How I Research Stocks - Step-by-Step Fundamental Analysis

This video is sponsored by Morning Brew. Visit the link in the description below to sign up for their daily newsletter today. Ladies and gentlemen, welcome to The Plain Bagel. I'm your host, Richard Coffin. Today's video is a bit of a peek behind the curtain to show you how the bagels are made and discuss my own investment research process as a investment analyst. I've had this requested quite a few times over the years, given that I work as a portfolio manager slash investment analyst for my day job, and I figured, what the heck, I would cover things at a high level, go through my general step-by-step process, and it's not a very formal one. I do change things up every now and then, but hopefully people who want to go through this process themselves find a bit of value in it. Now, a few notes before we get started. Firstly, this isn't a recommendation that people should necessarily stock pick or do their own stock research. I think most people are better served putting their efforts elsewhere, either hiring a professional or just investing passively. Countless studies have shown just how difficult it is to beat the market with stock picking. So unless you're passionate about researching stocks, you'll probably find this all very boring and strenuous, with no guarantee of strong performance. And secondly, while this is obviously my own research process, there are different ways to research a stock. There's technical analysis, which focuses on past prices. There's quantitative analysis, which focuses on analyzing the relationship between different quantitative variables. And then there's fundamental analysis, which is my own approach of understanding the underlying business. And within fundamental analysis, there are different styles as well. I do generally tilt towards value investing, which is trying to buy a great company at a great price, but there is also growth investing, which I do hold some growth companies where you pay up a little bit more, but they have a larger potential to grow their profits into the future. This video will be divided into chapters, so you can skip between the different sections. I'll try to provide alternative tools to the paid ones I use at work. And I'll also throw up a few terms and whatever on screen, so that you can have something to reference later on. And for the purpose of saving time, I won't try to define every individual metric that comes up, and we'll generally, like mentioned, keep things high level. So with that out of the way, let's jump into it. The first step, as you'd imagine, is screening for ideas and finding the stock that you want to research. The whole research process takes quite a long time. It has taken weeks at times, but obviously you'll wanna narrow down your list of potential stocks, so you don't waste your time doing this whole process, only to find that you don't really care for the company. Now, screening isn't necessarily a formal process. I do sometimes just research a stock because I want to, or there's been an interesting recent development, but I do have a screener that I regularly refer to. A screener lets you filter the universe of stocks, so that you only have a list of companies that meet certain criteria. I generally keep it pretty broad, but we'll look for things like revenue growth, being profitable, as well as keeping debt within a certain range. From there, I'll typically put the tickers through an internal tool that summarizes all their key financial information onto a one-page summary, not to make any decision off of, but again, just to get a quick overview of how healthy or unhealthy the company is, and whether it's something that I wanna look into. Covering things like past financial performance, expected consensus estimates moving forward, their debt levels, a bunch of details, just again, summarized on a page to see if there's anything of interest here. Now, once I have the company that I do decide I want to do this deep dive into, the second step is understanding the business. Makes sense. I know that sounds obvious, but as an investor, you really are a part business owner. So I do try to take the mindset of understanding the ins and outs of the company in the same way I might if I were to buy a private practice. And that means understanding all the company segments and what they do, how they earn their money, the nature of the company's revenues, and whether they're contractual, recurring, or seasonal, where the company operates in terms of geography, customers, suppliers, employees, regulators, management, anyone that plays a role in how this company will perform. And depending on which sector the company operates within, you can also make note of their key performance indicators or KPIs, which again, are kind of sector specific, allow you to compare companies that are within the same sector, but also requires a bit of industry background information. And there are times where I don't research a company because I don't yet have that familiarity with the industry it operates within. You do have to operate, as mentioned many times by others, within your circle of competence, where you feel comfortable. Now, this part is mostly qualitative. There will be, say, quantitative figures that come up, but a lot of it is, again, just understanding the details of the operations, what this company does. So where does someone find all this information? Well, outside of a Google search, which is not a bad idea to give you an overview of the company, a good idea is to start with the annual report or 10K in the US, as well as the most recent quarterly report, if that doesn't also apply to the 10K, all of which you can find on Edgar in the US, Cedar here in Canada, or the