investment thesis creep

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Overcoming investing bias: part one.

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“Should private equity, venture capital and other investors invest in underrepresented minorities and women simply because it’s the right thing to do?”

·       It’s an appropriate question. The funding gap for women and multicultural entrepreneurs is very real and remains huge when compared with men and white founders.

·       It’s asked frequently. And it’s asked with increased frequency, largely due to the impact of the Black Lives Matter (BLM) movement. The specific query: Has the recent raised awareness generated by BLM changed the investment habits of the PE and VC sectors?

·       And it isn’t adequately addressed with a one-word answer. There obviously are those in both the “yes” and “no” camps. It isn’t that simple, however.

The Challenge

The reality is stark.

The U.S. population is 13 percent Black, but just four percent of the venture capital industry is Black, according to 2018 data from the National Venture Capital Association. Two years earlier? The number was three percent.  

Only one percent of venture capital investments were committed to Black founders in 2018. And, only one percent  of VC-backed founders  are Black, with less than two percent Latinx. And there’s this: 82 percent of fund commitments were to all-male teams, with 12 percent to mixed teams and six percent to all-female teams. Finally, more than 75 percent  of all funding rounds went to all-white founding teams.

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It should surprise to no one, then, that the number of Black decision-makers in venture capital in 2018 dropped to one percent — representing just seven Black people at the 102 largest venture capital firms (at least $250 million under management) in the country, according to an annual survey by the Information, a technology-news outlet.

“The lack of access to capital is the single highest driver for business failure, and Black founders are less likely to gain it,” says Melissa Bradley, Georgetown McDonough School of Business Professor. “Access to capital is limited not because of demand, but due to pattern recognition by investors, different social capital based on educational and social choices (e.g. golf clubs), and a limited number of sponsors ... who can vouch and validate the entrepreneurs.”

But the reality of venture capital and private equity investing is this: investors can’t simply modify their investment thesis and start investing only because of how someone looks or what their background is. Investors’ fiscal responsibility is to adhere to their thesis and be prudent. It has to be about the idea, the opportunity and the team’s experience.

In doing so, however, investors clearly need to be more aware of how their evaluation, experience and criteria are biased. They just are. Full stop. Partner/decision-maker demographics, dollars invested and the evaluation process demonstrate this each and every day.

Changing the Process

Investors simply must broaden the pool of where their investment dollars can flow.

It’s tricky, though. Simply targeting more investments for underserved communities may appear to be a start, but it isn’t the needed fix. And here’s why — talent, good ideas and competence are evenly distributed among race, gender and geography.

“We should be well beyond this idea of separate but equal,” says Monique Woodard, a venture capitalist who created early stage investor Cake Ventures. “But in venture it seems as if we are moving right back there. Black entrepreneurs don’t need a separate water fountain. You have to fix the systemic issues in your funds that keep Black founders out and keep you from delivering better returns.”

·      According to research by Kauffman Fellows and the Kauffman Foundation, diverse founding and executive teams generate higher median realized multiples on acquisitions and IPOs than all-white founding and executive teams (3.3 to 2.5 and 3.3 to 2.0, respectively).

·      And, a study by First Round Capital found that its investments in companies with at least one female founder performed 63 percent better than its investments with all-male founding teams.

So, broadening the pool to include more women and people of color makes sound business sense.

For their part, investors largely haven’t noticed.

“Over the last decade, U.S. venture capital investments  quadrupled , the number of businesses started by women grew to 40 percent, and we’ve seen growth in the number of  entrepreneurs of color ,” write   Ilene H. Lang and  Reggie Van Lee in the Harvard Business Review . “However, the percentage of venture capital dollars going to women-founded companies has  barely budged  since 2012, and the numbers are even worse for Black and Latinx founders.”

The reason, they add, is “well-documented”: gender and racial stereotyping, unconscious bias, systemic economic barriers, and Silicon Valley’s preference for serial entrepreneurs.

Going Forward

It’s a fool’s errand to believe quick fixes – especially those focused simply on “changing percentages” – can permanently and adequately remedy a systemic problem. Instead, solutions need to be better thought out, better targeted and implemented more consistently across the industry. This will broaden the pool and ensure all opportunities are evaluated with the same criteria.

A productive starting point is deal sourcing.

“Venture capital is driven by relationships and many investments are sourced via personal referrals, usually through one’s direct networks,” Kimmy Paluch, founder and managing partner of venture coaching and services firm Beta Boom, writes in StartupNation. “Given the homogenous and elite nature of most partners and investors in firms, this yields a proclivity to investing in homogeneous and elite groups.”

Going forward, then, the VC/PE industries need to address the following:

·       Expand your networks. Opportunities are driven by networks. Commitments are influenced by networks. Barriers are constructed by narrow networks.

Fix: Proactively and intentionally expand your networks to groups that include more people of color and women.

·       Increase size of prospect tent. VC/PE firms shouldn’t increase commitments to Black, Hispanic and women entrepreneurs just because they are Black, Hispanic and/or women. But they shouldn’t leave them out in the cold either. 

Fix: The attractiveness of underrepresented founders can only be supported if they are included in the evaluation process. VC/PE firms must create internal protocols to broaden the pitches they hear and evaluate.

·       Change the discussion paradigm.   Studies show VCs ask more preventative questions highlighting potential losses and risk when meeting with female founders. The same happens with underrepresented minorities. When the conversation focuses on negative areas, investors walk away with a negative gut feeling and can’t “ get excited ” about the deal.

Fix: VC/PE firms need to be aware of this trap and consciously change their approach.

Of course, these steps are only a start: There are steps founders can take to improve their funding odds as well. We’ll address those in Part Two.

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The Selling Blind Spot

Maven Funds Management

Selling is a big blind spot for investors. For every thousand articles about when to buy a company, we’re lucky to find one about when to sell. Yet selling has a huge impact on our long-term performance. And the evidence is clear: most people are no good at it. But this weakness also provides the opportunity for an enduring competitive advantage.  

The Problem

It’s well known that a lot of individual investors suffer from selling biases like loss aversion. Recent research shows that the professionals struggle too. An  impressive study  found that professional fund managers, although pretty good at buying, are terrible at selling. It was a landmark study, so let’s unpack the findings.

