Have you ever opened a 10-k, read a few pages, and still had no idea what the company did?

Me too.

Financial analysis is hard enough. In order to select a good stock, you have to derive the valuation of your target company. Then you have to compare it to the current valuation and see if there is enough upside to invest.

But even before you get to valuation, you have to figure out what the heck the company does.

For some companies this is straightforward. Netflix pays writers, directors, and other crew members to make movies and television shows, and consumers pay Netflix a monthly subscription to have access to these videos. Makes sense.

But with other companies, it’s not as straightforward. Understanding industries like payments, biotech, or semiconductors requires going up a steep learning curve. What is the product and how does it provide value for customers? Which step in the value chain has the largest profit pool? What are the major drivers for market growth?

I’ve spent thousands of hours researching companies from many different industries. Along the way, I’ve developed a research process. While I’m no expert, I’m hoping that this article -- which outlines my process -- will be valuable to other students of investing.

It’s broken into five sections:

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Before researching a company, you have to, well, have a company to research. But time is limited: how do you decide which company to study?

As much as I’d like to have a fancy screening method, most of my ideas come from scrolling through Twitter, listening to a podcast, or talking to a friend.

Here are a few questions I keep in the back of my mind:

In order to track my ideas, I keep a list of companies on a Roam page. While you can do much more with Roam, my ideas page is very simple. For each company, I include:

1) the date I found it,

2) a blurb about why it’s interesting + any connections that come to mind,

3) a link to the source of the idea.

Once I have some time to work, I look at this list and select something that I still have energy for. Then, I begin my research.

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One of the toughest parts of researching new companies is figuring out where to look. In this section, I’ll outline all of the sources I use in my research.

There are a lot of sources listed here. During my research, I usually end up checking pretty much all of them! The quality of each source varies depending on the company so it’s important to focus on your own understanding of the business rather than any one particular source. That said, let’s get into it.

For every analysis, you’ll need to pull data to populate your financial model. Here are the tools I use to pull data.

In addition, there are resources like FactSet, CapitalIQ, S&P Global, Bloomberg and others that make it super easy to analyze companies with data sets and Excel plug-ins. Unfortunately, these are tens of thousands of dollars because their customers are professional investors.

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Alright, so you have a bunch of places to look for information. But what should you actually look for?

This list is considerable, and not all of the questions will provide meaningful insight into the company’s performance. It’s a matter of explore vs exploit. When researching a company for the first time, you won’t know what matters. You’ll read reports, summarize information, and crunch numbers: this is the time to explore. It won’t be until later on that you realize the 3-5 factors that impact the future performance of the business. This is when you develop conviction on a company and make your investment decision: exploit.

Here are some questions I keep in the back of my head when researching companies.

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I break it into a few sections:

I keep two things in this section.

The first is articles or links that I want to read later. This is much more effective than having dozens of tabs open in my browser. Additionally, because my research spans days or weeks, it allows me to pause where I am and keep going later.

The other thing I keep in here is open questions to research. These are things that I think might be interesting, but I need to dig into more or independently verify. Sometimes I come to realize that these questions aren’t relevant, but it’s good to list them out in case they are.

In this section, I write notes that act as building blocks. Each one is a summary of a concept or idea that might be useful to the final thesis. Writing it out not only helps with organization, but it also helps me solidify my thinking by putting it into my own words. A kind of mini “the best way to learn is to teach”, if you will.

At some point 3-5 themes will emerge from these drafting notes. These themes tell the story of the investment and become the pillars of the thesis. Sometimes I’ll organize the themes in Roam, or if I’m writing a public analysis, I’ll move over to Google Docs to structure the thesis.

The last two sections have the same purpose: to organize source material.

The Research Notes section is for notes that are direct quotes from primary sources or articles. This is usually filled with quotes from earnings transcripts, 10-K’s or industry reports.

The Stats section is to jot down important statistics about the company. Most of the time my brain will remember the important metrics without listing them in this section. However, it’s still valuable to write them down (especially with more complicated businesses) and makes it easier to pull together information for the thesis.

For both of these sections, I include the source of the information in the note below.

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After all of this research and analysis, it’s time to pull together a thesis.

Good investment memos can be summed up in an elevator pitch that’s no more than a couple of sentences. However, don’t be fooled. This does not mean that these pitches are simple or hastily prepared. Instead, compressing an investment idea into a few sentences is a sign of deep thinking.

The elevator pitch stands on the shoulders of 3-7 themes that support the thesis. And these themes are supported by the hours of research and analysis were done in order to develop conviction on the company.

To make this more clear, let’s use Chamath Palihapitiya as an example. Last year he took Opendoor public through a SPAC.