company's investor relations page, because they do do a good overview of the company's business, the risks applicable, and key financial information. From there, I like to go through investor reports and recent 8K filings, which provide important updates about the business. And I do have access to a lot of paid-for research, which I'll typically go through the external analysts' reports on this company. I also might look up commercials, tutorials, customer reviews, find any information I can about them. Now, as you'd expect, that's a lot of details, so I do type notes as I'm going. I do typically categorize stuff under the SWOT framework, which is strengths, weaknesses, opportunities, and threats. Strengths and weaknesses are internal factors for the company. Opportunities and threats are external factors. And that just lets me quickly categorize stuff. I'll also write questions that I want to get to later, that there's something I don't understand, or a risk that I've thought of that I want to look into. I kind of do a parking lot of ideas that I want to go back and research at a later point. And my goal through all this is trying to find quality companies, companies that have a competitive advantage, an attractive business model, and as Warren Buffett likes to put it, a moat, something that sort of protects them from competition. All right, so once we understand the business, the next step is understanding the finances, where we get into the numbers. Obviously, this is very number-heavy and does require an accounting background to understand the different segments that you look at. But generally, I'm looking at the company's financial position in terms of debt, how solvent they are, their capital structure, and whether they can meet their payments, the company's growth profile, their profitability, and again, where they have areas for improvement. A lot of this, as you would imagine, does really boil down to analyzing the financial statements, the income statement, which tells you how the company performed in the given year in terms of accounting earnings, the balance sheet, which gives you the snapshot of what the company owns and what they owe, as well as the cashflow statement, which is similar to the income statement, but shows you where cash is actually moving within the business, not just accounting earnings and accounting costs, where money was actually spent and earned. Now, I typically start by calculating a bunch of cumulative average growth rates, which I'll throw out the formula for, but I'll do this formula over a five, 10, or 15-year period to get an idea of what the average growth rate over these periods are for revenues and profit measures. I also really like common-size financial statements where you put everything as a percentage of a key figure. So for the income statement, that's revenue. For the balance sheet, that's total assets. And this is a great way to look from year to year to see what costs are getting bigger, which ones are getting smaller, relative to the amount of total money that the company is earning. Then I'll calculate a bunch of margins and ratios that, again, give that profile about how the company is growing, how profitable they are, and different operational solvency, liquidity things that tell me the general state of affairs. It's also here where I'll carry out a sort of peer analysis, comparing this company to ones in a similar space based primarily off of these financial details, as well as the key performance indicators found earlier. And I have, at times, pivoted to a new idea based on this peer comparison because something else looked more attractive once I really got down to the numbers. Now, throughout this whole process, and earlier with the overview of the business, I do carry out a check for red flags. Call it forensic analysis. In understanding the business, I wanna know what the related party transactions are, how management is compensated, any conflicts of interest, and in terms of finances, any accounting shenanigans. Unfortunately, you can't always rely on the figures as they're reported. Companies do, at times, fudge the numbers. For example, it's really common for management to highlight what's called an adjusted figure, which is where they take an accounting figure, but then make some changes to it so that it's more representative of what they believe the company has done. And it's not to say that that's always nefarious, but it's really important to look into what the definition of that adjusted figure is and what they're adding or taking out of this number, because the reason it's adjusted is that it doesn't meet accounting rules or regulations. Now, in terms of where to find all this information, I primarily rely on a data terminal that my company pays for, which unfortunately just isn't an option for a lot of people. They are very expensive. There are free versions out there with not quite as many features, but they're a good starting point for getting, again, the financial statements easily accessible. And if you can get something with an Excel add-in, kudos, because that really makes it easier to pull the data that you're looking for into the template you want when it comes to things like peer analysis or just the specific metrics that you wanna look into. I've made a crazy amount of use out of Excel templates and programs that pull data terminal information. And one of our sort of proprietary things, for example, is a peer comparison scorecard, where based on the industry, there are different metrics that are populated to compare companies at a very high level and quickly see how they look on different KPIs, finances, all that stuff. So I'll include some free alternatives. I can't really vouch for many of them, but I have heard of