Mastering the Art of Investing Thesis Writing

Bryce: [00:00:04] 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 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 are feeling brave and just want to dive in, then don't let us stop you. Here at JSC, we unpack all of the jargon in the confusing bits. We hear your investing stories with the goal of making investing less intimidating, and 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?

Alec: [00:01:06] I'm very good. Bryce. Great to be with you again. Yes, as always, I have a thesis that this will be a good episode. 

Bryce: [00:01:13] Nice. That's the energy. That's the type of gusto we want.

Alec: [00:01:16] That's the quality that you can come to expect. 

Bryce: [00:01:18] Yes, nice. Segway. We are closing out the three part series that we've been doing on building a thesis. Very important part of your investing journey, coming up with the why you are investing and making the decision to put your hard earned money into a particular investment. So the first episode we covered what a thesis is and why it matters. Last episode we spoke about how we record our theses. We spoke about how we review them and what to do if it's broken. Yeah, and in this episode, we're pulling it all together and taking a look at the different ingredients that go into actually making a thesis.

Alec: [00:02:04] Yes. And just like a how am I going to stretch this metaphor just like a cake? If you've got one really good ingredient, but you put too much of it in and you don't put any other ingredients in, it's going to be a pretty average case where you're not going to have it. So just just extend that metaphor to thesis. You know, you need a bit, you know, the right balance of all ingredients. And I think a trap for young players or old players are definitely a trap for me. Early days was thinking that the only ingredient that went into a thesis was valuation, but valuation is just a one of many ingredients that is required. It's like flour. You know, it may not rise without it, but it's not the only one. 

Bryce: [00:02:46] But it's also worth remembering that the professional chefs are likely to get the ingredients bang on after many, many years of practising well. And, you 

Alec: [00:02:57] know, some professional chefs often get the cake wrong and the souffle doesn't rise. You don't need 

Bryce: [00:03:05] to get a perfect mix from the very beginning, but we're going to go through a number of the ingredients that can go into a thesis to help you get a better understanding of some of the things that you can be thinking about. 

Alec: [00:03:17] All right. So to kill the metaphor and to get into what we're going to talk about today, what could go into a thesis doesn't not all of this needs to go into a thesis. We covered this a little bit in the first episode, but we're going to go a bit deeper. But to recap what could go into a thesis, a good understanding of the company, what it does, what the numbers say, who manages what the company is telling us about their future plans? A good understanding of the broader market or industry. What's going on with the competitors, with new technology, with regulation, you know, all of that bigger picture stuff. Competitive alternatives, competitors and alternatives. I should say who's trying to take their market share? Who's trying to take their customers, how they're trying to do it? And then like the financial projections and valuation, that's all ingredients that could go into a thesis for this episode. We split it up into ETFs and managed funds. What you what it faces could look like if you want to invest in an ETF or manage fund, and then we'll get into individual stocks. So let's start with ETFs and manage funds. What do I need and what don't I need? 

Bryce: [00:04:23] Well, for ETFs in managed funds, Ren a lot of the features that you just mentioned, you don't need to necessarily apply because of the nature of how these products are built. You know, you don't need to have an understanding or a deep understanding of individual companies. If you're investing in an ETF or a managed fund, a an ETF, you're just tracking an index in the managed funds. They will do that work on your behalf, which is why you're going to give them your money to do that. But there are a couple of things that you do need to have a thesis on. And for example, if you're looking at the passive side of ETFs, so 

Alec: [00:04:55] that's like an ASX 200 ETF for an S&P 500 ETF. Passive just tracks the whole market. 

Bryce: [00:05:03] Yeah, tracks the whole market. You still need to write down why you think it's a good investment option relative to other options you can put your money in. And what do I mean by that? I'm choosing between the ASX 200 ETF and the S&P 500. You still need to have some sort of a thesis as to why you've chosen the ASX 200 over the S&P 500, because at the end of the day, it's an opportunity cost where you put your money, you need to think about time horizon. And then, you know, if we can chat about semantics as well. But for me, yeah, people might say you don't need a thesis if you're investing in the ASX 200, but there's plenty of options out there, you still need to justify why.