One way to check if you’ve thought deeply enough about a business is to argue for the other side. Charlie Munger once said: “I never allow myself to hold an opinion on anything that I don't know the other side's argument better than they do”. If you earnestly address every argument from the opposing view and you still believe in your thesis, it’s time to place your bet.

Good read:

"As I'm thinking about spelling out my process and philosophy in regards to forming a potential investment, I thought I'd clean up the wording a bit, and paste it here if anyone else is interested. One important note though: I've come to believe that developing a full image in one's mind of how a business operates, competes, allocates capital, takes care of customers, etc. is much more important than checking off certain items on a list. Combined with developing that image is the necessity of only investing in those things that seem like obvious bargains. But the final checklist serves as a great way to help stay disciplined, and hopefully sidestep some avoidable errors. Everyone's will probably be different and evolve over time, but here is mine in its current state.

In 2019 the luxury car market was valued at $500bn. Estimates suggest it will grow at about 9% for the next 5 years. Ferrari sits in the category of luxury goods that is considered an experience and that category is projected to grow at an even higher rate.

One good thing of a luxury goods company is it is a price maker. Ferrari can increase the price of their cars by about 4-7% per year and still reach strong demand.

Special cars have historically been about 2% of sales but they will become a larger part of the business. By 2023 special cars will represent 20% of revenues. These cars which are limited editions – often 500 cars - sell for more than 1m each and sometimes sell out on the day they go on sale. Gross margins on special cars are about 3x base cars. If the number of special cars is increased, EBITDA margins for the whole group could increase from 33% to 38%.

Another important thing of a luxury goods player is careful management of supply. Current product capacity is about 16000 cars per year yet only 9000 are made. In comparison, Porsche sells 25000 to 30000 911s per year. Ferrari could increase production to 16000 cars per year and still sell them. Ferrari intends to launch 15 new models in the next 5 years. That’s a lot more than in the past. It takes about 40 months to produce and launch a new car.

2 potential risks to the Ferrari growth thesis:

Luxury goods companies with a similar financial profile to Ferrari have an average P/E 25. If you put Ferrari on that multiple it implies 60% upside. Valuing Ferrari by its cashflows implies a growth requirement of 3.5/4% per year, yet it has been growing its top line at 10% per year for the past 20 years.

There is room for further sales. Ferrari have sold almost no cars in China. Surprisingly the embedded fleet in China is less than 500 cars.

Just like many value investors look at the 52 week low list for long value plays, some people, including myself, look at the 52 week high list for short plays. You can access this list on Bloomberg or various other financial sites on the web (do a Google search). Earlier in the week, I saw that Darden Restaurants ($DRI) had ticked off a high.

For those that do not know, $DRI owns and operates a number of restaurant chains - very well known chains such as The Capital Grill, Olive Garden, Longhorn Steakhouse, etc. I was surprised to see such a stock on the 52 week high list - why? Because in this recession, I would assume people eat out significantly less. So why not investigate and see what we can find?

The first thing that I do when researching a stock, whether it be long or short, is read the last three annual reports. Why three? That's what my boss told me on my first day on the job, and I just haven't experimented enough to see if one, three, five, or ten is the right number.

One caveat. I will go back quite a few years and read the shareholder letter. I want to see if the shareholder letter actually matches up with how the company performs in future years. Also I want a realistic shareholder letter. I.E. If I read a shareholder letter from 2018 where the author is all bulled up on the economy, I generally laugh and move the idea to the short pile. And in some situations, if a business is very cyclical, I will go back to the annual reports of the last down cycle to see what was happening.

What else am I looking at when reading the annual reports? Not only do I want to see how the business is performing, I also want to see how management is using their capital. Were they buying back stock at the highs? Were they levering up for acquisitions in the same year? How has capex trended with sales and what is the return on that capital employed? Does CFO match trends in net income. What are the accounting assumptions?

Pension assumptions are the most overlooked information in an annual report. While $DRI's pension plan is fairly small relative to the size of the enterprise, $DRI is assuming a 9% expected return on plan assets. Definitely aggressive in the context of real world returns.

Other things I look at: I read the notes voraciously. I want to get an insight that other people may have glossed over. Remember, investing is a zero sum game. For every winner, there is a loser. I like to win.

I then read the last three proxy statements.