them. And if you're relying on a service for data, make sure you understand how the data is pulled, whether it's aggregated, whether they make any adjustments to it, because it makes it really important when trying to research a company is being able to rely on the data. All right, step four. It's taking longer than I expected, but step four is understanding the strategy. Everything we've done so far is sort of historical perspective on things. At this point, I wanna know what the opportunity moving forward is. This includes going over the strategic priorities of management, as well as where they plan to spend money, what the capital expenditures moving forward will be. Capital expenditures, I don't think I've talked about, but found in the cashflow statement, and it covers the money the company is investing in itself. I also wanna know how they'll be financing those plans. So I'll consider whether they're taking on more debt or issuing shares or hybrid instruments, which get a little complicated. Regardless of what the plan is, what I'm looking for is to evaluate its feasibility, the risks involved, and the company's track record for doing what they say they will do moving forward. I've seen a lot of companies fail by doing something that they have no experience in doing. So it helps when a company, if they are a serial acquirer, where they buy a bunch of businesses, it helps when they have a history of doing that successfully and growing their company as a result, actually optimizing the companies that they bring in under their umbrella, rather than just spending investor money to put growth on the accounting statements when they aren't actually improving their business. One way you can evaluate the track record is by looking at the five, 10, 15 year average, or some variation thereof, of ROI figures, which includes return on capital employed, return on invested capital, and return on equity, among others, but those are ones that I like to look at. And you can do a qualitative review of management as well in terms of their experience or tenure with the business. One of the things I found really helpful myself as an analyst, as a quick tip, is building out a checklist of things you want to explicitly look for. And this is a checklist that you build out as you research companies, and you think of things that you want to look for when trying to determine what the mode is, whether they're a healthy business, all this stuff. I have my own checklist that I built over time. Just an example of one thing on there is whether the company adds value for all the stakeholders, or are there any stakeholders outside of competition that will lose from operations, and that will present a risk to the business's success. In terms of where you can find information about the strategy for the firm, you can typically find it in those regulatory filings. The 10K will typically have some sort of high-level strategic objective for the business, but you can also look at investor presentations, which, again, we'll highlight it, and transcripts from earnings calls are great, because management is often asked questions about what they expect to do moving forward and the challenges they expect. You might also find transcripts from the different conferences management have gone to, which you, again, might be able to find on the investor relations page. And also through my company, I've been able to meet executives and have calls and attend in-person meetings with executives from different companies. In terms of researching the industry, again, I do have some paid-for services, which really help. I do really rely on the data terminal, as well as some expert inputs and news sources. But in terms of news, that's actually a good thing that most people can access, is just researching news about the industry. You might be able to find some different research stats about total addressable market and whether things are growing or contracting. So once I understand the business, I understand their finances, and I understand their strategy, from there, I'll look at the actual valuation for the stock. It's something I leave later on into the process, because I don't want my earlier steps to be influenced by whether this stock is expensive or cheap, even though that is important. There are a number of methods for doing this. At a high level, there's relative valuation, which is looking at multiples, things like the price-to-earnings multiple, EV to EBITDA, free cashflow yield, things like that, which you can compare historically to what it's been in the past, as well as to peers to see what related companies or companies in the same industry are trading at to see whether you're above, more expensive, or below that level. The more detailed approach is an absolute valuation, such as a discounted cashflow, which I do do from time to time for companies, where you actually forecast all the line items of different financial statements to forecast their free cashflow into the future, discounted to today's price, so that you have an idea of what you should pay today for that future performance. I like to change the variables to see how the company's stock price would be in different circumstances, and what's justified in terms of the stock's price. I'll also consider the more current events around the stock. Recent lawsuits, current headlines, press releases, which you can, again, find on the company's website. And I'll try to understand what variables in this realm are influencing the current stock price, as it tends to be the more recent stuff that sways prices in the short term. It doesn't matter much as a long-term investor, but it does help with the entry point. And I do consider some technical aspects of the stock, and more qualitatively, things