Alec: [00:05:42] It's also it also matters like time horizon, like my investing thesis for the ASX 200 is, I believe over the next few decades, the Australian economy will continue to get more productive. New businesses will emerge and the stock market will continue grinding higher like that. That's as simple as it is, really. But you know, if someone has a thesis that I'm investing in the ASX 200 because ScoMo is going to win the election and cut taxes and in the next 12 months, it will be a lot higher. That's a very different thesis, and that's something that you can test and see if you right or wrong about this time period matters, but it doesn't need to be more than a sentence nine times. What do you do? 

Bryce: [00:06:28] Yeah, on the same. I think for a lot of my ETFs, it's very similar to that, like the Nasdaq 100, for example. You know, I believe that you want to be involved and in companies that are going to be the biggest 100 tech companies for the next 50 years, and that's obviously going to change and cycle through. But I want exposure to the biggest high tech companies

Alec: [00:06:50] when we're talking ETFs. There's often a lot of choice, you know, if we're talking ASX 200, there's probably like five or six different options. So the thesis should also touch on which one, you know, my thesis includes the fact that I'm chosen the lowest fee option because I think they're all tracking the same index. They're all much the same if a lower fee option was to come out. I'd have to consider the capital gains tax of selling. But for any new money that I'm putting in, if there's one with lower fees, then if that's my thesis, that's the one I should be putting it into 100 percent. So the so there's still some thinking that goes into what index you want to choose and then which product that tracks that index. So still, roll room for a thesis just doesn't need to be a lot. So that's passive. What about active? What if I want to find a professional fund manager to give my money and for them to invest on my behalf? 

Bryce: [00:07:42] Well, you want to really have a thesis as to why you've chosen that fund manager out of the many thousands of fund managers that are out there. So you want to be thinking about track record, you want to understand the team that's around them, you want to understand the experience that they've had. You know, are they investing in areas that they specialise in? Are they trying to go to broad, you know, you want to really have an understanding of how that manager approaches? Is it the right strategy for your goals, time horizon? You know, all those things you need to think about and then put down on paper as to why that one fund manager is better for you and why you think they're going to outperform all the other fund managers that you could have put money with?

Alec: [00:08:21] Yeah, you touched on the two critical things, which are people and strategies. So like strategy is every fund manager has a specific way. They want to invest their large cap technology stocks or small cap Indonesian growth or, you know, whatever it is like, they have a thematic or a focus. No one is just saying, I'm going to just invest in everything. Or maybe there are, but you got to find them and then decide, that's right. So whatever their strategy is, you've got to decide that strategy makes sense. If my strategy was, I'm only going to invest in no e-commerce retail like retailers that only do bricks and mortar and refuse to have an internet presence, you can find the best fund manager in the world. You could get Warren Buffett, Hamish Douglass and Charlie Munger to sit around a table and try and execute on that strategy. They're just not going to do well because the company, it's the companies about, well, the companies are falling behind. So first thing is like, does the strategy make sense? Second thing is, is the fund manager the best person to invest in this strategy? You could flip it around. You could say, is this fund manager the best? And then is the strategy the following Does it make sense? But there are two things that matter. 

Bryce: [00:09:34] I think you should also consider why you would go that approach and an ETF. That's something that I would great point consider as well. Why would a fund manager investing in large cap stocks be a better opportunity than the ASX 200? 

Alec: [00:09:48] Yeah, yeah. 

Bryce: [00:09:50] So something to think about. So that's that's what you should be considering when you're making a thesis for buying ETFs, manage funds, listed investing investment companies, those sorts of things. 

Alec: [00:10:00] And it really just doesn't need to be long but just get in the discipline of putting something down. 