“We document a striking pattern: while the investors display clear skill in buying, their selling decisions under-perform substantially…selling decisions not only fail to beat a no-skill strategy of selling another randomly chosen asset from the portfolio, they consistently under-perform it by substantial amounts.”

The sell decisions of professional investors are so bad that they performed worse than chance. That’s rough. But the buy decisions did add value, so it’s not that fund managers have no idea about investing. Instead the authors found a flawed process where selling doesn’t receive adequate attention:

“We present evidence consistent with the discrepancy in performance between buy and sell decisions being driven by an asymmetric allocation of cognitive resources, particularly attention…We conjecture that PMs [Portfolio Managers] in our sample focus primarily on finding the next great idea to add to their portfolio and view selling largely as a way to raise cash for purchases”

“PMs in our sample have substantially greater propensities to sell positions with extreme returns: both the worst and best performing assets in the portfolio are sold at rates more than 50% percent higher than assets that just under or over performed. Importantly, no such pattern is found on the buying side – unlike with selling, buying behavior correlates little with past returns and other observables”

Most professionals have no good process for selling. They focus on buying, and only think about selling when they are fumbling around to free up cash. When they do sell, it is with little research. So they sell whatever sticks out the most: the biggest gainer or the biggest loser. It’s not logical, and they don’t think about the future prospects. The result is decisions that are so bad, they would have been better off throwing darts at a board to pick a position to sell.

This focus on past returns is also mirrored in much of the folk wisdom that floats around about selling:

• ‘Sell when a stock doubles (or is up 20%, or 30%, or whatever arbitrary number)’
• ‘Never sell at a loss’
• ‘Nobody ever went broke taking a profit’
• ‘Sell anything that falls by 10%’
• ‘Water your flowers and trim your weeds (sell companies whose share price has fallen)

Intelligent investing is supposed to be forward-looking. It’s the future that counts. Yet all these rules of thumb, and the trading of the average fund manager, is based on past price movements.

The core problem is that most people’s sell process abandons all that is good about their buy process:

It’s a big problem. But there is a better way. My style of fundamental growth investing, led me to adopt two core selling principles:

Principle #1: Sell quickly when a thesis is broken

This principle is key to generating high annualised returns by ' winning big, and losing small '. Selling quickly when a thesis is broken allows you to ‘lose small’ when you have made a mistake. More importantly, it allows you to quickly re-deploy your precious capital in to a new high-conviction idea.

Like running a marathon, it is simple, but not easy.

There are five steps:

• Identify your thesis (actually write it out)
• In that initial thesis, identify what would cause you to sell
• Continuously monitor the company, its competitors, customers etc.
• Update your valuation estimate and avoid thesis creep
• Sell quickly if the thesis is broken

Let’s work through those steps with a real-world example: Class (ASX:CL1). Class provides a SaaS software product that helps Self-Managed Super Funds (SMSFs) manage their accounts. It’s a sizable industry in Australia, with over 500,000 SMSFs. It’s a growing market: each year more people’s retirement balances hit a size where it becomes worthwhile to consider managing it themselves.

Step 1: Identify your thesis (actually write it out)

Few investors clarify their thinking on why precisely they are buying a company. Even fewer take the time to actually write down that investment thesis. If you do, you will be ahead of the pack.

We must have a clear idea of what our logic is in the first place, so that we can know when that thesis is broken.

We first bought Class shares shortly after the IPO in early 2016. It was a simple thesis. Class was disrupting traditional desktop software – an inevitable shift to the cloud was underway. At the time of purchase, Class was dominating the new cloud-based market, and winning over two thirds of new cloud customers.

Even better, Class’ major competitor, the incumbent BGL Super, had stumbled with their first launch of a cloud product. We initiated a position and over the next two years Class’ share price rose over 80%.

It looked like the ideal investment, a scalable software business that was dominating a sticky niche, while a sluggish incumbent failed to adapt.

But that would change.

Step 2: Identify what new evidence would cause you to sell

The moment before you buy a stock is the last time you will be thinking objectively. It is crucial that you use this moment to write down precisely what new evidence would cause you to sell in future.

We identified multiple risks that could have befallen Class. The government could have changed the rules around SMSFs. A major security breach could have broken client’s trust in Class’ cloud service. Neither of those came to pass.

Another risk was that a competitor could somehow crack the market and start stealing share. Class would not be so lucky on this count.

Step 3: Continuous monitoring

Eternal vigilance is the price of superior returns.

We must continuously monitor for thesis-breaking evidence. That means keeping tabs on the company, its staff morale, its new products, customers, competitors, regulators, suppliers, etc. There are many tools that can help this along: Glassdoor, Google Trends, product forums, Google Alerts, investing forums. But that should be just the beginning. Superior returns require superior portfolio monitoring.

In the example of Class there was one obvious source of intelligence that most of the market somehow missed. Remember that big incumbent BGL? Well BGL would regularly release announcements about how their new cloud based product was progressing.

For a long time these press releases were mostly hot air. Every company claims that their products are market-leading, next-generation, cutting-edge. But in early 2017 it became apparent that BGL’s new cloud products were gaining traction. Talking to BGL’s customers, it seemed that the incumbent may have started to get its act together.

No company goes without serious competition forever though. So we were careful to avoid a knee-jerk response.

That all changed in October 2017.

Step 4: Re-evaluate and avoid thesis creep

Thesis creep is one of the great traps that ensnare investors, particularly value investors. The company reports some bad news, and rather than recognise the mistake and sell, the investor holds on.

The share price has usually fallen by this stage, which can allow the original thesis to sneakily creep its way to something new:

“Sure, we originally thought the company would do XYZ, and it clearly hasn’t, but it’s just so darn cheap now, we couldn’t sell at this price”.

There were two new pieces of information that were released on the 5th of October. First, Class’ reported its latest  quarterly update . It showed that the company’s net new account additions had fallen, dramatically.

In the comparable quarter a year earlier Class had added 11,880 new SMSF accounts. The same number in 2017 showed just 6,232 new accounts. A fall of 47%. And this was after a soft June quarter, which the company had guided would quickly rebound. To make matters worse, the chart the company usually reported which would have shown this fall clearly was no longer included.

Something had changed.

Later that day it was confirmed. BGL  announced  that it had now surpassed 100,000 accounts on its own cloud-based product. Worse still (for Class), their biggest competitor had added 23,402 accounts during the latest quarter.

