Credit Reports act an extremely important resource for smaller companies that do not share anything other than Annual Reports. It might contain some of the qualitative developments that are taking place in the company.
4.Resources of peer companies also help quite a lot. In one of our recent initiations on a company that operates in a niche segment within the overall paints industry, seeing the bullish commentary of larger players like Asian Paints for this segment and financials of subsidiary of such companies that undertake this business helped build conviction on the growth prospects of the company.
If I must summarize the above, it would be that-
1. First focus should be on figuring out what is the future possibilities in the business and then move to building conviction and understanding risks around the same.
2. When building conviction, work with a decent look back period of 5-years and move sequentially from earlier periods to recent periods and not the other way.
3. Try and build a detailed research bank, as it had a lot of advantages, not just now but also in the future.
4. Lastly, build your own opinion first and only then look at what others have to say.
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Link to our previous blog-
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