12 SEPTEMBER 2024
By Kara Lilly, CFA
As an investor Iâve looked at thousands of companies around the world in private and public markets, including for some time working as professional investor at a now $90 billion asset management firm.
Here is a surprising observation Iâd make from this experience:
As complicated as businesses can be, there are only so many questions you need to ask to understand the basic mechanics of a company. Moreover, not only is it possible to synthesize the âgistâ of a company, with some practice, itâs possible to do this in minutes.
How? Many reps, and by asking good questions.
Here are nine questions that can help you understand most of what you need to know about a company:
When looking at something as complex as a company, the #1 place to start is also the simplest. What does this business do? How does it make money?
For example, Starbucks sells coffee and food to people, some of whom sit inside to eat and the rest take it away. Adobe sells software products to mostly creative customers in exchange for an annual subscription fee.
If you canât describe this in one or two sentences, then you donât know the business well enough.
No matter what business youâre looking at, the customer relationship is essential to understand. You want to understand the offer, how decisions are made, and the overall value proposition.
You might want to know:
All else equal, the more invaluable a good or service is to someone, the more likely there is pricing power (which is ideal), and revenue is predictable or recurring.
Speaking of revenue… what does it look like?
There are many ways to make money in a business and sustainably generate wealth over time. That said, whatâs better? Lumpy unpredictable revenue? Or visible, recurring revenue that grows over time?
All else equal, attractive revenue streams are predicable, recurring, and growing.
So, some questions to ask:
Revenue is obviously not the only driver of wealth creation though. Just as important are the costs associated with the business.
All else equal, less competition = more pricing power and growth opportunity. More competition = less pricing power and growth opportunity.
On the extreme end of this spectrum are monopolies and oligopolies with a lot of pricing power. On the other are commodity producers, with undifferentiated products and no pricing power. For example, many Canadian businesses â like banks – are functionally protected oligopolies that generate above average returns compared to global peers. Not out of excellence but lack of competition.
When considering competition, the present state is not the only consideration to make. What also matters is how the current level of competition is strengthening or disempowering the business. For example, sometimes, isolation for too long can make a business weak (“Galapagos island risk”). When businesses get complacent and lazy for too long, they can be unprepared for when real new entrants show up.
Every business has different ideal and also necessary conditions. Knowing a company requires you to know what “needs” to be true for them to be successful.
For example, maybe the business you’re looking at requires:
The Internet
Growth in China
Low interest rates
A certain technology
People to like puppies
Access to a certain resource
A certain kind of food to stay in fashion
The government upholding a specific law
Everyone using the same social media platform
A key industry to stay healthy international trade
Whatever a business “needs” to be successful, seek to understand explicitly. This will help you map out both opportunities and risk.
How does this business finish? Maybe you don’t know (usually you don’t know). But walking through this question will force you to imagine the spectrum of possible outcomes and growth trajectories.
Finally — one of the most important questions. How could this company fail?
To know a company is also to know what would blow it up. What would it take to lose it all?
This question is as much about understanding what’s vital in a company as it is about risk.
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