Bryce: [00:10:05] Mm-Hmm. Mm-Hmm. But it's a different kettle of fish when it comes to individual stocks. Ren. Yes, and it is a lot more to consider. 

Alec: [00:10:11] And as we have said throughout this series, there's a lot that we're about to talk about here. A bit quantity can be a cover for quality. If there's one thing that we're going to drill throughout this, it's that because if you do your own research after this series and you jump online and you like. I want to learn more about building a thesis. The key thing that you will say is just how long so many of these thesis theses are. But at the end of the day, if the core insight isn't right, it's all just window dressing. It's all just noise. So we're going to talk about a number of things here. But if you just have that like Warren Buffett, level mind where you can cut through all the noise and get to that. Like one piece of pure clarity, your investment thesis could only be a sentence like Warren Buffett will sum up some of his investments in little more than that. It's just that most of us don't have that, that level of critical thinking and ability to synthesise information and come to that perfect nugget of wisdom. But really, all of this is just ingredients that you can either add to the add to the recipe or not, depending on how you want to build your thesis. 

Bryce: [00:11:26] We're going to include in the show notes, a link that shows you a good structure for how you could go about a thesis building a thesis. But let's work through some of the key components. Ren starting with industry overview. 

Alec: [00:11:39] If we signposted at the top the way that this guide, I guess that we're sharing in the show notes has structured it is industry overview, business overview, investment thesis, catalyst, valuation risk industry overview is what the market share is. Who and who has that market share the competitive landscape, who's in the industry, what products they offer, who the customers are. Who the suppliers are. What what are the drivers and trends in the industry? And are there any regulations or legal issues that people could be should be aware of before they invest? So that's some of the things you could take off in terms of where you might find that information to fill that section out. News reports industry reports you can find things from industry groups like broker reports. Google, I guess, is going to be 

Bryce: [00:12:34] the answer most of it. 

Alec: [00:12:35] There's so much industry information out there. If you just Google, that's generally what's it. 

Bryce: [00:12:41] So you have a look at industry and then the next port of call would be to understand where the business fits within that industry. So you could look at things like the business model. You could have a look at some of the recent news around the business. Are there any sort of key financials that are worth pointing to? You know, revenue? Is it a profitable business? Has it been growing? We talk about management, so checking out key people that are involved, have they got some big names as part of the management team as well as you know, is it a local business or they spread out across the world? So having a look at the geographic mix and then also as as Ren mentioned at the top products and what are the type of customers that they're selling to? Similarly, where you find all this info? Google obviously, is a great place to start, but there's really rich resources with interviews from CEOs suppliers company reports. The business website is probably that the first place that you should be checking for this sort of information. Annual reports. Yeah. And just be curious, I think, because yeah, you're likely to find a fair bit of information on the companies that you're looking for. If they're large enough anyway,

Alec: [00:13:52] there will be information out there. A good place to go for business information is TIKR. I think it's still in beta, but you can sign up for free tikr.com/Equity Mates. You can skip the queue. That's, you know, if you want like the financial numbers and stuff like that, that's a good place to go. So that then brings us to investment thesis. And really, you've established, you know, what's going on in the industry, what's going on with this company? And now the key question you have to ask is why would this be a good investment? And there's a number of ways you can answer that question. But really, this is the the where it all turns, really. And as I was saying before, you know, if you got that Warren Buffett mind, this is the only question you need to answer. You can circle the other information and just answer this question. And there's plenty of answers you could give to this question. You could talk about the competitive advantages a business has and how they're going to sustain that advantage. You could talk about industry tailwinds or company tailwinds and how those external factors that are helping this company grow and why that will make it a good investment. You could talk about key strategies it has in place key managers like the CEO. You could talk about key products that it's about to release that are going to help it grow or, you know, new markets it's going to enter and stuff like that. Really any catalyst for change that will make this option a better investment than any other option that you could put your money with. 

