Understanding Company Analysis in Investment Research

Company Analysis in Investment Research

At Starbucks, Meera was merrily sipping her coffee happy with her cousin Rhea’s visit. “It’s a treat for your promotion!”, she had exclaimed. Smiling at her, Rhea said, “Yes, it is a treat.”

“Rhea, you work as an investment banker; and I’m contemplating of venturing in this profession. But is the work profile too boring?”

Giggling out loud, Rhea said, “Oh no, on the contrary, it is quite exciting and challenging. You see, I have to advise the client about whether an investing in a particular company will fulfill their financial objectives, which requires careful study of the company’s history, financial performance, industry trends, competitors, etc. Hmn, not let’s take the example of Starbucks itself!”

Investment research is quite important for an financial analyst. While assisting in identifying profitable investment opportunities, the analyst has to piece together the various strands of information available on the company being researched, understand them thoroughly and come to an opinion as regards the company’s prospects.

Investment research for financial analyst

Overview of investment research

The term “investment research” is a very broad one and includes company analysis (aimed at equity/debt markets), analysis of currencies/interest rates / options, macroeconomic research etc. In this course, the focus is on company analysis. At the conclusion of the analysis, you should be able to have and defend a buy/hold/sell recommendation with respect to a company’s tradeable securities (i.e. – stocks/bonds). The profitability of the trade recommended by the analysis is directly proportional to the accuracy of the recommendation that is made. As such, it is extremely important to gain an accurate understanding of the company being analysed.

Investment Research company analysis

Let’s take an example of Starbucks, a leading name in premium coffee outlets. An analysis of the company will explain how investment research is carried out.

(A) Business analysis

A clear understanding of the company’s operating environment

  • the economy in which it operates
  • industry
  • market position
  • strengths, weaknesses, opportunities and threats,
  • strategies
  • key success factors, etc.

(i) Economic Analysis

Though this information is obtained from reading and understanding reports prepared by economists, it is still important for company analysts to have a clear picture about the overall prospects (i.e. – future growth rates, possible threats to economic growth, etc.) for the economies that the company operates in. It is important to note that, if overall economic factors turn unfavorable (for example, the occurrence of a recession), the company is never immune from the impact. Overall economic conditions can significantly impact performance, forcing a company to re-examine its prospects and strategies.

Starbucks, an American company has operations in over more than 60 countries. Their primary business is beverages: majorly handcrafted coffee. Starbucks main requirement is procurement of coffee. Hence, it is dependent on the suppliers of coffee, some of which are impacted by government regulations and climatic conditions


(ii) Industry Analysis

You have to understand the key success factors pertaining to the industry that the company is engaged in. These can be understood by utilizing the Michael Porter framework – i.e. – try and understand an industry along the following lines – barriers to entry, supplier power, buyer power, threat of substitutes and rivalry.

The coffee industry has grown thanks to growing culture among youth to associate it with high standard of living and a means for entertainment. Starbucks is a leading name with branches spread out worldwide..Their main target customers are higher and upper middle class citizens, since the price ranges are quite high.


(iii) Competitor Comparison

While it is not necessary to rigorously follow the Porter framework, this process nevertheless allows you to structure your thoughts about an industry and can form a base from which you can organize your thoughts.

Despite a strong brand name, Starbucks’ does have its fair share of competitors. Its major competitor is Costa Coffee; which is also famous for its premium roasted coffee. Other competitors include Café Coffee Day, Caffe Nero, Barista Lavazza, etc. Also, there are cheaper options of coffee available at eating outlets such as McDonald, which prove a major threat to this brand.


(iv) Success Factors

You will need to clearly grasp the factors behind a company’s success (or lack of it!). These could include a whole host of factors such as cost control, wide product range, branding, etc. Further, you should also come to a view about whether the company can continue to maintain its success by relying on these factors. Companies typically talk about their success factors in their annual Reports.

Key success factors in this case is the brand name of Starbucks. It is known for its good quality with thick roasted flavour of coffee blended in an authentic way. With a constant growth rate, the company has managed to boost its profitability. Also, the expanding business line by venturing into various geographical segments has provided impetus to its growth.


(B) Financial Analysis

Broadly, you will have to arrive at a clear picture of a company’s existing financial performance and should also be able to link this up with the understanding that you have obtained about its business. After going through a company’s income statement, balance sheet as well as cash flow statement, you should be able to understand the reasons behind

a) Change in revenues – is it because of price increases / volume increases / both factors?
b) Change in costs – are there cost pressures, has the company been able to rein these in?
c) Change in EBITDA and net margins.
d) Balance sheet – is there any major change in capital structure

You’ll find information about finances of listed companies readily available in annual reports. For example:

Profit Margin as on 28th Sept 2014: 13%
Profit Margin as on 27th September 2015: 14%

After Tax Return on Equity as on 28th Sept 2014: 39%
After Tax Return on Equity as on 27th September 2015: 47%



(C) Valuation

The process of valuation typically involves preparing projections for a company’s financial performance. This is followed by comparing the company’s projected numbers with those of its competitors using typical valuation techniques. Some examples of valuation techniques (for equities) are P/E (Price to Earnings Ratio) and EV/ EBITDA (Enterprise value / EBITDA).“This was simply a brief idea of how we initiate investment research. Now you see it is pretty interesting, since the market is full of surprises and changes! We have clients investing in various industries and having different requirements. But as of now, we can savour the coffee of Starbucks instead of thinking about its stock prices,” chuckled Rhea.