How to Develop an Investing Thesis That Works for You

Bryce: [00:00:31] Welcome to Get Started Investing! In this podcast, we cover all the basics that you need to start your investing journey. Are you joining us for the very first time or is this the very start of your investing journey? Well, before you dive into this episode with us, our feed is designed to go from the very beginning. So we strongly recommend that you scroll up and start at episode one. However, if you're feeling brave and just want to dive in, then of course, don't let us stop you here at GSCI, we unpack all of the jargon, the confusing bits we hear your investing stories with the goal of making investing less intimidating. And of course, we want to have a good time along the way. My name is Bryce and as always, I'm joined by my equity buddy Ren. How are you going, bro? 

Alec: [00:01:10] I'm very good, Bryce. Pumped for this episode. We are starting the next of our three part series. 

Bryce: [00:03:03] the start of another three part and there was a lot of interest on this one Ren. We're going to be talking about building a thesis. It's something that we've spoken about many times on this podcast, on the Equity Mates investing podcast, but I can understand that it can be a little bit daunting and overwhelming to hear people say you need an investment thesis and then the next point is building one and you actually have no idea on how to do that and what it all means. 

Alec: [00:03:32] Yeah, I don't think we've ever really stepped it through in the amount of detail we're going to step through. We've got some examples and hopefully by the end of this three part series, you'll be a little less daunted when you next hear an expert or someone talk about having a thesis for a stock and what to do if that thesis is broken. Hopefully, those terms will be a little less intimidating because at the end of the day, it shouldn't be a reason to stop you. You just need a reason to buy something in the first place, and that's really what we're going to get into. So in this three part series in this episode, what is the thesis and why does it matter? Next one, how to record it and track it. And then finally, we're going to answer the most difficult question of this whole, which is valuation. How does a valuation fit into a thesis and how do you actually go about valuing a company? If you want to invest in it, 

Bryce: [00:04:26] yes, at a beginner level, we're not going to start throwing discounted cash flows and all the jargon at you in too much 

Alec: [00:04:32] detail. Yeah, yeah, yeah. So let's start at the very beginning Bryce thesis. Yes, we're done with uni. 

Bryce: [00:04:38] Unarmed. Oh my god. It's a word that probably conjures up a lot of fear, a lot of bad memories of university having to punch out thousands of words. But luckily, that doesn't have to be a thesis in terms of when we're talking about investments, because simply a thesis is really just an explanation of why you believe an investment will deliver an attractive return, why you think what you're investing in is a good idea. That's plain and simple, and there's nothing more to it. 

Alec: [00:05:09] Yeah, an argument for why a particular investment strategy will do well do better than the alternative investments that you can make. Backed up by research and analysis. The extent of the research and the analysis is purely up to you because I think this is the point. That we should establish at the top and go back to throw out. It's your money that you're investing. Yeah. So the length, the depth, everything about the faces, it's up to you. Like if you want to be like Bryce and just take a punt on things, flip a coin and that's your thesis. It landed on heads. Therefore, I'm investing. It's your money to lose. It's your money to gain like you. That's OK. We'll talk. Three different examples of theses is the plural of face thesis theses they cite. They cite these sources. I don't know, and we have seen a range like we've seen hundred page to write ups. We've seen slide decks, we've seen a paragraph, we've seen a sentence like the the length of a thesis is entirely dependent on you because it's your money, 

Bryce: [00:06:21] it's your money. It doesn't matter what other people think, run your own race. You just need to be confident and be able to justify it to yourself and no one else. And we'll discuss in a little more detail how to write that down and how to record it all in the next episode. But yeah, you're right, Ren. It is good to to point out right now that we're not talking. It doesn't have to be thousands of words and like going through all the numbers and all that sort of stuff. 

Alec: [00:06:48] I've got to say sometimes I think quantity is used to disguise a lot of quality time. If you don't have, 

Bryce: [00:06:58] like all of my uni assignments, 

Alec: [00:07:02] if you don't have like a really clear insight, something that you think is the market is going wrong with, just like a really clear idea of why you think something is going to go well, you can mask that by putting a spreadsheet of the spreadsheet and building all these complex models and putting assumption on assumption, and you can, like make it look really good. But at the end of the day, like that core insight that reason why you're buying a stock really should be able to be summed up in a sentence? Yeah. 

Bryce: [00:07:35] And that's why a thesis matters because you can often buy stocks, and I have done this without good reason. Many, you know, inmates told you about a stock. You've seen a flashy headline, you've heard someone's made a lot of money. 