Bryce: [00:15:26] So I guess the question is finding that information again. Like, that's not something that you can just necessarily Google is easy as easily as business overview or industry overview. 

Alec: [00:15:38] Yeah, yeah. Yeah, that's that's all good global. That's all facts. Business overview, industry overview is who is what is where is when did like those fact based questions answering the investment thesis question? This is where it requires you to really flick the brain on and make some judgements or some assumptions yourself, because you could definitely google it. Like if I Googled, why would Apple be a good investment? I'll get a whole bunch of articles that tell me why Apple would be a good investment. We had a chat to someone for help get started in investing some A-series, so we started recording who told us one thing that they do before they make an investment. Is they Google? Why would X Company be a good investment and why would X Company be a bad investment and they try and rate both sides? You can outsource getting your thesis made and you can just read articles about it. But the problem is, if they're wrong, it's your money that you lose. Yeah. So this is where you got to answer that question yourself and make yourself confident with how you answer that question.

Bryce: [00:16:39] So the final piece to the puzzle of the big ingredient that goes into this is the valuation, and we will chat about that because it's it's very important. But before we do, we'll just take a quick break to hear from our sponsors. So evaluation Ren is an incredibly important part of the investment thesis. I will put a bit of a caveat here and a pardon the jargon warning that for someone who may just be joining us for the very first time, also welcome. Great to have you on board. There might be some overwhelming, you know, jargon in this component, but it it doesn't have to be that way and we'll try and talk through it at a at a simple level. It's a very important part of the investment thesis. 

Alec: [00:17:24] Yeah. And I think the key thing here is if valuation is overwhelming or too hard or it's not something that you want to do, you don't have to invest in something like that. That's the beauty of the world we live in today is that there is so many other options, ETFs or managed funds where you can outsource that work to someone else. So that's a really important thing to keep in mind. And something that I wish I knew when I started my investing journey would have saved me some money. Yeah, but the reason the valuation is important if you're choosing to invest in an individual company is because you might have done all the work. You might understand the company so well, and you might have like a really clear insight into why this company is going to be a star for years to come. The issue is that everyone may agree with you. The market may agree that all of your analysis is completely correct, and they might be pricing the company for that. They might be saying that we expect this company to ten times in size in the next five years and be pricing it as if it was already, you know, 10 times in size. For that reason, the price you pay will always matter when we're talking about individual stocks, not the case when we're talking, you know, index funds, ETFs, managed funds, but the valuation work when we're talking about individual companies does matter. There are two ways that you can look at valuation, relative valuation and intrinsic valuation, and relative valuation is basically you comparing it to similar companies. And the logic behind relative valuation is that companies or assets that are similar, so similar risk profiles, similar potential returns should be priced similarly. And so you can compare companies against each other and in, say, if one is cheap or expensive on a relative basis. And so what do we mean by that? If Afterpay ends up a similar companies and one is make and they're both making a million dollars in profit a year and one is valued at a million dollars and one is valued at $10 million, one is a lot cheaper than the other. Yeah. 

Bryce: [00:19:59] How do you actually find out that information, though? 

Alec: [00:20:01] So that's there's a number of ratios that exist. Price to earnings is a simple one that you can pay. You'll say that or a price to sales, which compares the price you pay to the amount of revenue the company makes. There's a bunch of other ones as well, but I think to start with, those are probably the two most simple to have a look at. And so using that Afterpay WinZip example, if they're both making a million dollars in profit, one is valued at a million dollars. One is valued at $10 million. One will have a price to earnings of one. One will have a price to earnings of 10, though the one with one is a lot cheaper than the one with 10. So, you know, on a relative basis, one is more expensive than the other. 

