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3 Key Elements of a Great Investment

An investment thesis is defined as the reasons and rationale for making an investment, and it is essential for the investor to draft a sound thesis to use as the basis for investing. By the word “sound”, I mean that the thesis should contain critical elements which the investor has considered before making the investment. The three key factors which need to be in any thesis are discussed below.

Competitive Moat

The investor has to clearly define the company’s competitive moat, which is what makes the company unique and able to withstand competitive threats. If the company has no discernible moat and is just one of many other companies within an industry, then the question arises as to why it should be such an attractive purchase. The moat can be expressed in qualitative terms (patent, regulation, high switching costs) and also in quantitative terms (e.g. company has higher return on invested capital and profit margins compared to its competitors). It is vitally important that a moat can be identified and defined, as this would form the core pillar for the investment thesis. You can refer to my recent article on intangibles as a type of competitive moat.

Catalysts

Catalysts are defined as events or initiatives which enable a company to grow its revenues and profits. Companies without catalysts are essentially telling the world that they are not attempting to grow the business, or are so busy fighting fire that they have no resources or time to think about business development. Both scenarios are not desirable, and the investor should steer clear of companies which do not have a concrete business plan or are unable to articulate one properly.

Catalysts may be in the form of a partnership to start a new venture, acquisitions made which need time to synergise, the building of a new factory to increase production due to higher demand, or initiatives to expand the company’s geographical reach by entering into new markets.

Risks

This section is arguably the counter-balancing section, in case one gets too carried away by optimism after writing about catalysts and competitive moats. Risks should include all the current known events which could derail growth, or basically just what could go wrong. An investor should have a realistic sense of such risks by studying the business and operating environment, or consulting broker reports which may also discuss various pertinent risk factors.

Examples of risks may include demand falling due to over-capacity within the industry, expansion into other regions not panning out as planned, or an acquisition which may perform poorly in spite of management’s best efforts.

The Foolish Bottom Line

The three key sections above will form the backbone of a sound investment thesis. Investors should be armed with the necessary knowledge of the company, and be aware of its risks and catalysts to weigh the merits and demerits of the proposed investment.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.