Doing Research 📖 What does that Mean?!
A common phrase that people use to somehow wash themselves clean of all their potential liability is "Do your own research", but what does that actually mean?
I see so many people say that they've done their research, but that can look completely different for different people.
I wanted to share a structure for what Research actually means, and how you can apply it when looking at stocks. So save this post, come back to it, and consider adding it to your investing practice.
Before we get into the things to do, we should look at the things that are often misunderstood as research...
Watching YouTube videos from Joe Blow online is not research...
Watching "Hot Stock this week" tiktoks is not research....
Asking chat gpt what stock you should buy is not research...
Motley Fool is not research...
Copy trading an influencer or a professional is not research...
Looking at analyst estimates and following their targets is not research...
If you lie to yourself about whether or not you've done an adequate amount of research, you only rob yourself of future results.
So, what does proper research look like? Let's dig in.
Ultimately, we want to find wonderful businesses that we can invest with a margin of safety, so we need to find out what would qualify the business we were looking at and what a fair price might be.
We start by building a watchlist of companies we understand. Eliminate everything that we don't (be aggressive here).
The easiest way to understand a business, and be able to decern if it's wonderful is to look at businesses that fall within your circle of competence. Those are businesses that you interact with, that you use products from, in industries you understand, that solve key problems. Leverage your life experiences to give you an edge on the markets.
Personally I know nothing of Bio-Tech, so I'd never dare even look into that space. I do however know the clothes that my wife buys, that I've had exposure selling on secondary markets, that I can see online trends for. That's how I found Aritzia which resulted in a +700% return in 3 years.
If you work in a hospital, you have an edge on the medical field over most other investors.
Next we need to identify if the company has a durable moat. Some secret sauce that keeps this business excellent and protects it from infringing competition. You'll find proof of this in the financial statements, historic ROE, margins, look at their competitors and compare.
The next step would be to comb through recent 10K or annual filings, as well as 10Qs. Do the work here, this is important! Don't take shortcuts.
Read the annual letters, see how managment talks, see if they live up to their goals or if they make bold claims then never bring them up again if they fail. Read the about the risks, the negative impacts on the businesses, where they are finding strength. What isanagment expecting for the future? These government mandated documents have so many details on the business and 99% of investors never even look.... You can always find these on the companies Investor relations page.
Review 10 years of financial performance. The reason it's important to look at such a long timeframe is so that you can see how the company did when the economy was turbulent. A 10 year timeframe should give you plenty of insight on how the business operated throughout different economic cycles.
We want to find strong moat businesses that are durable and resilient.
Look at growth rates and how the business has performed, and what caused their performance (it's all in the filings!).
[An important note here, using AI can be helpful to analyze documents like these, but it's not uncommon for results from AI to be mistakes or made up. Reference what it tells you and fact check everything!]
Next we want to review managment. Who are they, what do they stand for, how long have they been with the company, what's their track record. Judging the quality of the managment will ultimately tell you what to expect from a busienss.
Do they have integrity (do they own their mistakes or are they honest about business hardships)? How much are they paid? Do they have their own money invested in the company?
What does their compensation package look like and what goals/milestones must they hit to reach certain levels of their compensation ladder.
Charlie Munger often said "Show me the incentive and I'll show you the outcome". Figure out what is incentivizing managment to see if the company is a good fit. If they are heavily invested with their own personal money (this applies to the board of directors as well) then you would expect to be aligned on the results. If they are only incentivized to grow EPS, do they take shortcuts that are detrimental to the long term success of the business just to hit a short term target?
(Founder CEOs are great to have leading the company because they are often most aligned with long term investors)
Confirm the durability of the business, their balance sheet fortification. Are they highly leveraged?
Using the information that you've now learned from the company, you should be able to build some financial models to help determine the fair value of the business. Only if you've determined that the business is wonderful is it worth getting this far in the research process.
There are many models, but ultimately the math should be straight forward. Are you buying $1 of value for $0.50 cents?
Once you come up with what you want to pay, apply a margin of safety to that result to account for all the various factors or oversights that you may have missed during your research.
Finally, the last part is to wait. If you've done all the work, you've ran the models, you know what to pay, then just wait until the market gives you an opportunity.
"You don't make money when you buy or sell a stock, you make money when you wait".
-Charlie Munger
Structure your research and findings into a comprehensive document.
Prepare a white paper that catalogs all your research that you can refer to and reference back to as the thesis you've produced plays out.
Another important tool to structure your research around is a checklist. Identify all the key things that you want to see or not see, key questions that need to be answered ect. that are all written out as a checklist to confirm your findings align with your goals.
Most large money managers have some form of a checklist to verify the quality of their research and the company.
Use key tools that are available to the public such as: 10k Filings
Investor Presentations
Earnings calls (Listen to these!!!)
Competitor reports
Insider buy and sell data
If possible, go talk to people who work for that company!
(the number of Aritzia employees I talked to for over an hour is more than I care to admit 😆)
Research should be a long and thorough process.
In a year, you only ever really need to buy one stock, if it's well researched and falls within your margin of safety price. You only need to swing at the fat pitches that make the most sense to you.
Don't chase the hype, don't cave to Fomo. Look where others aren't looking, and flip over many rocks...
"All intelligent investing is value investing" - Charlie Munger. Know what something's truely worth, and pay less than that.
That's only possible once you've properly done all the research.