Bryce: [00:20:45] And and I think Google Finance, Yahoo Finance, Bloomberg, a bunch of other platforms online will actually give you competitive comparisons for some of these may relative price metrics or valuation metrics. So yeah, you don't have to do the work yourself. There are places online that you can see this 

Alec: [00:21:06] ticker does that as well to give them another plug so

Bryce: [00:21:09] we can compare apples with apples and look at companies and compare them against each other. If if, of course, you don't want to be looking at a mining company versus a retail company, for example, that's not the right way to do relative comparison. So then you might think about doing intrinsic valuation Ren, which is actually looking at the value from within the company. 

Alec: [00:21:33] This is a lot harder. Yeah. Basically, what we're trying to do here is project the future cash flow or the future profit of a company and then calculate the present value of that cash flow. Now what do we mean by that? That's already too much jargon. Yeah, the best way to describe it is that a. Today and a dollar a year from now aren't worth the same, no, and that's because if you give me a dollar today, I can invest that and get, let's call it with interest rates those days, one percent return. And so if you give me a dollar today, I can make that a dollar and one cent in a year. So it's more valuable than you giving me a dollar in a year. Yeah, yeah. And so because it's more valuable today than in a year, we discount the value of that dollar. And we say it's less valuable than if you gave it to me today. And similarly, in two years time, it's even less valuable. So in terms of what it's worth to me today, we discount it more 10 years from now. It's even less valuable because every year in those 10 years, I could have made a return. So if we discount it even more. And so that's the basic logic behind a discounted cash flow. It's the a company's profit today is worth more in a company's profit and what it pays out to its shareholders. All of that is worth more than what it earns in 10 years, because if the company's earning that today, it can either pay me a dividend or it can invest it in something that grows and helps it make more profit in the future. Whereas 10 years from now, that's worth less. So that conceptually what investors try to do when they try and calculate intrinsic value, they try and work out what the company's future profits are worth to me as an investor today. And then you compare that to the share price it's trading at and you say, is it worth buying today based on that work? 

Bryce: [00:23:37] Yeah. In theory, it makes sense in practise if you've just started your investing journey. There are a lot of assumptions that go into it. Some calculations that need to be done, some modelling that needs to be done. So don't get overwhelmed with having to feel like you need to predict the 10 year future cash flows of Apple or Microsoft to to make an investment. But to Ren point, this is where a lot of the professional investors, you know, try to outwit and outsmart their competitors. This is where the money is certainly made in accurately trying to predict all of the inputs that go into a company's success over a number of years and trying to understand what that is all worth today. Yeah. You know, it's it's something that you just need to keep plugging away on. And it's not something you're going to get overnight, even if you do get a calculator online that can spit out a valuation for a company. There are so many inputs that go into it that can give vastly different ranges. I mean, it'd be an interesting exercise to see if you and I try and do a valuation for the same company and see what comes out. 

Alec: [00:24:48] True. Well, I think in our summer series in previous years over on Equity Mates, we did that. We had a discount cash flow calculator and we just changed some of the assumptions and just showed how different the the valuation was. So I've written down three things in terms of how I like what I guess what my takeaways are around doing a discounted cash flow or doing a valuation. The first one, and I think this is the most important one and one that I wish I could go back and tell myself. As a younger investor, there's never a perfect number as a beginner investor, even a lot of professional investors, they think what like what is what is the value of that share and give me it like exactly in terms of a price? This isn't scientific like this. This is as much art as it is science. You're making assumptions about the future and you're putting doing a whole bunch of different calculations that, you know, build on assumptions on assumptions, and you're never going to get a perfect number that everyone agrees on. That is the right answer. This isn't like maths in school. There'll always be a range. There'll always be a margin of error. So for me, I wish I could go and tell myself that because it would have probably saved a bit of my hairline has saved a lot of stress. So no one, no perfect. No no to the real workers in the forecasting, not in the calculation. So as you mentioned, Bryce like you can go online and just get a calculator these days and put all the assumptions in and I'll spit out a number. But like what I've learnt from speaking to all those expert investors is that like what separates the very best from the good is the work that they do in accurately forecasting what a company's prospects will be like. And if they can be more right about that forecasting work, the calculations will take care of themselves. So the real challenge isn't in cracking the calculator out and doing that. The real challenge is in really understanding the business and where it's going to go and what that may. Third thing, it's really that valuations are constantly changing, so facts change. Companies prosper. Sex change, strategy change changes, management changes, all of that stuff, and so the valuation that you do today will probably be different to the valuation that you do in six months. And so I think it's again just a reminder that you never you're never going to get that perfect answer in that perfect answer is never going to stay the same. So I definitely spent a lot of time trying to get my head around valuation. And I think I've come to realise that valuation is inexact and we have to be okay with that as investors. And so that's why you try and build like a margin of safety and stuff into your investing. So it's a good thing to try and do. It's like a muscle that you'll build over time and you'll get more comfortable with it. But everyone makes mistakes with this stuff, and it's easy to say don't stress about it, but seriously, don't stress about it. 