Why do I read the proxy statement? Well for a few reasons. I like to see the make up of the board (and how they are paid), I want to see management holdings of stock, I like to see the proposals shareholders are voting for and how management responds, and a few others. The two most important things to look at when reading a proxy is: 1) How is management compensated and 2) What related party transactions have been taking place

In regards to #1, you want a management team that is compensated for things like return on capital, not sales. Why? Because a management team can pump up sales by spending capital on low return projects. All this will be under the report from the compensation committee. While it may be counter intuitive, I like to see management being compensated with restricted and common stock, yet I generally dislike when compensation is linked to stock performance. This just gives management an incentive to cheat and lie to boost their stock price. I want a management team to think like owners. I also want to see that compensation for a certain year was in line with what the business actually did...i.e. I do not want to see lots of bonuses paid out for a terrible year.

In regards to #2, it is fairly self explanatory. The less insider / related party transactions the better. $DRI has none which is a gold star in my book.

After reading the last three annual reports and proxies, I should be fairly comfortable about what the business does, its drivers, how they make money, where the capital is being spent and at what targeted return, etc. From here I will read as many conference calls and corporate presentations I can stand. You can find the conference calls on Seeking Alpha, or if you are an institutional investor on Bloomberg or Street Events. Good investor relations departments put all their historical presentations on the website, easy to find for investors. That reminds me, I will also spend quite a bit of time reviewing the corporate website, trying to get a better understand of the business. Lots of jewels to be mined there.

Why do I read the presentations and conference calls? Well first of all, I want to figure out the shared expectations of the market and the concerns of the market. Generally, an investor relations department will tailor their presentations to analysts questions and concerns. I.E. If a company is getting a lot of questions on its liquidity in private conversations with analysts and buy side professionals, the investor relations department will stick a slide in saying how great liquidity is. Always happens. On the conference call, follow the Q/A section and see what people are asking about and concerned about. You make money in the market by having different expectations about the future than the general consensus.

After reading the annual report, proxies, conference calls, and presentations you should have a pretty good understanding of the business, the market's perception of the business etc. You now need to do your comp work. And I do not mean build a comp sheet.

Where do you get your comps? A lot of the good ones are in the proxy. I then go in and add my own (and maybe take out a few I do not find appropriate).

You get the picture. You want to get insights into the business in which you are examining and insights into the strengths / problems the market is focusing on to exploit diversions between reality and opinion. I am telling you, less than 5% of sell side professionals do this. Why? Maybe they are too busy building excel models or maybe they believe Investor Relations' job is to blow smoke up every one's ass. I don't know. If you are smart about it, you can get good information.

So now you know a fair deal about the business, the industry, what is going on in the real world. From here it depends on the company being analyzed. You want some real on the ground, scuttlebutt research. For $DRI, I may call 10-15 different restaurants and chat up the hostess or manager and get some information about what is going on in the stores. How has business been? What's new to the menu? What are customers liking? Etc. For other businesses, I may call direct competitors or maybe even suppliers to get the same sort of information.

At this point, you should have a pretty solid opinion of what is going on in the business. At this point, I will throw together a few excel spreadsheets. The first will be a model (with some historical included) that will have three or four drivers. At this point, with all your due diligence, you should know the drivers. If not, go back and call the competitors and figure it out. You want to compare your thoughts on the drivers with the market assumptions. So you have your model, with your drivers, and then you compare it to the market's assumptions and drivers.

Unfortunately, that is not the only step. How much of this is already priced in? Maybe everyone know the analysts are wrong and that is priced in with low multiples. So now I want to compare the multiple to those direct competitors on a current basis, but also on a historical basis. What is the lowest a restaurant similar to Darden has ever traded for? What is the highest multiple ever traded? What is $DRI's highest EV/EBIT multiple ever (on a normalized basis)? What is the lowest cash flow multiple it has ever traded for? Etc.

If you find a stock where your expectations are significantly lower than the market, and the stock is trading at a relatively high multiple to its competitors and its historical range, well that is just a beautiful thing.

Thesis: New management is changing the culture. Content is king - Sony's presence is underappreciated. Gaming, image sensors, music are the businesses that are very valuable; they comprise 2/3 of operating income and 1/3 of revenue.

Gaming: business is large and is evolving to a recurring revenue stream model where you pay a monthly subscription fees supplemented by in-game purchases. Additionally, they have had some success in mobile games, have the #2 selling mobile game. Transition to digital game downloads should lift margins.

Sensors: Photo and video is the future of social interaction so images will continue to be an important business. Sony's image sensors are critical for digital camera option. Hal of all CMOS image sensors are Sony; 80% share of iPhone 11 and 12. Profitability has been deperessed.

Music: ~60b TAM by 2026 paid music subscriptions globally. #1 music publisher globally with 30% share and #2 record label. Streaming is now 60% of digital revenues. Digital music is more profitable than physical music.

Valuation: Expect 30% upside based on sum of the parts valuation