like whether management is buying or not. But really, at this point, if I like the company and I think the valuation's attractive relative to what it could potentially earn, then I'll likely be investing at this step. Now, the problem is that stocks that have gone through all the previous filters and steps at this point tend to be the most expensive. The stocks that have great growth track records, great profitability, excellent management, all that perfect stuff, they tend to be more expensive because investors recognize that, and they bid up the stock price accordingly. But if the company is not attractively valued, it isn't all for naught. At this point, I will simply move it to a watch list, at which point I will monitor it. I've already done the fundamental research and will have more flexibility to hop into the stock if there's a dip in the price given a current event. I can quickly analyze the current event, see if it's material or not, and then take advantage of any movements in the stock price. I will also dollar-cost average in companies I really like. And generally speaking, that's a sound strategy for diversified investors, but I always have an eye on valuation. Paying too much for a stock does increase your risk of capital impairment, so I at least want to ensure that the price I'm paying is within a reasonable range. So that's the valuation step. And finally, step six, we've made it this far, is to review and finalize notes for future reference. At this point, I'll have an idea of whether I want to buy this stock now or wait, but I will also seek answers to fill in the gaps, address those questions that came up throughout the research process. I'll also try to play devil's advocate and find conflicting reports about, say, the thesis I've sort of developed for this company, find opposing opinions to try and sanity check some of my assumptions. I also have the benefit of being able to then share it with my team, who have more experience with researching stocks than myself. And I typically write up a formal report, but will still organize my notes regardless, just so that they're easier to digest in the future. Making sure things are bullet points, providing the sort of summary that I can quickly reference in the future, so I can get up to speed about my company and the thesis I have for it, and also points I want to follow up on. And the reason why I think this step is really important is not only because when a stock's on your watch list, you can quickly review things and then get back up to speed about the company, but when times get tough and say something negative develops about the business that a lot of people are spooked is going to challenge their future performance, you can go back and see what the fundamental business is and what you believe the value lies in, what your thesis about the company is. And that will make it easier to evaluate whether that has fundamentally changed or if this new development is just noise that you can generally ignore and focus again on the long-term prospects of the business you've invested in. So that's my investment research process as an analyst. We made it. Thank you for sticking to the end. I know I didn't really get into all the nitty gritty about the specific things I look at, but that is really out of respect for my employer. They were gracious enough to let me do this video. They don't have the perfect Krabby Patty secret formula, but they do have proprietary stuff that it's in their interest to keep. As I've hopefully highlighted, this is an ongoing process once you've found a stock and especially once you've invested in it to keep researching the company, not to get caught up in the day-to-day happenings, but to regularly review it and make sure you're not missing anything. So thanks again for joining me. And before I sign off, I do want to give a quick thing to our sponsor Morning Brew. As I mentioned, keeping up to date on the news is an important part of the research process. I've always had to keep an eye on a bunch of outlets to try and get an idea of the important headlines for the day. But if you want a free resource for keeping a pulse on the general markets and what's happening politically, what's happening in the business world, they're a great resource. Morning Brew sends a business, finance, and technology newsletter directly to your inbox every day of the week, and they'll cover important headlines that you'll certainly come across in researching stocks. For example, they recently went over how the US saw a 21.7% jump in home building project starts in May, which is the highest level it's been in a year. It's still below 2008 levels, but should help with the country's 3.8 million home shortage. But the best part of the newsletter, outside of the price, it's free, is that it's entertaining to read. Genuinely, it's one of the first things I read every day because the writing is witty, really easy to read compared to what you would typically see in the space. It's entertaining, makes for an easy start to the day. So if you want to join the other 4 million professionals already reading Morning Brew, you can click the link in the description below to sign up. It takes us in 10 seconds to start getting their free quality newsletter to your inbox directly. So thank you, Morning Brew, and thank you guys for joining me today. I hope you found this video helpful. If you did, please make sure to like, subscribe, all that good stuff. It does help the channel tremendously. And let me know your thoughts on the research process, both positive and negative, genuinely, because I am always trying to improve it. This is not the end all be all of processes, so I'm always happy to hear feedback. Thanks again for joining. See you in the next one.