When we first purchased shares, Class was winning approximately 66% of new cloud accounts. Now it appeared to be winning just 20%. That’s a huge swing in competitive position. We updated our intrinsic value estimate with the new information. Lower growth and higher acquisition costs meant the shares were significantly overvalued.

It was time to face a tough truth.

Step 5: Sell quickly when the thesis is broken.  

Class had been a star of our portfolio. I had even interviewed the CEO in a fireside chat at a client event. It wasn’t easy to reverse course and admit that we were wrong. But when a thesis is broken, we must be decisive.

We reached our sell decision on the same day the news broke. Although the shares were already down slightly, it would take many months for the market to fully absorb the new competitive paradigm. We were able to exit our position for a 67% gain.

It worked out well. Today, almost 18 months later, the shares are now over -50% below where we sold.

Sell quickly when a thesis is broken.

Principle #2: Sell if you would not be buying today

Holding is an active decision, not a passive one. It just doesn’t feel like it.

Each day the market offers us the opportunity to buy or sell our shares. Every day that we hold a position we are effectively choosing to ‘re-purchase’ it at today’s prices, and in today’s position size. If we don’t think that the current position size is the best possible allocation of our precious capital, we should sell.

This principle – to sell if you would not be buying today – includes those situations mentioned in the first principle. But it also adds the hard edge of a valuation-based sell. If the share price has risen so much that you would not be buying the shares today, it is time to sell. No business is so great that its share price can’t rise high enough to render it an unattractive investment.

It sounds simple, but again the execution takes work. It requires maintaining an accurate estimate of the company’s intrinsic value, and being willing to trim the position, or even sell out entirely, when share prices rises too far above intrinsic value.

My personal approach to investing in high growth businesses is to sell slowly when the motivation is purely based on valuation. This is to reflect the ability of truly superior businesses to consistently outperform even the most optimistic estimates. It is both an art and a science, but ultimately we must be disciplined: sell if you would not be buying today.

Selling is a big blind spot for most investors. But that weakness means we have a huge opportunity to improve. If you adopt a sound selling process, based on the future and not the past, you will gain a massive competitive advantage over other investors. 

• When to sell

Matt Joass, CFA is the Chief Investment Officer of Maven Funds Management, a Sydney-based manager that focuses on identifying small fast-growing businesses.

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Active management has historically been cyclical, and we believe this remains true despite the fact that excess returns have compressed over the last 15 years.

• Passive investing has its risks, which are even more heightened in today’s market environment.
• Leading active core equity managers consistently outperform, despite the fact that it has become increasingly more difficult to do so.
• At J.P. Morgan Asset Management, our ability to utilize scale effectively, develop an integrated set of research capabilities and foster a strong culture drives our long-term outperformance.
• We offer the full spectrum of active U.S. core equity solutions across a variety of investment styles and risk profiles. Top decile information ratios across all strategies in our suite underscore our commitment to efficient use of risk capital, which is especially important as we enter a new market environment regime.

Active managers have outperformed, but excess returns have compressed 

As illustrated in the following chart, excess returns in large cap stocks have historically been cyclical. While we believe this is still the case, it has become increasingly difficult for active managers to outperform the index. During the period prior to the Great Financial Crisis (GFC), the average top quartile manager in the large cap core space – the largest U.S. equity category – was able to generate a 3.32% excess return. However, since then, the average three-year excess return has compressed to just 1.35%. In addition to lower returns, the percentage of managers who have been able to outperform has decreased from 61% pre-GFC to 47% post-GFC. 

The compression of excess returns and number of managers able to outperform is, in part, attributable to the unique environment produced by unprecedented government stimulus. From December 2008 to March 2022, the Federal Reserve maintained the target fed funds range at zero for the longest period of time in history. The target rate reached a peak of only 2.37% in December 2018, before it was swiftly cut back to its historic low in early 2019. In addition to the low rate environment, the Federal Reserve enacted four tranches of quantitative easing to further spur economic growth.

This combination had notable implications for equity valuations and the broader U.S. stock market. The availability of low-cost borrowing kept many companies afloat, while lower discount rates of future earnings made the broader equity market more attractive. These market distortions created an environment where investing fundamentals were not the primary determinant of market performance. Thus, active managers were challenged to outperform. This trend prompted many investors to move their core allocations into passive strategies. As such, passive managers are now the dominant players in the large cap core category, with a current market share of 79.5%. 

Passive investing is not without its own risks

Even though excess returns remain compressed today, the market environment has changed. Interest rates are higher and market leadership is narrower, which has led to increased index concentration, now near multi-decade highs. This means that passively investing in the S&P 500 Index is an active decision, which introduces less obvious, but impactful, risk into portfolios. Investors who remain in passive may be caught off guard as we gradually move into a normalized rate environment – distinct from the zero-interest rate policy environment of the last decade – and see broadening of returns based on fundamentals.

As illustrated in the following charts, since the beginning of 2023, 86% of the S&P 500’s returns were attributable to the 10 largest companies in the index. Those companies dominating market performance now constitute 32.5% of the index’s market capitalization, significantly above the long-term average of 21.6%. Relative to the total index, this cohort is valued at a premium with its forward P/E ratio at 148% of the index level. Following this strong performance run, not only are valuations elevated but also analyst expectations are as well. Although it is true that these companies have generated strong earnings growth as a cohort, they are not monolithic. 

Conversely, the remaining 490 stocks in the S&P 500 are valued at 92% of the index level. This dislocation underscores the importance of active management for two main reasons:

• In a market with such extreme concentration, managers must be highly selective in their positioning to avoid the risk of being caught betting on yesterday’s winners.
• In a new interest rate regime with less capital liquidity, there will be greater differentiation of company performance, providing ample opportunity for stock selection in both the top 10 and the other 490 companies to drive returns.

With this inflection in market dynamics, active management should allow for investors to take advantage of both of these phenomena, while passive investing simply introduces hidden risks.

Leading active managers consistently outperform

Although active managers have been more challenged on the surface, leading managers continue to deliver healthy alpha for their clients. Historically, long-term equity returns are driven by earnings and dividends, while short-term returns are driven by P/E multiple expansion as a result of market sentiment, company news or emerging themes. An experienced active manager focuses on fundamentals – long-term earnings and growth – to drive stock selection and continually monitor risk.

