INTRODUCTION

Investing in stocks is not just about picking companies at

random or following the latest trend. Successful investors,
such as Warren Buffett, have built their wealth by
thoroughly analyzing businesses to ensure they are
making wise, long-term investments. This e-book is
designed to help you understand the key factors you
should look at when evaluating a stock.

Each company is unique, but there are universal principles

that can guide you through the process. This guide breaks
down 15 essential elements of stock analysis, focusing on
business fundamentals, management, risks, profitability,
and valuation. By the end of this e-book, you’ll have a solid
foundation for making more informed investment
decisions.
BUSINESS FUNDAMENTALS AND
MANAGEMENT

1. Business Model
Understanding the business model is one of the
most fundamental aspects of investing. It involves
asking how a company generates revenue and
where its income streams come from. Does the
company rely on one product or service, or does it
have diversified revenue streams? A diverse
business model might be more attractive because
it is less vulnerable to market fluctuations in one
specific area.

Attractiveness of the model: As an investor, it’s

crucial to assess whether you find the business
model compelling. For example, a subscription-
based company like Netflix has recurring revenue,
which can be more stable compared to a retail
business that depends on frequent customer
purchases.
2. Capability of Management
A strong management team is crucial to a
company’s success. Look at the track record of the
executives and board members. Have they
consistently created value for shareholders? If a
company has a history of poor management
decisions, it might be a red flag, regardless of its
other strengths.

Skin in the game: This phrase refers to whether

management owns a significant portion of the
company’s shares. When executives are also large
shareholders, their interests are more aligned with
those of investors. This alignment is important
because it indicates that management is more
likely to make decisions that benefit long-term
shareholders rather than focusing solely on short-
term gains.

3. Sustainable Competitive Advantage

Competitive advantage refers to what sets a
company apart from its competitors. Does it have
a unique product, a strong brand, or superior
technology? These factors can provide a company
with an edge that protects it from competitors.
Warren Buffett often refers to this as a "moat"
around the business, making it harder for others to
encroach on its market share.

Pricing power is one key indicator of a competitive

advantage. If a company can raise prices without
losing customers, it suggests that its products or
services are highly valued. For instance,
companies like Apple have strong pricing power
because customers are willing to pay a premium
for their products.
 RISK, GROWTH, AND CAPITAL

4. Attractiveness of the Industry

When evaluating a stock, it’s important to
understand the industry it operates in. Some
industries grow faster than others. For instance,
technology and healthcare tend to have higher
growth rates compared to industries like utilities or
traditional manufacturing. The overall growth rate
of an industry can provide a tailwind for companies
operating within it.

Cyclical vs. non-cyclical industries: Some

industries are cyclical, meaning they are highly
sensitive to economic conditions. For example, car
manufacturers tend to do well during economic
booms but struggle during recessions. Non-cyclical
industries, like consumer staples (groceries,
healthcare products), are more stable because
their products are always in demand.
5. Main Risks
Every company faces risks, but identifying the key
risks for a specific business is vital. These could
include regulatory risks, supply chain issues,
technological disruptions, or geopolitical factors. A
company that operates in multiple countries might
face different sets of risks, from currency
fluctuations to trade tariffs.

Black Swan events: These are rare and

unpredictable events that have a major impact,
such as the 2008 financial crisis or the COVID-19
pandemic. Although you cannot predict these
events, it's important to assess how resilient a
company might be in the face of unforeseen
challenges. Does it have strong cash reserves? Is it
highly leveraged with debt?

6. Balance Sheet
A company’s balance sheet provides insight into its
financial health. A strong balance sheet typically
has low levels of debt, a significant amount of cash
on hand, and limited intangible assets like goodwill.
Goodwill is often created during acquisitions and
represents the excess price paid over the actual
value of the company being acquired. Too much
goodwill can be a sign that a company has
overpaid for acquisitions.

A healthy balance sheet gives a company more

flexibility to invest in growth opportunities or
withstand economic downturns. It's also important
to compare the company's debt to its earnings
(Debt/EBITDA ratio) to see if it's carrying too much
debt.
7. Capital Intensity
Capital intensity refers to how much money a
company needs to invest in maintaining or growing
its operations. Some businesses, like manufacturing
or energy, are highly capital-intensive because they
need to invest large amounts of money in
equipment, factories, or technology. Other
companies, such as software or service-based
businesses, are less capital-intensive.

