Fundamental analysis of a stock is incomplete without some sort of qualitative analysis. A lot of people (who like stocks but don’t know much about security analysis) base their decisions off some sort of qualitative analysis. Most people actually do this subconsciously. For example, if someone is thinking of buying Singtel their thought process would probably be something like this: Most people in Singapore use Singtel. It also has stakes in the largest telecom provider in India and the second largest in Australia. It is largely owned by Temasek (A government investment corporation). Therefore, it can’t fail and it is a good company to invest in.
Sure that’s some sound logic, but qualitative analysis should be something more wholesome. (If you know what I mean) You may have forgotten about the entrance of a new telecom provider in Singapore that will squeeze Singtel’s profits. Or perhaps one of its cable suppliers may have increased prices. Only focusing on one part of the business may land you in danger of losing your capital. So in order not to miss anything out, we’ll be introducing you to….. Drumroll….
Porter’s 5 Forces andddd SWOT analysis
WHAT ARE THEY?
Both of these are management tools that allow the management of companies to assess their current position in the market and how to progress from there. Porter’s 5 Forces gives you a comprehensive picture of the competitive environment in the company’s industry by analysing the pressure of each of the forces. Whereas SWOT analysis is more of the inner potential of the business or concept like what is the business’s strengths or weaknesses etc.
Porter’s 5 Forces
Porter’s 5 Forces was created as a way for business managers to gauge the level of competition in their company’ industry. We as investors can also use it to determine the profitability of businesses in particular industries. As you can see below, there are 5 parts to this. (5 forces duh..)
Competition in the Industry
It is important to assess the competition in the industry because competition reduces profit margins. Simply put, if there are 2 stores next to each other selling the same thing at different prices surely you would go to the cheaper store. Therefore both stores will have to compete and price their products at as competitive a price as possible. What you are looking for is a business that has very little competition in its industry.
Threat of New Entrants
Similarly, it is important to look at the barriers to entry into the industry to assess future competition in the industry. The easier it is the enter the industry, the higher the future competition. For example, entering the telecommunications industry is really hard because of the high barriers to entry (i.e. Capital Intensive, high fixed costs, legislation, etc.) whereas an internet startup selling t-shirts that you can design yourself would be easy to enter because of the low barriers to entry.
Threat of Substitute Products
How easy is it to find a substitute product? It’s a little bit like using Microsoft Word, Excel and Powerpoint when you can use Google Docs, Sheets and Slides for free. (Ok maybe not excel but for the other 2 probably) If the good or service that is provided is easily substituted then the company is at risk of losing out to its competitors.
Threat of Suppliers
How easy is it for suppliers to increase the prices of their goods or services? You need to consider how many suppliers there are. If the company’s main supplier increases their price, would they easily be able to switch to another one? The fewer suppliers there are and the more the company depends on their supplier, the more the business would be at the mercy of its suppliers.
Threat of Consumers
The threat from consumers is literally the opposite from paragraph above. If the company is selling its goods to one major client. The loss of this client would cause revenue and profits to fall dramatically. So it is important to look at how many clients the company has and the proportion of good sold to each client.
Evaluating these 5 Forces will allow you to see quite a complete picture on the external forces affecting a company. This is, however, incomplete if you don’t even consider the resilience of the core business idea. The SWOT analysis (I love the name) helps to analyse the viability of a business concept. SWOT stands for Strengths, Weaknesses, Opportunities and Threats. Here you simply (or not so simple since it is quite a lot of effort) take the business you are analysing and split it into its various business segments and then conduct the SWOT Analysis on it.
What are the strengths the business has? It could be something like a patent which gives the company rights to its creation. Or a strong brand name like Google, where its name has become synonymous with searching for information on a search engine. Or it could be some sort of unique technology that is difficult to replicate. Just try to list down all the strengths that the company you are analysing has and put them in the Strengths box in your SWOT analysis.
Similarly, list down all the weaknesses that you can think of. Perhaps something like the lack of new innovation or high levels of debt that would prevent the organisation from increasing leverage. Anything that may be hindering the business from achieving its optimal performance should be listed here.
This category is more forward-looking than the previous 2. It looks more at the future of the business than the current position of the company. For example, it could be how the company is poised to take advantage of new trends like the Internet of Things or Crowd Funding. It could even be the possibility of a merger or acquisition. Anything that could potentially benefit the company should be in this section.
Threats are any potential dangers to the business you are analysing. This could be a potential lawsuit or changes in government policy like increasing taxes on the goods or service that the company provides. Or maybe technology is causing the business to become more and more irrelevant to consumers. List it all here.
Once you list all these down, you should be able to see the potential of the stock that you are analysing and ultimately make a good decision. Both Porter’s 5 Forces and SWOT analysis are management tools used to assess the position of a company to help with future planning but since a good stock is part of a good business it is very useful in your investment analysis as well. However, please do not solely base your decisions on the qualitative factors of the company. You don’t want to end up overpaying for your stock. Thanks for reading and I hope you find this helpful in your future analysis of good stocks!