What defines a leading active manager?

Despite headwinds for the active large cap core category, we believe the ability to utilize scale effectively, develop an integrated set of research capabilities and foster a strong culture enables us to be one of the leading active managers in the industry. At J.P. Morgan Asset Management, our global platform exemplifies and integrates each of those characteristics, which allows our active managers to uncover winning stock opportunities and deliver alpha to our clients over the long term.

With $835 billion in client assets under management 1 , we are committed to using our vast global resources to produce the highest quality research.

• Our research platform, spanning four continents with 80 dedicated analysts covering 2,500 companies, provides our analysts with both a local and global perspective on the sectors they cover.
• With an annual global research budget of over $150 million, we are able to recruit top talent and provide our analysts with the best resources available. This investment in data and talent underscores our commitment to continuing to produce leading insights.
• Our large presence in the equity markets creates a unique level of access to company management teams, enabling our analysts to host over 5,000 management teams per year and share the insights they glean globally.
• To enhance the knowledge transfer process and create efficiency, we have a harmonized investment process. This means that our analysts and portfolio managers are speaking the same investment language, no matter what country they sit in.

Over the last four decades, we have developed an integrated set of investment capabilities, which generates leading bottom-up, research-driven insights. 

• We use a “Strategic Classification” assessment to consider the qualitative fundamentals of each company. The economics, duration and governance of a business are examined to limit risks that may be overlooked by a purely valuation-driven process. 
• We then have a five-year “Expected Return” framework to consider valuation. Each analyst uses their proprietary earnings and growth estimates to forecast company growth through the full business cycle to the end of the forecast period. This process derives a valuation multiple, which is then used to group each company in each sector into quintiles, from most attractive to least attractive. The “Expected Return” process creates a consistent valuation framework across the investment universe that is leveraged by our portfolio management team.
• Since 1987, our top ranked (undervalued) stocks have outperformed the market, while our bottom ranked (expensive) stocks have underperformed. 

Our culture is built upon the tenants of continuous improvement and partnership

• We consistently re-evaluate our processes and look for areas of improvement to avoid complacency. An example of a recent enhancement is the introduction of “Pre-determined Game Plans.” While launching coverage of a company, an analyst creates a one-page document explicitly summarizing the investment thesis, business thesis, thesis threats and potential signposts. This practice encourages honesty in the investment process and limits thesis creep.
• The partnership model between our analysts and portfolio managers further differentiates us from other managers. We treat the research analyst role as a career position, not a stepping stone. Our analysts manage risk in their own sector-specific portfolios and they are compensated as such. This cultivates more honest and curious conversations to drive our leading insights.
• Our portfolio managers are assessed on a blended 3-, 5- and 10-year performance metric, encouraging analysts and portfolio managers to commit to our process and maintain a long-term focus.

J.P. Morgan’s active core solutions

A strong research platform forms the foundation for leading actively managed investment strategies that have a proven ability to generate excess return over a range of market cycles. Depending on the preferred risk budget, J.P. Morgan offers a full spectrum of active U.S. core equity solutions across a variety of investment styles and risk profiles. Top decile information ratios across all strategies in our suite underscore our commitment to efficient use of risk capital, which is especially important as we enter a new market environment regime.

U.S. Research Enhanced Index Strategy (100 & 150)

Managed within a tight tracking error budget (max 1% or 1.5%), we keep each strategy’s risk characteristics close to the S&P 500 Index, seeking to minimize style, sector and factor impacts.

U.S. Analyst Fund Strategy

Managed with a reasonable tracking error budget (2%-4%), our Director of Research collaborates with our research analysts to deliver a best ideas portfolio. 

U.S. Large Cap Core Strategy

Managed with a reasonable tracking error budget (2%-4%), our portfolio managers aim to develop insight, conviction and valuation support to holistically construct a balanced core portfolio.

U.S. Large Cap Core 130/30 Strategy

Managed with a slightly higher tracking error budget (2%-5%), we combine a long only and extension portfolio to create a 160% gross and 100% net exposure, while maintaining a beta one exposure to the index.

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TRENDS & TAIL RISKS™

A bi-weekly publication dedicated to the principle that deeper and broader knowledge drives superior investment results, 3 keys to sell discipline, chief conclusion.

Buying an investment may be only half the battle.  What about when to sell?  We think the ability to sell well is one of the rarest and most valuable skills in investing.  Our research team reached the conclusion, after many years of hard experience in the markets, that we believe a disciplined approach to selling is the best one.  We have three pillars upon which our sales discipline depends when it’s time to exit: valuation, thesis creep, and unexpected fundamental change.   

“Certainly, it hurts.  The trick, William Potter, is not minding that it hurts.” – T. E. Lawrence’s “Seven Pillars of Wisdom” upon which the movie “Lawrence of Arabia” was based.

My first mentor in the investing business gave me my big break out of Wharton.  I was really a lucky guy, because he had one of the best long-term track records of any value investor anywhere, and for some reason he believed in me.  But my biggest lesson from him was not about value investing, it was about discipline.

He told me there is no one right way to be a successful investor.  In his opinion, there are many roads to heaven in investing. Both brilliant growth investors and value investors can succeed, but success only comes to those with discipline.

I thought about his counsel the other day, when our sell discipline led us to exit what had been a long time holding of ours.  I thought it might be worth writing a few lines about our sell discipline, because it is such an important part of our risk-management framework.  Also, in my experience, it’s one of the most frequent topics of conversation we have with our clients and friends.

"Given how hard it is to accumulate capital and how easy it can be to lose it, it is astonishing how many investors almost single-mindedly focus on return, with a nary of thought about risk.” – Seth Klarman

When to Sell? Three Reasons…

“How do you know when to sell?” is probably the most common question I get about investing.  The answer is we typically sell for three reasons. 

1. The first pillar of our sell discipline is valuation, selling when a security reaches what we think is fair value.

Our research team knows that we can never fall in love with our investments. Rather our investments are only tools, a means to an end, that are useful only to the extent that they can be held prudently on a risk-adjusted basis. 

Here the key phrase is “risk-adjusted.”  The easiest way to think about this is to understand that we constantly evaluate what we might gain if we are right, versus what we may lose if we are wrong.  Valuation is the tool that helps with that.