Alec: [00:07:51] You heard Bryce talking about it on the podcast. You heard me talk it out on to us those bids. Exactly. 

Bryce: [00:07:57] There are many reasons that you could buy a stock or be encouraged or excited about buying a stock. 

Alec: [00:08:04] You saw a Motley Fool sponsored. This stock is the next Amazon. It's like buying Afterpay at $2. Exactly, exactly. There's a lot of promise out there to get you to just buy something without doing a lot of research, 

Bryce: [00:08:18] but a thesis will actually help guide what you invest in and for how long and and why. And so it will make you think through those prompts. And actually, if you can't yourself come up with a good reason as to why those prompts are going to be a good investment or return, then it's time to say, see you later. 

Alec: [00:08:40] And if your investment strategy is, I'm going to follow everything Bryce says on the podcast, or we would definitely not recommend that. But but if that is going to be your investment strategy and that's your thesis, Bryce loves this retail stock, and he is the retail whisperer. It's important to write that down because then you can go back and say, Why am I losing money on all these stocks? And you go back and you're like, Oh, this one Bryce talked about, Oh, this one Bryce talked about all this one Bryce talked about. So even if your thesis is, there's someone I trust my financial advisor, some idiot on a podcast that I'm going to follow, you need to even just write that down, because then you can say how well that person you trust is gone. 

Bryce: [00:09:22] But I can understand if people's faces are. I will invest in Bryce stock of the year and never in friends. Then I totally understand that that's 

Alec: [00:09:32] a pretty good that Lexus has outperformed the market. 

Bryce: [00:09:37] Yeah. So it gives you the opportunity. A thesis gives the opportunity to look back a review. Remind yourself as to why you bought the stock because sometimes it's easy to look into your portfolio and go, Why on earth do I have that stock sitting in there? It sucks. I'm losing all this money and it's a good opportunity to go back. 

Alec: [00:09:54] Now we keep saying you can go back. There's something implicit in that that we should make explicit, which is that right, your face down? 

Bryce: [00:10:05] Yeah, yeah. Every stock that you buy should have some sort of accompanying explanation as to why. 

Alec: [00:10:12] Yeah, and to be personal about this, I've gone through a number of iterations of how I want to write it down. I think I had a notebook for a while and I was, you know, writing very neatly and I was like, This would be like a real margin. Yeah, two centimetres in do the line roll down the page. 

Bryce: [00:10:31] Why do that back in the day is silly anyway? 

Alec: [00:10:34] Yeah, no idea. I wonder if you still have to do that at school. 

Bryce: [00:10:37] Textbooks come with margins these days. Don't matter anyway. Anyway, we've got computers. 

Alec: [00:10:45] I think it was actually to give the teacher space to write comments. Maybe. 

Bryce: [00:10:50] No, I surely know. 

Alec: [00:10:51] Maybe. And then I was like, You know, I'll have this notebook and it'll be a record of all my investments and I'll be able to look back on. And I've migrated from that to a Google doc, and I've just got a Google doc where I just write stuff down. And sometimes you go back and you cringe and you're like, I was so wrong about this. But that's important because otherwise you sort of forget what the analysis was at the time, what your thinking was at the time. So just the ability to go back and review is is useful and it can be anything, you know, if you're a real social media operator and just make a private tik-tok and film yourself and you can go back and watch yourself and be like, Oh, I was wrong there I was right there. You know, Google Doc, no file on your phone. There's no lock stock thesis up, but that wouldn't be a bad shop. No, let's keep rolling with why it's important. So that's why you do it to hold yourself accountable, to be able to reflect on your thinking, to not trick yourself into thinking that you bought it for a reason other than there was the reason at the time. But why is that important? What can that help you avoid? 

Bryce: [00:12:05] Well, it can help you avoid holding onto stocks unnecessarily too long. You know, if it's easy to have that loss aversion where you stock's going down, you are you feeling pretty uncomfortable about selling it because you've lost a lot of money? You think it's going to return to where it did. But if you've written a clearly written out thesis as to why you bought it and you no longer believe in that thesis, then it's going to give you that sort of extra motivation to get rid of it. It's also going to help you avoid making the same mistakes over and over again.