Bryce: [00:27:43] Yeah, it's incredibly overwhelming. 

Alec: [00:27:45] It's not going to make or break you as an investor. It's just something you'll get better at as you go. 

Bryce: [00:27:50] Yeah. And I'm sure plenty of people in the Get Started Investing feed community are investing in companies with a long term horizon and not necessarily worrying too much about the valuation because, as you said, it's a muscle that you learn and takes a long time. You don't want it to stop you making any investments at all. 

Alec: [00:28:10] The challenge of being invested and like taking that first step matters so much more than that second step of getting your investments perfectly optimised and getting valuation right. Like you, when we're talking about valuation stuff, we're talking about the edges, like making a little bit more money, you know, being in the market, that's what matters. 

Bryce: [00:28:31] So to close out, you know, it's all well and good to have paint a very rosy picture for your investment thesis and why. I think it's a good investment, but obviously it's worth considering some of the risks that could go into the investment and your company as well. So consider things like, you know, regulation of the industry that it's in, or is that likely to affect the business operations going forward? Is there risk around its products? Is it a business that is at risk of having huge cost blow-outs, you know, inputs into products that are made if they blow out what's going to do to its profitability? Is it likely to be at risk of foreign exchange and technology as well? And then how good is it going to be at actually executing its strategy? So just a couple of things to consider as well. It's always good to have a bit of a bear case as to what could go wrong.

Alec: [00:29:25] That probably is is enough for this chapter. There's probably a few concluding thoughts. I think the number one thing is, if you're overwhelmed by this three part series, don't let that stop you investing because you will learn so much more by just getting started. And even if you make mistakes and you start with a small amount of money, but also that if you're not ready to invest in individual companies, there's plenty of other options. 

Bryce: [00:29:51] Absolutely. Just get started. Start writing things down. It doesn't have to be perfect. It might never be perfect, but the main thing is that you're giving it a go and you're learning from your mistakes. Ren. And I haven't nailed it. We're far from it. We've been learning for a number of years now, but it's still absolutely trying to get better and better every day that we invest. So don't, as Ren would say, don't let perfection be the enemy of the good. Favourite saying And yet, look, we all know that just getting started is is is going to be the biggest learning for you regardless. So big topic to cover. 

Alec: [00:30:26] Big topic. Honestly, it could go so deep on it. Books have been written on a pretty boring book, but yeah, it's a muscle and you know you get better over time. We still are not great. No, but we're getting better. Yeah, yeah. And just don't be overwhelmed by a hundred page thesis, if that's one thing, because there's a there might just be a whole lot of nothing hiding in that. 

Bryce: [00:30:52] Well, Ren, as you said, this is the last of a three part episode on building a thesis. We've got a few more chapters to come before the summer series towards the end of the year, which we're recording at the moment and having a great time. So we can't wait to release that for you guys. But just a reminder that if you do love what we're doing, would appreciate a five star review on your podcast app. And yeah, it does really make a big difference. So it's been great chatting stocks as always. Ren and we'll pick it up next week with another chapter.

Alec: [00:31:21] Sounds good.