When our research team thinks about what this means to us, it comes down to the expected upside we anticipate for the risk of continuing to hold an investment versus the downside that we might reasonably expect.  Since we don’t know the future, we think a reasonable way to handicap the unknown is to examine what we do know. 

We do this by examining how our holdings are valued on a whole host of financial metrics.  Oftentimes, this discipline leads us to sell when the news is rosy, and everything seems amazing.  After all, it’s during just such times that people lose their discipline, fall in love with an investment, and pay too much.  Even a great company can be a lousy investment if you pay too much for it.  Just ask anyone who overpaid for a condo in South Florida at the peak of the Housing Bubble.  They still may be losing money, even after almost fifteen years.  So, the price you pay for your investment matters.

The specific valuation tools we might use often include price to cash flow, price to book, enterprise value to sales, and the trend in revenue to share.  More complex tools we often rely upon may include asset value measures, where we add up what we think the parts of a company might be worth if viewed separately, sometimes referred to as “replacement cost” or perhaps “sum of the parts.”   At the same time, we examine the valuation of comparable assets and similar companies globally.  It’s about having a broad enough tool kit to match the right methodology for the right investment.  It’s part art and part math.

This exercise might sound stuffy or boring, but we believe that it is neither.  Rather, our team’s view is that the core of our process is valuation.  After all, the stocks or bonds that we own are far more to us than just flickering lights on a computer screen, sometimes red, sometimes green.  These are investments that represent shares in business enterprises with dynamic operations in the case of equities or, in the case of bonds, senior claims on future cash flows.

The Dark Arts of Valuation are informed both by a knowledge of accounting, that explains assets and cash flows, and finance, which teaches methods by which these may be valued.  The literature dedicated to both can and does fill whole libraries.  I have devoted twenty years of my life to them. This brief letter, sadly, is unworthy of doing them justice.  But it is worth highlighting that valuation is the chief pillar of our sell discipline. 

2. The second pillar of our sell discipline is to consider selling if the thesis changes.

This can take two forms. First, our team’s view of the investment’s fundamentals may change.  Second, the actual fundamentals themselves may change. 

Our research team calls the first “thesis creep.”  Consider, for example, an investment in a cyclically depressed sector made with the view of a turn in the cycle rather than longer-term fundamental improvement.  Such an investment could be an excellent risk/reward at the right price and the right time but would still have many hallmarks of strong cyclicality.  Therefore, it could have growing downside risk as we got deeper into the cycle. 

These characteristics could make it a great multi-year trade but suggest that the best way to enter it is with the goal of selling at the right price (valuation driven) and keeping a wary eye on the economic cycle.  If our team’s view morphs over time to consider the investment capable of more, perhaps of being a long-term investment rather than a trade, then we should closely examine the facts.  We most often see this late into a cycle when a trade has been a good one, and the easy trap laid for the unwary is to keep holding the investment, even though its objectives have already been achieved.

Unexpected fundamental change in a company’s business is another such example where the facts may change materially from our earlier expectation.  For example, we do not own any newspaper stocks in our model portfolios. The rise of the Internet since the late 1990s seems to have irreparably compromised the business model of local newspapers.  This industry was once a prominent holding of Warren Buffett’s Berkshire Hathaway, who once extolled the merits of these “local monopolies.”  However, just a few days ago Mr. Buffett eliminated his holdings in this once core investment.

3. The third pillar is when we disagree with the direction taken by a company’s management team and cannot resolve that disagreement.

Without question, in my experience, the single most frustrating situation in which to find yourself as an investor is to awaken to the unpleasant reality that a company’s management team has acted to irretrievably alter the entire basis upon which you made your investment. The unfortunate example I described at the beginning of this letter, which motivated our recent sale of a long-time holding, was driven by this discipline.

Just think about how hard it is to identify an investment that our research team can get behind.  How difficult is it to find the rare combination of a great business, capable of defending its profits over the long run, priced at an attractive valuation?  For our research team to develop such conviction in an investment, our team must understand why the market made such a profoundly flawed assessment of a security and its future.  After all, we believe the market is the most efficient tool ever devised by man to allocate resources and forecast the future.  To us, this means that we never take lightly our disagreements with the market.

The above example of our sales discipline was motivated by how radically the new management team was growing what had been once only a small, and what we believed to be a much weaker and more competitive business line.   Management was deploying more and more capital into what our research team believed was an inferior business.  That we didn’t like at all.  But still, the core existing business, that motivated our investment in the first place, was humming along and meeting our expectations.  We were torn.  What to do?  We sold. 

What would we have preferred to see management do?  The outcome we were hoping for was continued investment in the core business, augmented by opportunistic share repurchases at favorable prices.  That had been the company’s strategy under its prior management team.  This can be an excellent strategy even in a market of subpar growth, because the cash flows from that business can fund opportunistic consolidation among competitors or favorably priced buybacks that grow investors’ per share interest. 

I have seen this formula work before, many times, and am constantly seeking out those that execute upon it.  I thought our research team had found it again.  We were wrong.  Or rather, management decided on a different direction in which our research team had little faith.  This tortured the logic of our initial investment beyond our tolerance.  It’s not the outcome we were hoping for, but again, we think it’s vital to never fall in love with your investments.

“Our favorite holding period is forever.” – Warren Buffett

In Conclusion

We agree with Mr. Buffett.  Our favorite holding period is forever too. 

Such a strategy is not only tax efficient but far easier to execute, because “all” you must do is buy.  But what happens when something changes, and your sell discipline tells you it’s time to leave?  We think the ability to sell well is one of the rarest and most valuable skills in investing.  Our research team reached the conclusion, after many years of hard experience in the markets, that a disciplined approach to selling is the best one.  We have three pillars upon which our sales discipline depends about when it’s time to exit.  What’s your sell discipline?  If you don’t have one – or if you can’t explain it – you might want to up your game, because our view is that disciplined execution of sales is one of the keys to what separates great investors from others.

CWA Asset Management Group, LLC is an SEC-registered investment adviser, doing business as Capital Wealth Advisors (“CWA”) and as blueharbor wealth advisors.  This material is for informational purposes only, as of the date indicated, is not complete, and is subject to change. Additional information is available upon request. Any opinions expressed herein represent current opinions as of the date of publication only and may change based on market or other conditions.  This material may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual results will not be materially different from those described here.   Certain information herein has been provided by and/or is based on third-party sources and, although believed to be reliable, has not been independently verified, and CWA is not responsible for third-party errors.  No representation is made with respect to the accuracy, completeness or timeliness of information or opinions herein and CWA assumes no obligation to update or revise such information or opinions.