Alec: [00:12:33] Yeah, I think that's a critical one, if you will. But I'm just going to keep using you as an example. If you keep hearing Bryce speak convincingly about a stock on the podcast and you keep following him in because of his, you know, his honey smooth voice, which is an actual quote I heard from someone last week about your voice. If you keep following his voice into stocks and you keep losing money, you need to be aware that's a mistake you keep making. Yeah, yeah. So avoiding the same mistake over and over again, it's important. There's another reason that I think is really important, and this is definitely one that hits home for me and I'm definitely subject to so we speak about cognitive biases, which is where your your brain basically isn't perfectly rational and it can make mistakes in processing information and coming to outcomes, I guess. There's one called the endowment effect, and a number of studies have found that people are more likely to retain an object that they already own than acquire the same object they don't already own, even if the objects are exactly the same. And basically, the idea is that we place additional value on things that we already have. And so we're more unlikely to sell them or if we do sell them, we want a higher price than if we were to just buy exactly the same thing. When that comes to stocks, what that means is that we often fall in love with stocks, and we might have bought a stock for a particular reason, and that reason no longer holds. We are wrong or it's already played out, but we love it. We love it so much. So we hang on to it and we keep holding on to it, even when the original reason is no longer there. And so knowing what your original thesis is and going back and saying the reason that I'm holding it now isn't the reason that I bought it is an important thing to be aware of. 

Bryce: [00:14:29] Yeah, I couldn't agree more. Some, yeah, I've had. I've fallen to that. Definitely. Yeah, holding on to I love this stock. 

Alec: [00:14:38] Yeah, yeah. So it's 

Bryce: [00:14:39] really silly. 

Alec: [00:14:39] Anyway, there's there's a famous investor, David Einhorn, who had a hard rule at his fund. It was called the No Broken Faces rule and basically as an analyst or whatever. And his fund you go and you pitch a stock at an investment committee meeting. And if people, if they decide to buy it right over the course of however many years, if the original thesis when you went in. Hitched, the reasons that you gave no longer hold, you weren't allowed to hold the stock, so you couldn't be like, Oh, there's another reason, but but but there's another reason why I want to keep holding it. Not, no broken faces roll. It's broken. You're out. 

Bryce: [00:15:15] Love that. Love that. And I think that's particularly true, and I'm sure you speak about this in future episodes. But Ren before we turn to actually looking what goes into building a thesis, some of the inclusions that you and I might include in our thesis, or some more common inclusions that are used around by other investors, let's just take a very quick break and we'll hear from our sponsors. So Ren, we know that thesis thesis theses are really important, and we encourage everyone to write something down every time they buy a stock and even it's worth writing down why, why you sold and how you felt about that at the time. We can get to that later. But what goes into a thesis? What am I actually going to put on the paper? Is there a formula I can follow should there be something that everyone writes down? The same is it, you know, predictable every time? How do you approach it? What goes into a thesis? 

Alec: [00:16:12] No set criteria. Love it. Yeah, basically, it is simply as how am I going to make money here? 

Bryce: [00:16:19] So there's no marking criteria.

Alec: [00:16:21] No, no. No one has to say this other than yourself. 

Bryce: [00:16:24] Yeah, mine is under lock and key. Twenty feet underground. 

Alec: [00:16:29] That's why you never write a thesis for anything and you can't lose your money too hard to get to, you know, very some way too hard to get to. 

Bryce: [00:16:36] I forgot the password, 

Alec: [00:16:37] but it's how am I going to make money here? Answer that question. However, if later and in however much detail you want to, you know, try to win a literary prise. You're not trying to prove how smart you are to your boss or anyone else. This is am I right or am I wrong? Have I done the analysis and am I right? You will make money. If you're wrong, you might lose money. You might not. But this is just answering that fundamental question Why am I putting the money? I've worked hard to get into this investment. 

Bryce: [00:17:07] That's the objective of it. How do you translate that? How can that be put down on on paper? Is it just I'm going to sell this when it goes up $100? That could be a thesis that because that's how you make money, you sell it for higher than it was. Then you bought it.

Alec: [00:17:23] You can put when you want to sell it, but a thesis isn't I'm going to sell this when it goes up a hundred dollars. The thesis is here's why this will go up $100. 

Bryce: [00:17:33] Yeah. So then what can we include in that? 

