MENU

How You Can Make Well-Rounded Investing Decisions

When it comes to analyzing companies, there are a barrage of useful tools out there which can assist the enterprising investor. Some of these include PEST Analysis, Porter’s Five Forces, and the SWOT Analysis. I shall focus on SWOT analysis in this article, with the other two to be covered in subsequent articles. [Editor’s note: Articles discussing PEST analysis and the Porter’s Five Forces model have been published. They can be found here and here.]

So what is a SWOT analysis and why is it so useful? SWOT stands for Strengths, Weaknesses, Opportunities, and Threats and involves the review and analysis of various aspects of a company in order to obtain insights on its growth drivers and risks. A SWOT analysis is included in most brokerage reports, but it is possible for you to do a SWOT analysis on your own – as long as you are armed with the relevant information to populate each category.

Let us now look into each aspect of the SWOT analysis, along with examples on how to proceed within each category.

Strengths

Strengths would refer to the competitive advantages a company has, as well as attributes which make it superior to its competitors within its industry. Some examples of strengths could be specialized techniques or know-how a company possesses which other competitors do not. It could also be a better reputation and track record for excellence. Other examples of strengths include better customer service, better after-sales service or more efficient supply chains . Strengths are important as they tell us why a company is attractive and a good potential for investment in.

Weaknesses

The weaknesses category is the opposite of strengths, and acts as a counter-balance in case the strengths-analysis becomes overly-optimistic. Weaknesses tend to be areas where a company may do badly in, or may not have placed resources or efforts to improve on. Examples include divisions which are performing poorly, or aspects in the business (such as sales support) which require improvement. Depending on the type and extent of each weakness, it may invalidate the investment thesis for a company, or cause our view of the company to be weaker than originally expected.

We must remember to balance-off a company’s strengths and weaknesses in order to obtain a holistic view of the company’s capabilities.

Opportunities

Opportunities represent chances for a company to grow and expand market share, or to capture more contracts and enjoy better business prospects. Opportunities could include favourable trends which act as tailwinds for the company, a tie-up with a strong partner on a joint venture which increases the chances of winning larger contracts, or a fragmented market which could be fertile grounds for acquisitions for the company. These opportunities should be viewed from a medium-term perspective of at least three to five years, in order for any catalysts to play out and for corporate strategies to bear fruit.

Threats

Threats are risks which may derail a company’s plans for growth, or which may act as a stumbling block on the company’s path to success. Most threats in the business world are due to competitive forces, and also technological innovation. Competitors tend to enter the fray when a company is making excess profits from a new business idea, and this eventually reduces overall profits for all players within the industry. Innovation results from an improvement in products manufactured or services rendered, and can lead to obsolescence for a company if it does not adapt quickly enough. Other threats do exist too, and must be carefully and continually evaluated to judge their impact on a company.

Foolish bottom line

As can be seen, a SWOT analysis provides the backbone for analyzing a company from many angles, and can provide you as an investor with a wealth of information to base your investment decision on.