Information presented is for educational purposes only and should not be considered investment advice or an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies.  all investments involve risk, including risk of loss and are not guaranteed.  past performance is no guarantee of future results.  there can be no guarantee that cwa will achieve any specific investment objective or level of performance.  cwa does not offer legal or tax advice.  please consult your investment or tax professional for additional information concerning your specific situation.  specific companies, industries or securities described are meant to be illustrative of investment style only. additional information regarding cwa including fees, expenses, and risks of investment, is contained in cwa’s investment advisory agreement, its form adv, form crs and related disclosure documents and should be reviewed carefully. cwa’s adv 2a and form crs can be accessed via https://adviserinfo.sec.gov/ ., for additional disclosure information, please go to https://www.capitalwealthadvisors.com/disclosures/..

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• Angel Invest

Groove Capital Blog

How to build your investment thesis.

Beginning as an angel investor can be overwhelming, and, oftentimes, knowing where to start is the hardest part. While it can be tempting to dive head first into the vast sea of potential deals, being intentional on where to start can increase ease, interest, and potential returns. The key to finding that intentionality is through a personal investment thesis, now let’s define it.

What is an investment thesis?

An investment thesis serves a personal guide that takes into account different factors to narrow down one's lens for potential investments. While length or breadth of a thesis is less important and entirely personal, knowing your goals, passions, interests, and focus (around founder and industry) can help define what your thesis looks like.

Here are a few questions to ask when beginning that process:

• What is driving your interest in investing?
• What are some industries you follow and are passionate about?
• Where would you say your expertise lies?
• What qualities do you look for in a good founder?
• Is there a certain minority group/founder you want to support?
• What geography do you want to be investing in?

What are some examples of thesis statements?

A few examples of investment thesis statements include:

• Broad : I invest in early and growth-stage companies who may scale effectively, are apt to dominate a given market, and display an exit potential.
• Middle Ground : I target early-stage startups led by ambitious entrepreneurs that solve problems felt by my generation. I target companies that exist in industries where I can leverage my advisor and industry expertise. I am geographically agnostic with a focus on leveraging Midwestern connections.
• Narrowed : I invest in startups that are working to reverse the negative environmental impact that governments, corporations, and individuals have on our planet. I look for scalable companies that reimagine how we live, work, and play to be more harmonious with the earth that are based in the Midwest. I prefer to invest in minority founders who are pioneering the space.

A broader thesis allows you to cast a wider net but will create difficulty in staying focused and as a result, likely waste time along the way. On the contrary, a thesis that is too narrow will limit deal flow and inhibit your ability to create a well balanced portfolio. While there is no perfect middle ground, reflecting on your own values and interests can help set a baseline parameter which will become more refined and clear over time.

How often should I revisit my thesis?

While establishing your initial thesis is the first step, in order to make sure it still aligns with your goals, passions, and expertise, it is crucial to revisit it on an annual basis. Oftentimes, your thesis will adapt with your investment experience and, therefore, the more deals you are exposed to, the better you will understand your personal values, interests, and strengths.

Pro tip: Set a date on your calendar each year as a reminder to better hold yourself accountable.

Here are a few questions that might be helpful to ask when revisiting your thesis:

• Where do you think your knowledge and interests have grown or narrowed to over the last year?
• Which geographies do most of your deals come from?
• What are your favorite investments in your portfolio and why?
• Which deals have felt the most exciting? Impactful?
• What lessons have you learned along the way?

Ava Najafi is an Associate at Groove Capital and a current senior at the University of Minnesota’s Carlson School of Management where she is pursuing her Bachelor’s degree in Finance and Entrepreneurial Management. She also serves as Managing Partner at Atland Ventures where she helps manage the operations and strategic decision-making of the fund while overseeing investment activities and internal relations. Ava’s favorite part of investing is meeting with founders and sharing their passion for the space as well as the ultimate goal of making a difference greater than themselves.

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• Investment thesis

What is an investment thesis?

Why you need a solid investment thesis, how to write an investment thesis , step one: determine your minimum viable fund size, step two: pinpoint your investment focus, step three: portfolio construction , how to present your fund thesis to lps, investment thesis example.

Breaking into the venture capital ecosystem is both challenging and competitive. Having a great investment thesis is key to running a successful VC fund. Without a clear investment strategy and effective portfolio construction , your fund won’t get very far.

In this article, we’ll cover how you can develop a strong investment thesis.

In private equity and venture capital , an investment thesis (sometimes called a fund thesis or fund strategy) outlines how you plan to use invested capital to generate returns. Your investment thesis clarifies how you’ll make money for the investors in your fund—it’s a definition of what your fund will do. 

Your investment thesis may include:

Your fund size

The number of companies in your portfolio

The stages and industries of those companies

The geographies those companies are located in

The differentiated way your fund will support your portfolio companies

Your average check size

The amount of capital reserved for follow-on investments

The return profile for your fund, based on the size of the stakes you’re trying to take in each company and your estimated success rate

How the fund will set itself apart from similarly sized or focused funds

An investment thesis tells a story by describing how each of these elements work together. 

Your fund’s investment thesis explains how you’ll cooperate with, compete with, and differentiate from other venture funds. An effective fund investment thesis is realistic and sustainable. It aligns with your investment team’s network of professional contacts (which provides access to deals), untapped opportunities in new and existing markets, and your LPs’ investment interests. 

Your fund thesis also supports compliance with the “ venture capital fund ” definition under the Investment Advisers Act of 1940 , which is important if you plan to rely on the related regulatory exemption for private funds. 

Creating your own fund investment thesis involves determining fund size, investment focus, and portfolio construction. 

The size of your fund influences almost every element of your investment strategy: The number of companies in your portfolio, your check size, the amount of reserve capital you have, and the return profile for your fund. Fund size also affects the types of LPs you attract and helps determine your fund’s portfolio management fees, which then dictate the operational expenses you can realistically support. 