Alec: [00:17:36] So some common inclusions that you'll see in a lot of investment theses are a good understanding of the company, what the company does, what the numbers are, revenue, profit share, all that stuff, growth rates, who the management are, what the company is guiding, what their future plans are, the likelihood of success of those future plans, like a really good understanding of what the company is today and what it's trying to beat in the future and who and how who's trying to get it there and how it's trying to get 

Bryce: [00:18:08] there, that those are a few things that you could put down in terms of the company. Then there's also broader market or industry type stuff. So what are the big trends that you're interested in? Why is that company or the ETF that you're investing in? Why is that trend important? Why is it going to do well over the next few years? New technologies, regulation, all those sorts of things. You could take down a note, and it's worth pointing out here that we're not saying your thesis needs to include all of these things. It can be one or multiple. 

Alec: [00:18:39] Yeah, yeah. Like if you're investing in Coles and Woolworths, some of those things are as important, like the risk of regulation of the grocery sector isn't a huge thing or the risk of new technology in the grocery sector is less than in other sectors. If you're investing in a Afterpay regulation is really important. New technology is more important. So it obviously depends on what industry or what company you're investing in. But these are some of the key things that it's like. It's worth turning your mind to and thinking about. So good understanding of the company. Good understanding of the broader market or the industry. Competitors and alternatives is a big one because for everything the company is saying that they want to do where they want to be, what they're going to achieve. There are other companies that are working just as hard to get there. You've really got to be aware of who's going to stop your company achieving that goal. Who's going to get there first? Who's going to do it better? Who's going to disrupt the company? And I think it's really important when you're thinking about competitors, at least this is how I think about competitors. It's really got to have like a broad view of who your competitors are in terms of any one who's substitutable for your product. Mm-Hmm. And you know, like a really simplistic example of that is blockbuster were the the kings of the video rental game and like they had the best market share. And you know, if you were doing an analysis of the video rental industry, you know, blockbuster with kings. But Netflix, you know, were a different business model, but they were substitutable and they just took market share. You know, American Express with a best credit card company, but Afterpay and zip substitutable possibilities, and they are taking American Express in the tape and taking those very violent metaphor. But you know, they're taking market share and you've got to be aware of like where where the trends are, where consumers are going. And it's not just like who the competitors doing the same business, but like. Is this business model going to be obsolete will be disrupted? Yeah. 

Bryce: [00:20:45] So a couple of other things to close out and we'll chat a little bit about this in episode three. There's some inclusions around financial projections and also valuations. But Ren, all of these things are great to include, but you might be sitting there thinking a lot of this relies on me trying to predict what is going on in the future. I don't have a crystal ball. What I write down on the paper might be completely different in a week's time, in a year's time. So how do you address this feeling of I actually don't know what the outcome is going to be in 10 years time? So why should I be trying to write this down now? Well, there's two things. 

Alec: [00:21:24] First of all, investing by its very nature is making inferences or predictions about the future. Like you are investing in a company because you think it will be bigger and more valuable tomorrow than it is today, and there's no way around that. So I mean, in some ways you have to think probabilistically, you have to think you can't predict the future. But what is likely here and how likely is it for me? I think that's a muscle, but it's also just something that comes from being very curious and like reading broadly and being interested in the world and being engaged with where it's going. And you can start to build a muscle in terms of thinking about the future. There's obviously no shortcut to predicting the future. No one can accurately predict the future, but you can start to think probabilistically about the future. The other thing is, if you don't want to think about the future, think about today and just back really good managers. Yeah, you know, you could look at Amazon in the late 90s and say, I don't know about the future that I've read Jeff Bezos investor letter when they went public and the way he approaches this task, the way he thinks about it. I want to back him in, and you could say something similar about a number of managers and entrepreneurs today. And you could say, I just I'm not sure about the future. I just want to find the best people. My thesis is that these people are incredible. They're smarter than everyone else in the industry. And I think smart people is what matters. 

Bryce: [00:23:00] Yeah, I guess the question then flows well, when is enough enough when it comes down to writing? And we touched on this earlier, so we went labour on it too long and we have a full episode next week on actually writing it down. But as we said, it can be anywhere from 50 words up to 50000 pages if you want. The main thing is that you're answering the question How am I going to make money here? And why am I putting my money into this thing? That's really what you want to achieve with your thesis. How you do that, we will touch on a little bit later. Yeah, but we've got some examples here. 

Alec: [00:23:35] Yeah, I think let's let's really ground this in reality. So this is from The Motley Fool. And as much as we make jokes about The Motley Fool, they have their moments. The advertising just sucks. But we came across this. It was three paragraphs. It was an example of a thesis they shared for a US company and actually a US company that we spoke about in our solar energy industry, Deep Dive on the main podcast. So I'm just going to wait it out. Actually, no, you've got the you've got the best voice in podcasting. Why don't you write it out? 

