The concept of investment thesis may have confounded many newbies in the investment arena. But once you encounter a considerable number of substantial examples, you should be able to understand how it’s formulated and how you can create your own.
For starters, an investment thesis summarizes your reasons and conditions for investing in a particular company’s stock. It comes out after a study or analysis of the company’s long-term trends and a consideration of short-term events that may occur — all of which could affect the company’s stock performance.
Again, the whole concept of creating an investment thesis should make sense once you’ve encountered some examples, so better read on till the end of this article. I’ll be listing a few examples for you to model from.
In the meantime, let’s begin to break down the meaning and significance of having an investment thesis.
Is an Investment Thesis Just a Tool for VC’s?
Before answering this question, let me review what venture capital is.
Venture capital is a type of financing that you, an investor, would provide to small businesses and startup companies that you believe will have a potential for long-term growth. Since the nature of VCs involves some noteworthy risk as well as huge amounts of funding, venture capital is often offered only by well-off investors. Financial institutions such as investment banks also provide it.
So, is an investment thesis limited only to the use of venture capitalists? In other words, is it limited to big-time investments? Or, can newbies actually use it?
Not really. I’d say that an investment thesis is an absolute must, especially for starters.
Let’s move forward with the definition, so you would see my point.
Breaking it Down: What is it Really?
Fundamentally, an investment thesis is an analysis you (a potential buyer) would conduct to assess whether an acquisition is worth a shot. For that matter, you’ll be using an established set of investment criteria.
You may either have the thesis formally written up in a document or prepared as a slide presentation to your investment committee for the deal’s approval.
In essence, an investment thesis serves as your guide in choosing investment steps that agree with your investment objectives. In other words, it’s like a game plan.
For each potential company you plan to acquire stocks in, a corresponding investment thesis should constitute the following:
- A broad observation of the macro trends in the industry the company is operating under
- An identification of the company’s position in this trend
- A review of the characteristics the company has that should help it endure (as well as the company’s growth-dampening weaknesses)
- A summary of the reasons why you believe the company is currently worth its price (or not) — this would be your thesis
So, the investment thesis includes what you know and expect from the company, the factors surrounding its potential growth, and why (or why not) you’re investing in it.
Skipping This Step Can Be a Fatal Mistake
Since an investment thesis makes you a wiser and more-informed investor, skipping the part of creating it could be fatal to your investment goals.
Indeed, a well-formulated thesis guides you in making proper investment decisions and coming up with the right investment strategy.
It helps you decide which initiatives to get involved with, which startups to fund, and which entities to buy or take over.
A Few Real-Life Examples
I’m presenting a few short samples here of what an investment thesis would basically look like. Big-time funding institutions and investors may construct a more detailed 20-slide presentation or a 15-page document, but we can stick with what’s simple just so you can embrace the concept.
An Investment Thesis for Apple
The global smartphone industry has returned to positive growth recently, showing its resilience along with an ongoing demand for mobile devices. Worldwide smartphone shipments, according to the International Data Corporation (IDC), increased 0.8% year over year in 3Q19, and up 8.1% from the previous quarter. This has reversed seven quarters of decline, indicating a potential for positive growth in the coming years.
Among Apple’s business segments, its iPhone department has been the most profitable thus far, and it should benefit more from the abovementioned trend.
The growth of the smartphone market has already slowed down in recent years, but Apple has established a strong base of loyal customers. This fanbase should prove to be a sustainable source of revenue, especially as Apple seems to have implemented a formula among its products that promotes customer retention.
Moreover, Apple customers pay a premium for Apple’s leading products and their accessories.
Most importantly, Apple can develop new segments out of its recent innovations, enabling it to make profits continually, despite the waning of specific tech products.
Your thesis: Many of Apple’s customers may appear to stay loyal for a lifetime, and the company still has a lot of plans for developing new tech products. Apple, however, is already on low single-digit growth. Its dependable cash flow and diligent dividend distribution to investors can be a reliable hedge against potential downsides.
And Another One for CHTR
Charter Communications (CHTR) had its stock struggling during the first half of 2018.
They’ve had worse-than-expected quarterly earnings — pay-TV and broadband subscriptions had declined and consumers had the tendency to cancel their cable TV to opt for online video streaming.
Most investors were already having fears, and when the quarterly results came in, the investor’s negative sentiments only seemed to have worsened.
You note, though, that CHTR’s cash flow is predominantly driven by broadband and not by the video products. Broadband also remains a must-have product — in fact, it should increase in significance as more consumers shift to online viewing.
Moreover, CHTR’s broadband is the fastest in the market, while the company’s management is the best in the industry.
Your thesis: Even though the general investor sentiment is currently poor on CHTR, the company can still rely on strong management and broadband product that only needs a little more advertising effort to attract more consumers. While others are having negative views of the company, an opportunity is actually created to purchase CHTR stock at quite an attractive valuation.
Your Thesis, Your Strategy
Indeed, having a clear investment thesis drives your investment efforts along safer grounds.
Creating one requires you to, first of all, pick an industry you want to focus on — something you already have experience with or that you are absolutely passionate about. Then, you need to conduct substantial market research, digging in for both quantitative and qualitative data about the industry.
Along with your industry research, you should come up with four to five companies that show potential and are positioned quite strongly within the industry you’re looking at.
Finally, you would specify an investment thesis for each company. You analyze a company’s performance and all the other factors that could affect its growth in the coming years. Then, you objectively identify the reasons why this particular company would be worth your investment.
All in all, the process of creating an investment thesis takes time, and your thesis can actually change and improve as you consult a network of co-investors and experts in your chosen market.
It may sound a little tiring a step to take, but creating an investment thesis before handing your money down can save you from a lot of trouble.
After all, you can’t be too careful with any kind of investing.
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