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Let’s first start by reviewing what a situational analysis is and its importance in my stock analysis process. In an earlier post I introduced the situational analysis as my #1 priority when I examine a stock for a possible investment. An investor can choose to take a quick look at a stock’s price, charts, recent news or ratios, but the important focus of a SA is on company fundamentals and learning what the company is all about without creating an immediate bias. What this helps an investor to do is create the needed discipline for stock picking and avoid investing in stocks simply because you love the products or company. As an investor you always want to know as much about what you’re buying as you can and this format helps you to do that without becoming too emotionally involved in the process.
A situational analysis is your best tool for organizing all the information you’re going to find in your research and something that will help you from getting distracted or confused during this process. It’s easy to keep and maintain over time on any stock you’re following and it offers simplicity and flexibility which is great for a beginner. Writing out a SA is especially useful because you don’t need to have a financial background to do one. It looks at the past, present and future of a company and is great for comparing rivals or peers within the same industry. It doesn’t need to be pretty and the simpler it is the better it works. Far too often a new investor believes that they need a complicated process to invest in stocks when in all honesty there are times where simple and straightforward works the best. A SA doesn’t need to be done on only companies you want to invest in. If you know you want to eventually own three companies in the same industry, but don’t have the money today, maintaining a SA on each of them will help you to determine which one is the best candidate for your first investment.
A SA enables you to do three key things as you analyze a company and I find that it helps to write these at the top of the page for each stock before I start:
- It ignores information that isn’t important or relevant
- It organizes information that maintains a clear focus on what matters most
- It includes information that can be easily revised and changed over time
- Internal Environment (SWOT)
- Customer Environment (5W-H)
- External Environment (PEST)
- Competitive Environment
Questions you may want to ask include:
- Does the company make money?
- Do they have strong brands?
- Where in the product life cycle are their products or services?
- Do they compete on price?
- Do they have a competitive advantage/disadvantage?
- Is management committed to shareholder interests?
- Does the stock currently offer value? What kind?
- Are they able to control costs?
- Is the growth of the company manageable and sustainable?
- Is management able to accurately forecast demand, operations and performance?
- Does the company do what it can do best?
#1: Internal Environment
A SWOT stands for Strengths, Weaknesses, Opportunities & Threats and includes only information within the operational environment of a company. I like to think of a SWOT as including everything that I can find about a company within its own walls. The information that goes under each title should be specific, but you don’t need to use complicated financial terms – remember to keep it simple.
For IGM here are a few examples you can start with for your SWOT:
Strengths:
- Member of the Power Corporation family who holds substantial financial assets and shared internal resources
- Long established history with highly identifiable brand names
- Large national network of financial advisors
- High quality fund managers and fund partnerships
- Highly skilled and competent management
- History of prioritizing shareholder interests
- High overhead costs due to commission structure of sales staff
- Few highly visible retail branch offices
- Expand on current and new product offerings
- Grow clientele and customer base
- Continue to incorporate new acquisitions and implement cost controls
- Increased difficulty of managing size and scale of the company
- Loss or retirement of executive managers/leaders
- Difficulty in retaining key employees and advisors to competitive opportunities elsewhere
#2: Customer Environment
In this section you get to be a marketing executive for a day and ask yourself questions about who the target market of the company is and what their clients look like. 5W-H stands for the classic Who, What, Why, Where, When & How and you focus this on the companies client base. Always remember that a client or customer can be a business, government or individual consumer. This section is important because before you put money into a company or look at their external environment you want to make sure that you understand what they’re all about. You want to know who they sell a product or service to, what relevant information might impact them in the future about those customers and what consumer trends could affect their operations. This collected information gives you insight into how the company is doing with their customers and you can update your SWOT with anything new that comes up.
Example questions you want to investigate and answer about IGM’s clients might be:
- How old are their core customers?
- What is the range of ages?
- Where are the majority of their offices located?
- Is their sales staff mobile?
