Four Basic Questions to Help You Think Like an Analyst
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Four Basic Questions to Help You Think Like an Analyst
The answers to many questions for any business can be found by asking four very general questions to kick-start the analyst thought process:
- What is the goal of the business?
- How does the business make money?
- How well is the business actually doing?
- How well is the business positioned relative to its competitors?
Once you start thinking in these terms, and sharpen your observational skills, you’ll be well on your way to thinking like an analyst, constantly on the hunt for investment opportunities.
What is the goal of the business?
The goal of restaurants, for example, is to feed customers. This seems pretty straightforward—although some restaurants have also tried to combine meals with entertainment to mixed success—but don’t just assume a business’s purpose is obvious. Be sure you have a good idea of what it’s really trying to achieve. Then ask if it makes sense for this business to try to achieve this objective. Does it make sense for a restaurant to also entertain customers, for example?
Things To Know
- Thinking like an analyst involves observing the business world and asking questions to understand how it works.
- There are experts who have developed useful frameworks to help organize our thinking.
How does the business make money?
Once you have a good idea of what the business is trying to do, think about how it makes money. In our restaurant example, how much does the food in the restaurant actually cost? Can the restaurant charge more for its food because of a pleasant ambiance or because it is providing entertainment? Is the restaurant trying to sell a lot of meals at a low price, or is it attempting to sell fewer meals but at a much higher profit per meal?
How well is the business actually doing?
Then ask yourself, "How well is the business doing?" Don’t worry about picking up any financial statements just yet; rather, focus on observing what you can about the business. Back to our restaurant example, think about where you choose to eat and why. Has your favorite place been around a long time? Are there lots of locations for your favorite restaurant? Are they busy, with people in line or in the parking lot? Are they in good locations? Do they seem to get a lot of repeat business? Do they seem to have a better caliber of waitstaff? How fancy are the interiors? As a potential investor in this or similar businesses, all this stuff counts.
How well is the business positioned relative to its competitors?
If you think you have a pretty good understanding of the business’s performance, at least as an observer, spend some time thinking about how well it functions in its industry. In other words, assess the competition.
Is there a lot of competition in its industry? With restaurants, there certainly seem to be a lot of choices, but what about an entirely different industry, like computers? Are there as many types of computer companies as there are restaurants? Not by a long shot. Does that mean that the computer industry isn’t as competitive as the restaurant industry? Not necessarily. Instead it might mean that competition functions very differently. Since it takes a ton of capital to start up a computer company, and not so much to start up a restaurant, maybe there is more risk in computer manufacturing? Maybe finding new products is also more difficult? Maybe one of the only ways to compete in the industry is on price? Asking these kinds of questions can give you a good idea of how well a specific business is positioned to cope with the challenges it may encounter.
Putting it all together
At this point it may seem like we’re going a little nuts generating questions, but thinking like an analyst involves observing the business world and asking questions to understand how it works. Thankfully, there are also experts who have done a lot of this thinking already, and many of them have developed useful frameworks to help organize our thinking even more.
If we think back on the four questions we mentioned earlier, we should be able to get a good handle on a business’s goals and on its performance just by reading about it and studying its financial statements. It’s really the last question, the one in which we consider how well a company is positioned relative to its competitors, where we might need some more help.
