Investing in stock markets has immense potential provided you select a company based on strong fundamentals and keep a long term perspective. The essential first step to see how strong the fundamentals are is to evaluate the company based on its strengths, weaknesses and future growth prospects. While there are many tools to help you make an assessment, one of the most widely used is the SWOT analysis. The SWOT analysis for stocks evaluates the investment potential of a company from the following angles:-
Let us see how to put this analysis to use :-
The first step is to analyse the strength of the company you have selected. Over the years successful companies have been able to play on their strengths and emerge as market leaders in their space, consequently becoming promising investment avenues. Following are the critical factors to look for while evaluating the strength of the company -
●Corporate Governance ( Managerial quality, regulatory compliance, treatment of personnel and other stakeholders)
●Products or services ( quality of product, demand of product, criticality in the value chain, research and development capabilities)
●Margins ( Sustenance of margins vis-a-vis competitors)
●Customer Base ( Brand Loyalty, brand penetration, customer loyalty)
A company with strong managerial capabilities, sustained competitive advantage over peers due to their product offerings , excellent innovation and great brand recognition, has a strong chance of succeeding in the future as well and can be considered a viable bet. However, it's important to keep in mind that strengths are sector specific. For instance, the strengths of a tech company , an agrochemical or a pharma company will differ. While a pharmaceutical company may have R&D expense or several patents as critical criteria, the tech company may have a client portfolio, and order book as the strength. So keep the industry and sector in mind while evaluating strengths to reach the right conclusion.
While its important to analyse strengths , its equally important to look at the weak spots. These weaknesses might be temporary or could be grave enough to impede a company’s growth prospects, if left unchecked. While evaluating the weaknesses of a company is not an easy task, one thing that can give you an idea in this regard is the annual report. In the notes of accounts, companies tend to mention contingent or the potential liabilities that may arise. Apart from this, other areas to look for while assessing weaknesses are
●Slow pace or lack of research/innovation
●Unstable management or declining promoter’s interest including siphoning of funds from the company resources, hasty exits of key personnel, regulatory non-compliance, frequent defaults etc.
As in the case of strengths, some weaknesses are also industry and sector specific. For instance while the utility sector may not face any competition, the FMCG sector may experience it at an elevated level. So again, be mindful of the intrinsic nature and limitation of the industry when you look at weaknesses.
Opportunities show the potential growth pattern a company may chart out. For some companies, spotting a prospect could be easier than others. Thus, as an investor, you need to be on the lookout for companies that have been able to spot the potential of an upcoming niche and are rapidly diversifying their offerings to be present there, ergo, possess an early mover advantage. Based on the strategy and aggression to tap the potential area, the company’s growth potential can be mapped. For instance, Maruti announced entering the electric vehicle segment when it was evident that India, there will be a high adoption to e-vehicles owing to their environmental feasibility. Similarly, a lot of start-ups are finding opportunities in different segments, such as artificial intelligence.
While evaluating on the opportunities front, here are a few things to look out for:-
●Expansion opportunities in terms of product offerings as well as geography.
●External opportunities such as mergers or acquisitions, a new segment, new industries, etc.
●Macroeconomic factors such as lack of resources or an abundance of the same, etc.
●Social trends and the ability to adapt to the same.
When you look at the annual report or the transcript call, check the management discussion and analysis section. Here companies disclose their future growth plans and how they will leverage the growth of the economy or sector to achieve their objectives. This can give you vital insights about what opportunities the company has and how is it planning to tap into them.
The last of the four-point framework in the SWOT analysis of stocks is the threats. The threats a company faces indirectly indicates the risks your investments could be exposed to as well. Threats are basically weaknesses magnified, that have a direct impact on the business of the company.For example, a high contingent liability could be a threat. Some of the other areas to look for while evaluating for threats are as follows :-
●Government policies that have a direct impact on the business
●Competition from peers.
●Substitute and its pricing
The “ Notes and Accounts” section in the annual report can provide vital insights into the potential threats a company faces. You can look at the line items such as a lawsuit against the company, ban on product/process of the company, any pending litigation matter, stay order, or any ban on the production/license (more applicable to pharmaceutical, agrochemical sector). Stiff competition from peers, whether it is in terms of product diversification or pricing strategy are also potential threat areas to watch out for.
To sum up, if you are still in the initial stages of your research about the fundamentals of a company, a SWOT analysis is a good starting point . While this may seem like a time consuming pursuit, this is an important activity to thoroughly assess a company so that you know fully well about the investment avenue you are about to explore. This preparedness also goes a long way in protecting your capital to a large extent. So shortlist companies based on how well they fare on the SWOT analysis, select fundamentally strong names and keep a long term perspective to reap the benefits of stock investing.
The author is the Co-founder and COO, Groww