- Are their retail locations convenient for clients to get to?
- How educated or well trained are their employees?
- What is the average amount invested by each client?
- What is the average net worth of each client?
- How long on average has each client been with the company?
- What is the education or lifestyle of their clients?
- Why would customers want to buy their products or services?
- When do they purchase investments (time of year, time of economic cycle)
By the end of this activity you should be able to answer clearly if you are a potential customer and why. Don’t get discouraged if you have difficulty finding the answers to any of these questions. If you call up the company or contact their investor relations department they’re often more than happy to send you out free information on the company in the hopes of persuading you to either invest in shares of the company or to become a potential client yourself.
#3: External Environment
A PEST stands for Political, Economical, Social and Technological and includes everything that occurs outside the company walls that can have an impact on the company you’re looking to invest in. There will be times when you won’t be able to fill each of the four subheadings with the same amount of information as a SWOT, but that largely depends on the industry and company you’re researching.
Let’s examine political to start. Some industries require an investor to place a greater concentration on political influences than others and when I analyzed Exelon Corp I made the point that political oversight was a serious consideration for the company because they operate within a regulatory environment like many utilities do. The company’s solution was to stack their board of directors with individuals of significant political influence in contrast to a number of their competitors who had not, helping to balance the amount of risk the company is exposed to at any one time. Political influences are often found in the news and current events and can cause havoc by sending the price of a stock in wild directions. While this creates value at times for an investor no one enjoys watching their purchase swing wildly in a volatile range. A pharmaceutical company or food manufacturer will have exposure to activities of the FDA and other regulatory bodies. Companies selling consumer or industrial goods may have exposure to international trade laws or tariffs. An investor only needs to look to October 2006 to see the significant reaction that markets can take when at that time the Federal Government if Canada made public its intent to tax income trusts as corporations starting in 2011. Many investors hadn’t foreseen government intervention and ignored the risk present in that group of equities. The subsequent drop in nearly all trusts demonstrates clearly the political risks that can have an impact on your investments.
The important point is to be conscious of what risks (political, economic, social & technological) that a company or sector may be exposed to and look to see how individual companies have positioned themselves in anticipation of those risks.
Here are some examples for IGM to start your PEST with:
Political:
- Obligated to report financial statements and accounting within legal framework of government regulations
- To sell financial products advisors must be certified with a professional body
- Current economic instabilities may lead to lower fund contributions and higher withdrawals in the industry
- Increasing amount of discretionary income expected to be created by aging and retiring population
- Baby boomers: don’t have the time, knowledge or desire to manage their own financial assets versus spending time on leisure activities
- Population is aging with more emphasis on financial security
- More investors are using computers to track and/or invest online independently
- Greater access to global investing platforms for investors
- Evolution of competing products (ETF’s & Index Funds) that compete with traditional mutual funds
#4: Competitive Environment
Here is where an investor gets to be a detective to search out any and all competitors of the company you’re analyzing. Whether big or small you want to take the time to see what the competition is doing and how that directly impacts the ability of the company you’re examining to operate and grow. You might want to begin by looking at a sector ETF for companies within the same industry, use an online investing site that lists competitors (like at the bottom of globeinvestor’s Company Snapshot), look up the names of businesses in the phonebook or Google the subject (say...wealth management) to see what turns up.
Frequently in this section of my analysis I’ll find a company that’s a competitor to the stock I’m researching and begin to become interested in that as an investment. I’ll create a new SA on that company and this helps to give me a broader perspective on the industry. You might think that one company is a market leader and phenomenal investment only to find out that another competitor trades at a cheaper valuation or has better fundamentals.
A list of possible competitors that you will want to examine in your analysis of IGM would include:
- RBC
- TD
- Dundee Wealth
- Manulife
- Sun Life
- Great-West Life
- AGF
- BNS
- BMO
- CIBC
- Independent professionals & CFA’s
See Also:
Part II:
Part III:
Part IV:
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