Competitive research

To determine your ideal fund size, start by researching funds with goals and benchmarks like yours to see how they’re faring. You may also want to research successful funds across a handful of different industries and sectors to see what works. You can learn more information about funds by subscribing to trade publications, reading press releases from funds when they close, or on social media.

Once you’ve settled on a fund size, the next step is to outline the stage, industry, and location you’ll invest in. Articulating your investment focus helps narrow your aim and convince limited partners (LP) with interests in these sectors and stages to get on board with your strategy. It also makes it easier for founders who meet your parameters to identify your fund as a potential investor—and discourages founders who aren’t a good fit from pitching your firm.

At what point in a company’s life cycle do you want to invest and offer guidance? If you’re interested in being a sounding board for early-stage companies who are just getting started, you might want to invest at the pre-seed , seed , or Series A stages. However, if you prefer to work with companies that already have steady revenue and an established business model, you’ll probably want to focus on a later stage. 

Ultimately, the stage where you can focus your investments will be a function of your fund size and the anticipated number of companies in your portfolio. So keep this top of mind when building out your minimal viable fund size.   

Which sectors are you interested in? Do you plan to target a specific industry—like healthcare, fintech, or real estate—or focus on companies across a handful of different industries? 

Where are the companies you’ll be investing in? What particular challenges and assets do they have because of where they operate? You may choose to invest in local companies if you already have a deep network of contacts nearby. On the other hand, if you’re open to traveling, or want to capitalize on emerging, international, or underserved markets, you may want to expand your reach. This may also apply if your fund’s investment thesis is based on industry, for example, so you may be agnostic to geography. 

Other considerations

Depending on your investment goals, you might have other criteria to look at, like a company’s social impact, environmental influence, or commitment to diversity, equity, and inclusion. 

A thoughtful portfolio is critical to running a successful fund and shaping your overall investment thesis. Your strategy for portfolio construction signals to LPs how you plan to allocate their capital across investments. Your fund’s investment portfolio is essentially the roadmap for the life of the fund. It spells out the number of companies you’ll invest in, the amount of capital you’ll pour into each company, your target ownership for each company, how much you’ll set aside for initial investments, and how much you’ll reserve for follow-on investments.

Portfolio construction is made up of the following elements: 

Investment focus

Diversification: Types of companies you’ll invest in and what percent of the fund will be for non-qualifying investments or investments outside the thesis

Check size: The amount you’ll invest in each company

Investment horizon: How long you have to allocate the capital and how long you’ll hold each investment

Expected returns: How much you expect to return on the capital invested

Investor requirements: Maximum or minimum contributions

A good rule of practice is to ensure that your investments align with your portfolio construction model before making each investment decision, and then actively thereafter. Set aside time to regularly evaluate whether your investments align with your model, and where to course-correct. If your investments deviate from your original thesis, you’ll need to adjust your model or reset your focus. This is particularly important to track if you include a specific investment thesis in your fund’s legal documents.

Learn more about how to create a portfolio construction strategy

Most VCs prepare versions of their fund thesis that go into different levels of detail, ranging from a one-sentence elevator pitch, like the example below, to a full pitch deck.

You should be able to sum up your fund strategy in one or two straightforward sentences. Here’s an example investment thesis from a hypothetical venture fund:

“Krakatoa Ventures is raising a $25 million seed fund to back U.S.-based startups focused on climate technology and earth sciences. The fund will capitalize a highly specialized network of climate scientists the general partners developed during their two decades of academic study in volcanology and climatology.”

→Ready to make a full pitch deck for LPs? Prepare for your next meeting with investors using our free pitch deck template and example pitch decks .

This example highlights a key aspect of a great fund strategy: It shouldn’t be a thesis that just anybody can go out and execute. Your edge, such as your personal experience and network, are integral parts of the plan. Articulate why you’re better positioned than anyone else to execute your investment thesis.

Related Content

How to Write Your Investment Thesis: A Comprehensive Guide

Aryannsingh

Welcome back to our engaging discussion on the intricate world of investment thesis. In this in-depth exploration, we will not only revisit the fundamental aspects of crafting a robust investment thesis but also uncover the nuances that transform a good thesis into a great one. By seamlessly blending historical insights with contemporary strategies, we aim to guide you through the journey of mastering the art of investment theses, providing a comprehensive understanding of their significance and how to leverage them for fund success.

Unlocking the Fund Launch Formula

Before delving into the intricacies of investment theses, let’s briefly revisit the Fund Launch Formula. A well-established four-step process, it serves as the blueprint for the success of any fund. Each step is pivotal, and a thorough understanding of this formula is essential for navigating the complex landscape of fund management:

1. Find an Amazing Deal

This initial step involves scouring the market for exceptional investment opportunities. The emphasis here is on identifying deals that not only align with your fund’s objectives but also present substantial growth potential.

2. Frame It Out

Once a promising deal is identified, framing it out involves developing a comprehensive plan. This plan encompasses the intricate details of the investment, including potential risks, market dynamics, and the strategic vision for maximizing returns.

3. Pitch Investors

With a well-framed deal, the next step is to pitch investors. This is where the effectiveness of your investment thesis comes into play. It’s not just about presenting a deal; it’s about articulating a compelling argument for why investors should trust you with their capital.

4. Legal Docs

After garnering investor interest, the final step is to formalize the arrangement through legal documentation. This ensures compliance with regulations and sets the stage for the official launch of your fund.

The Essence of Investment Theses

Understanding the essence of an investment thesis is crucial for navigating the dynamic world of fund management. At its core, an investment thesis is your persuasive argument for why investors should entrust their capital to you. It’s a roadmap that outlines how you intend to outperform the market, mitigate risks, and ultimately deliver value to your investors. Investors can optimize their time by utilizing thesis services for making better thesis , allowing them to dedicate more time to market analysis for informed future investments.

Learning from Historical Success: Long-Term Capital Management (LTCM)

To illustrate the power of a well-crafted investment thesis, let’s journey back to the 90s and examine the case of Long-Term Capital Management (LTCM). This legendary fund built its success on a seemingly simple yet effective thesis — exploiting pricing differences between the 30-year bond and its lesser-known counterpart, the 29.75-year bond.

The lesson here is clear: simplicity, when coupled with effectiveness, can lead to substantial success. However, it’s crucial to remain vigilant and adaptable, as even renowned funds like LTCM faced challenges, particularly in the face of unexpected events such as the Russian bond default.