Growth CAPEX (Capital Expenditures for Growth) is

the amount of money a company reinvests in future
growth. While high capital expenditures can be a
sign of expansion, it’s important to assess whether
the company is investing wisely and whether these
investments are yielding returns.

8. Capital Allocation
Capital allocation refers to how management
allocates the company’s resources. This includes
deciding whether to reinvest profits into the
business, pay dividends, or buy back shares. The
most successful companies are those that
efficiently allocate capital to generate the highest
possible returns.

Return on Invested Capital (ROIC) is a key metric to

assess how well a company is allocating its capital.
A high ROIC indicates that management is investing
in areas that are generating strong returns, whereas
a low ROIC could indicate inefficient use of
resources.
 PROFITABILITY, GROWTH, AND
VALUE CREATION

9. Profitability
Profit margins show how efficiently a company
turns revenue into profit. A higher profit margin
indicates that the company is able to control costs
while maximizing revenue. Gross profit margin,
operating margin, and net profit margin are three
key metrics to evaluate.

Free cash flow is another critical measure of

profitability. It shows how much actual cash the
company generates after accounting for capital
expenditures. Companies with strong free cash flow
are often in a better position to reinvest in their
business or return cash to shareholders through
dividends and buybacks.
10. Historical Growth
Revenue growth and earnings growth are two key
indicators of a company’s past performance.
Revenue growth shows whether the company has
been able to increase its sales over time, while
earnings growth indicates whether those sales have
translated into higher profits. As a rule of thumb,
look for companies that have grown their revenue
by more than 5% annually and their earnings by
more than 7%.

Companies that have consistently demonstrated

strong growth in the past are more likely to continue
doing so in the future, especially if they operate in
growing industries or have a strong competitive
advantage.

11. Usage of Stock-Based Compensation

(SBC)

Stock-Based Compensation is a way for

companies to reward employees and executives by
giving them shares in the company. While this can
align the interests of management with
shareholders, it can also dilute existing shareholders
if too many shares are issued.

It’s important to check whether the company is

using SBC responsibly. Is it issuing new shares at a
high rate, or is it buying back shares to offset
dilution? If the company’s outstanding shares are
increasing rapidly, it might be diluting shareholder
value.
12. Outlook
Future growth prospects are just as important as
historical performance. Look at the company’s
future earnings potential, new product launches, or
expansion into new markets. Can the company
grow its revenue and earnings by more than 5-7%
annually moving forward?

The company’s outlook should also consider

macroeconomic factors, industry trends, and
competitive pressures. A company with a bright
future is likely to outperform the market over the
long term.
 VALUATION AND OWNER’S
EARNINGS

13. Valuation
Valuation is the process of determining how much
a company is worth relative to its earnings, assets,
and growth potential. Key metrics include the Price-
to-Earnings (P/E) ratio, Price-to-Book (P/B) ratio,
and Enterprise Value-to-EBITDA (EV/EBITDA). A
company with a low valuation relative to its peers
might be undervalued, while a high valuation might
indicate it is overvalued.

It’s essential to compare the company’s valuation

to its growth potential. Sometimes, a high P/E ratio
might be justified if the company is growing rapidly.
However, if the company’s growth prospects are
limited, a high valuation might be a red flag.
14. Owner's Earnings
Owner's earnings is a concept popularized by
Warren Buffett. It is calculated as net income plus
depreciation, amortization, and other non-cash
charges, minus capital expenditures. This metric
gives a clearer picture of how much cash a
company is generating that can be used for
dividends, buybacks, or reinvestment in the
business.

A company that consistently grows its owner’s

earnings by more than 10% annually is likely to
create significant value for shareholders over time.

15. Historical Value Creation

Value creation is the ultimate goal of any
company. Look at how much value the company
has created for its shareholders since its IPO or over
the past decade. This can be measured by stock
price appreciation, dividend payments, and share
buybacks.

Companies that compound shareholder value at a

high rate over time are the ones that investors
should seek. Compound growth, as Warren Buffett
has shown, is the key to long-term wealth creation.
 Conclusion
Summarize the importance of a thorough stock
analysis, covering everything from the business
model to capital allocation and valuation.
Encourage readers to apply these principles when
evaluating potential investments.
Mention that they can learn more by exploring
additional resources, such as advanced financial
analysis courses or subscribing to a newsletter on
stock analysis.
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Pieter Slegers
Compounding Quality