What does it mean to “Do Your Own Research (DYOR)” [Traditional Finance Edition]

Introduction

Nowadays we always hear the term “Do Your Own Research” (DYOR); however, most people who don’t have a finance background might not know what exactly that means. As such, I wanted to put together a brief guide that breaks down DYOR from the traditional finance perspective.

By way of background, I have ~10+ years of finance experience including roles in private equity and investment banking. While my day to day is not currently focused on public markets investing, the skills I’ve learned are applicable to any type of traditional finance investing (public or private markets).

In each of the following parts, I will detail the four topics below and how they play a vital part in DYOR. Additionally, I will pose questions that you should attempt to address when evaluating each respective topic. Note, I will not be covering the modeling aspect of the financial analysis as the guide is intended for newcomers to the space.

DYOR Key Topics

  1. Company Overview
  2. Industry Overview / Competitive Landscape
  3. Company Financial Analysis
  4. Comparable Company Analysis / Precedent Transactions

As always, feel free to reach out with any questions or if you’d like to go into detail on any topic.

Company Overview

When evaluating a company, while obvious, the first thing that you must familiarize yourself with is the company itself. In public markets, the easiest way to understand a business is to review the Company’s annual (10-K) or quarterly (10-Q) reports. When reviewing these reports, try to address the following questions to ensure you have a fundamental understanding of the business.

  1. Revenue Model: What is the Company’s revenue model (i.e. do they manufacture widgets, are they a software subscription business, do they operate restaurants, etc.)?
  2. Business Segments: What segments / business lines does the Company operate and what % of revenue, gross profit, or EBITDA (if available) is each respective business line or segment?
  3. KPIs: What are the Key Performance Indicators (KPIs) that the Company uses to evaluate its business and how have those metrics trended over time. For example, a software business may track Monthly Active Users or Net/Gross Customer Revenue Retention, or a restaurant business may track Same Store Sales growth, or a widget manufacturer may track volume and price / gross profit per unit.
  4. Concentrations: Is the Company’s revenue, gross profit, or EBITDA (if available) heavily concentrated in any one area (geographic, customer, location, product etc.)? If so, provide a breakout of those concentrations and determine how they have changed over time (by reviewing prior reporting packages). A general trend that you want to see is that the Company continues to diversify concentrations away as time goes on.
  5. Geographic Footprint: Where are Company HQ and branches located? How may their locations have an impact on their ability to execute their growth strategy
  6. Suppliers / Vendors: Who are the Company’s main suppliers / vendors and how long have those relationships been in place? Are there any concentrations among the supplier / vendors? What are the contract specifics with these parties (tenure, cancellability, take or pay, price escalators, etc). 
  7. Growth Strategy: What is the Company’s growth strategy? Is it organic or inorganic (M&A) growth? How does the Company plan to execute on its growth strategy and has management proven their ability to execute on that strategy previously? For example, if a management team has never implemented an M&A strategy and they come out and say they want to do five massive acquisitions in the next year, that is a reason for pause as acquiring a business is one thing but successfully integrating that acquisition is entirely different (and much more complicated).
  8. Management Team: How strong is the Company’s management team and are there any gaps that the Company needs to fill? For example, evaluate how long the management team has been with the Company and the Company’s performance under their leadership. Does the management team have the experience to execute on the growth strategy they’ve outlined or will they need additional resources (i.e. if a management team has never brought a new product to market and that’s part of their upcoming growth strategy, it may be reason for pause. However, if they just hired the product lead from a competitor who has experience rolling out this specific product, that would give me a lot more confidence that they have the right resources in place).

The list above is intended to provide high level guide to (i) understanding Company’s business model, (ii) identifying key concentrations and historical trends, and (iii) evaluating management’s ability to execute on the growth strategy they’ve outline.

Industry Overview / Competitive Landscape

Now that we have an understanding of the Company’s business model, it’s important to understand (i) the broader industry the Company operates in, (ii) who the Company competes against, and (iii) the areas of differentiation between the Company and its competitors. When evaluating the industry dynamics, attempt to address the following questions below:

  1. How large is the Company’s current Total Addressable Market (TAM)? How has the TAM changed over the last five years and what are the growth expectations for the next five years? Ideally, the Company will operate in a large TAM ($25B+) which has grown historically and is expected to keep growing over the next five years.
  2. What are the growth drivers of the TAM (i.e. price, volume, increased penetration, etc.)?  It’s key to determine growth drivers as certain drivers may not be sustainable (i.e. 20%+ annual pricing increases or one-time COVID volume increases, etc.)
  3. Who are the Company’s main competitors? What is the market share of each respective competitor (including the Company) and how has that market share trended over time? Generally, if a market is highly fragmented, and the Company is a dominant player in the space, that proves to be a significant competitive advantage as the Company can leverage scale and take aggressive strategies which smaller players may not be able to execute. Further, a highly fragmented market may provide opportunistic, accretive acquisition opportunities.
  4. How does the Company differentiate itself from competitors (e.g., premium products, broader product catalogue, more functionality, lower cost, etc.)?
  5. How difficult is it for new entrants to enter the market and what are the barrier to entry (i.e. significant capital requirements / start-up costs, regulatory requirements, entrenched relationships, etc.)? High barriers to entry create a significant business model moat / defensible position for the established companies.
  6. What are the customer switching costs (i.e., if a customer wanted to switch to a competitor’s product how difficult would that be)? Switching costs may not only be monetary but could be time / training. The higher the customer switching cost, the better it is for the company with the existing relationships.
  7. Is there any threat of substitute products? For example, a customer of a Quick Service Restaurant chain may choose burritos one night and substitute that with burgers the next night. Note, this is also an example of switching costs, in this case the switching costs between dinner options is quite low for the customer (assuming price and proximity are relatively the same).

Generally, the best companies have a leading market share in a high growth industry which has significant barriers to entry with high switching costs.

More content to this guide coming soon: stay tuned!