The recommended process for carrying out business analysis is divided into multiple levels. Each level varies depending on depth and accessibility of the information.
The First Level Screen
The first level deals with material public information that is freely available to anyone. It allows the lay investor to be able to conduct a first cut analysis to determine if a company is worth investing through information found in the public domain. Although the risk level due to misinformation is high (I estimate that public domain information accounts for only 30%), an outstanding management coupled with a significant margin of safety applied in determining the company’s intrinsic value will significantly mitigate the investor’s risk.
The Second Level Screen
The second level serves as a check-and-balance and validation of the first level information. The analyst uses unorthodox means to obtain material and insider information that is not easily acquired in the public domain. E.g. the investors can pose as customers to understand service level, sales staff competency or employee satisfaction. Through such unorthodox means, the investor can glean insights that are not easily available to public. The second level screen is a significant move in providing validation to the analysis in the first level, as well as uncovering any possible problems that is hidden from the public eye.
The Third Level Screen
In this level, the investor strives to acquire an intimate understanding of the workings of the business, processes, visions, company culture, philosophy, management succession planning, people buy-in factor, team dynamics. The investor is interested to determine if the company can evolve a profitable enterprise that lasts beyond a century, filled with people who are builders of a true lasting legacy like a endlessly ticking clock tower. There are many profitable businesses that grow fast but decay after some time; but, like Warren Buffett, the value investor seeks to have ownership in a profitable business that will last forever.
Recommendations
It is recommended for any investor to understand his investments as much as possible, but the different levels of screen demands increasing amount of time and resources. How much is enough, would actually depend on how much time and resources one can set aside for your investments. For the uninitiated investor, probably the first level will suffice as a start. Given the inability to commit more time and resources to perform a full fledged analysis, this level is recommended for all DIY investors. And do take note that there must be a significant margin of safety and the study must be carried out merticulously to accurately ascertain the transparency and integrity of the management. Those companies with a management that have signs of inconsistency or possible lack of transparency should be avoided at all times.
The second and third level screens, when appropriately applied, will further lower the investor risk due to half-truths of public domain information. For any investor who is not holding a job as a finance analyst, to carry out this level of analysis entails taking leave from work to visit the company, talk to their staff, pose as customers, etc. This level can be seen as too much to ask for from DIY investors, but is probably more suitable for the part time or full time research analyst who is able to commit more resources. Nonetheless, if you are willing to invest your good money and spend time to read annual reports, why not consider taking it one step further to talk to people?
The First Level Screen
The first level deals with material public information that is freely available to anyone. It allows the lay investor to be able to conduct a first cut analysis to determine if a company is worth investing through information found in the public domain. Although the risk level due to misinformation is high (I estimate that public domain information accounts for only 30%), an outstanding management coupled with a significant margin of safety applied in determining the company’s intrinsic value will significantly mitigate the investor’s risk.
The Second Level Screen
The second level serves as a check-and-balance and validation of the first level information. The analyst uses unorthodox means to obtain material and insider information that is not easily acquired in the public domain. E.g. the investors can pose as customers to understand service level, sales staff competency or employee satisfaction. Through such unorthodox means, the investor can glean insights that are not easily available to public. The second level screen is a significant move in providing validation to the analysis in the first level, as well as uncovering any possible problems that is hidden from the public eye.
The Third Level Screen
In this level, the investor strives to acquire an intimate understanding of the workings of the business, processes, visions, company culture, philosophy, management succession planning, people buy-in factor, team dynamics. The investor is interested to determine if the company can evolve a profitable enterprise that lasts beyond a century, filled with people who are builders of a true lasting legacy like a endlessly ticking clock tower. There are many profitable businesses that grow fast but decay after some time; but, like Warren Buffett, the value investor seeks to have ownership in a profitable business that will last forever.
Recommendations
It is recommended for any investor to understand his investments as much as possible, but the different levels of screen demands increasing amount of time and resources. How much is enough, would actually depend on how much time and resources one can set aside for your investments. For the uninitiated investor, probably the first level will suffice as a start. Given the inability to commit more time and resources to perform a full fledged analysis, this level is recommended for all DIY investors. And do take note that there must be a significant margin of safety and the study must be carried out merticulously to accurately ascertain the transparency and integrity of the management. Those companies with a management that have signs of inconsistency or possible lack of transparency should be avoided at all times.
The second and third level screens, when appropriately applied, will further lower the investor risk due to half-truths of public domain information. For any investor who is not holding a job as a finance analyst, to carry out this level of analysis entails taking leave from work to visit the company, talk to their staff, pose as customers, etc. This level can be seen as too much to ask for from DIY investors, but is probably more suitable for the part time or full time research analyst who is able to commit more resources. Nonetheless, if you are willing to invest your good money and spend time to read annual reports, why not consider taking it one step further to talk to people?
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