Bryce: [00:24:03] Nice. Thanks, Ren. Renewable energy is one of the biggest megatrends of our lifetime. But you put me off there, so it would take the global economy three decades and more than $100 trillion of investment to transition its primary power source from fossil fuels to renewable energy. One of the leaders in this transition is Brookfield Renewable. It has one of the largest globally diversified renewable energy platforms and even a bigger pipeline of development projects. Brookfield also has an extensive track record of creating value from the sector, including two decades of steady income and dividend growth, driving superior performance. Brookfield is also well-positioned to navigate the biggest risk facing the industry. Access to low cost capital to finance capital intensive development projects due to its rock solid financial profile, backed by a top notch balance sheet. Given Brookfield position within its mega-trend and its historical success, I have high conviction that it can deliver market beating total returns for years to come and would consider adding to my portfolio on any meaningful price decline. 

Alec: [00:25:15] So that's it. Three paragraphs Covid the industry, the company, what it does risks, risks and why Brookfield is in a better position to navigate risks than its competitors.

Bryce: [00:25:29] Yeah, that's a that's obviously a pretty well written, pretty well researched thesis. You don't need to go into that level if you're just starting out as a beginner. Don't be put off by that. That's a really good. For example, 

Alec: [00:25:41] yeah, yeah, yeah. And then, you know, six years from now, six months from now, the whoever wrote this at The Motley Fool could pull out their notebook or open their Google doc and look at where Brookfield is, then compare it to what they wrote and say, Well, was I right? Were they able to deliver on this pipeline of development projects? Were they able to continue steadily growing income and dividend? Were they able to navigate this risk of accessing low cost capital better than their competitors? If competitors have actually been able to do that better and have a lower cost of capital than that's something where you were like, All right, I was actually wrong in my original thesis. So it just gives you some points to say this is why I invested at the time. In the future, I can look back and say if I was right about that. So that's an example. What we've done, though, is if you want to say a bunch of other examples, we've found a few different sources where you can look will include all four of these links in the show notes. So jump in there and have a look. But we've included the link to Motley Fool's thesis. The Bryce just read out TDM Growth Partners, one of the best growth investors we've come across here in Australia. Have they made public their Peloton investment thesis? So we'll include a link to that. And then on Reddit, there's a subreddit security analysis that a lot of people share investment theses and get the Reddit community's view on. Are they right or are they wrong? So I've filtered that on theses, and there's a link to that so you can jump in there and say a bunch of Redditors sharing their investment ideas. And then finally, a good source of investment thesis CCS is investor letters. When professional investors write letters to the people that give them money to invest, they often include a thesis or two on companies that they've invested in. So they're not a good source to see how professional investors are approaching building a thesis and obviously the summaries of their faces. But it's a start. So we'll include a link to a resource that aggregates investor letters. So if you want to actually see a bunch of different examples, there's a few options there. It may be the case that you want to listen to the next two chapters in this series and then jump into those links, but that the whenever you want 

Bryce: [00:28:07] a nice, great links. Thanks, bro. Not very nice. One Ren Well, that brings us to the end of it. 

Alec: [00:28:15] Sorry, sorry. I mean, I know I'm being a bit of a handbrake here. I just want to say one more thing. You know how we would like. You might have to predict the future, and we didn't have a very satisfactory answer for that. Yes, the tedium article really unpacks that. Yeah. And I think it's titled What We Have To Believe and you know, they really talk about the process of trying to not predict the future but make testable inferences about the future. So if you're worried that you can't look into a crystal ball and say what's going to happen in the next five years, that articles are good could look at that well 

Bryce: [00:28:50] with the right. It's it is a really, really good article or in that brings us to the end of episode one on building a thesis. We really Covid off what a thesis is and the importance of having one touched a little bit on what you need to include or what you can include in a thesis and next episode. We're going to actually dig into that a little bit more, how you would write it down, where you can record it and touch a little bit more in more detail on the tracking of thesis and why it's important to review and keep in touch with the decisions that you've made. There's no point writing a thesis down and reviewing it in 50 years time. So well,

Alec: [00:29:29] maybe, yeah, but you might have lost all your money by then, but that's 

Bryce: [00:29:33] exactly the point which we will touch on next episode. But stick around because there's plenty more to come in this chapter on building a thesis, but it's been great to chat Ren. We'll pick it up next week. 

Alec: [00:29:44] Sounds good.