Crafting Your Investment Thesis: A Strategic Approach

Now that we understand the significance of an investment thesis, let’s delve into the strategic approach to crafting one that resonates with both investors and the market.

1. Leverage Team Experience

During a recent coaching call, a fundamental question emerged — what to invest in? The advice provided emphasized leveraging existing experience. If you have a background in a specific industry, such as running gyms, consider building a fund around acquiring and enhancing businesses within that domain.

2. Partnering with Experts

For those lacking specific expertise in a particular field, the recommendation is to seek partnerships with individuals who possess the necessary skills. This collaborative approach allows you to combine your fund management acumen with their domain-specific knowledge, creating a potent force in the competitive landscape.

Market Testing Your Investment Thesis: A Pragmatic Approach

The journey doesn’t end with crafting an investment thesis; market testing is an indispensable step before scaling up. Let’s explore practical approaches to validate the effectiveness of your thesis:

Ghost Trading: Simulating Success

Consider “ghost trading” as a method to test the effectiveness of your investment thesis. This involves simulating trades with theoretical amounts to gauge the potential success of your strategy. It’s a risk-free way to refine your approach before involving actual funds.

Syndication Deals: A Small-Scale Litmus Test

Start with syndication deals, which involve pooling money from multiple investors for a specific venture. This allows you to test your investment thesis on a smaller scale, fine-tune your strategy, and gain confidence before scaling up to a full-fledged fund.

Scaling Your Fund: The Strategic Imperative

Once your investment thesis has withstood the rigors of market testing, it’s time to scale your fund. This phase involves two crucial steps:

1. Pitch to Investors: The Art of Persuasion

Pitch your refined investment thesis to potential investors. The market testing phase would have prepared you to address potential concerns and showcase the viability of your approach. This is the art of persuasion, where the effectiveness of your communication can make or break the deal.

2. Legal Documentation: The Foundation of Trust

Finally, initiate the legal documentation process. Ensure compliance with all regulations and formalities before officially launching your fund. This phase is about establishing trust with investors, and meticulous documentation plays a pivotal role in achieving that.

Crafting and mastering an investment thesis is not just a step in the fund management process; it’s an odyssey. It requires a deep understanding of market dynamics, a keen eye for opportunities, and the agility to adapt to unforeseen challenges. By leveraging historical insights, embracing strategic partnerships, and rigorously testing your thesis in the market, you can set the stage for a successful fund launch and sustained growth.

Written by Aryannsingh

Hi guys, I am Aryan Singh, a professional writer and helping hand for people facing problems in writing. Visit my website - https://thesiswritingservices.in/

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What Is an Investment Thesis?

Investing is a process. One important task an investor should perform before putting money into an opportunity is to develop an investment thesis. An investment thesis is a written analysis laying out the case for why an investment opportunity should generate a compelling return.

Here's a closer look at how to build an investment thesis and why it's essential to create one. 

The importance of creating an investment thesis

Many people make the mistake of investing their hard-earned money into opportunities they don't fully understand. Maybe they received a tip on a hot stock at a party or got caught up in the frenzy of  meme stocks  and  cryptocurrencies on social media. Perhaps that investment has now lost value, and they're not sure whether they should buy more , sell , or continue holding .

An investment thesis can help solve this problem. By creating a thesis on why you believe an investment will deliver an attractive return, you can use it as a guide to determine your next step when the investment experiences a large decline or some disturbing news emerges. You can measure those factors against the original thesis to see if it remains intact.

If the thesis hasn't changed, you can continue holding or potentially increase your investment. However, if you found that the thesis is busted, you can sell your investment and move on.

How to write an investment thesis

It's important to take the time to write a well-thought-out and thoroughly researched investment thesis. That will allow you to easily make sense of it for future reference. Here are four easy steps for writing an investment thesis.

Identify the underlying catalyst at play

The first step in writing an investment thesis is to determine and then outline the catalyst driving your investment thesis. For example, are you interested in the long-term upside from a  secular trend  or  economic supercycle , or a shorter-term rebound from the economic  cycle  or a  bear market ? Write out the primary reason you believe this investment has attractive upside potential.

Assess how the investment is positioned within the catalyst

Next, look at how the particular investment opportunity compares to others that benefit from the same catalyst. Is it the largest  publicly traded company  focused on this opportunity? Smaller but with more upside potential? Does it align with a particular  long-term investment strategy ? Will it help you with  balancing your portfolio ? Write out why this investment is a solid choice to benefit from this catalyst.

Consider the biggest risks 

As the saying goes, the best-laid plans often go awry. That's why it's vital to consider what will happen to this particular investment opportunity if something goes wrong. Some examples to consider:

• Can it withstand a recession ?
• Could Congress enact legislation that would damage its prospects?
• Is there a lot of competition within the industry?
• Does it have too much debt, volatile cash flows, or an otherwise weaker financial profile?
• Is the price high? Could that result in underperformance if the catalyst doesn't play out according to plan?

Consider and jot down anything that could negatively impact this investment.

Determine your conviction level

Finally, write down your expected return from this investment and how much conviction you have in its ability to achieve that return. Then, given the catalyst, its position within that catalyst, the risk/reward profile, and your conviction level, is it worth the investment?

By going through these steps and writing a detailed investment thesis, you can proceed with confidence. Further, you can reference it in the future to ensure your thesis is playing out as expected. If not, you can make changes to your investment.

Investment thesis examples

An investment thesis doesn't need to be that long. It just needs to contain the most important factors driving your decision to invest in a particular opportunity. Here's a simplified example based on my investment thesis for Brookfield Renewable  ( BEP 1.49% )( BEPC 0.98% ), one of my largest holdings:

Renewable energy is one of the biggest megatrends of our lifetimes. It will 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 energy transition is Brookfield Renewable. It has one of the largest globally diversified renewable energy platforms and an even 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's position within this megatrend 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 position on any meaningful price decline.

This example succinctly lays out the catalyst (the renewable energy megatrend), the investment opportunity's position in the trend (Brookfield is a global leader), its ability to withstand risks (Brookfield has a top-tier financial profile), and my conviction level (high).

An investment thesis isn't just for stocks ; you can craft one for any investment opportunity you're contemplating. For example, you might have the opportunity to invest in a new business venture or a private company. To write an investment thesis for a venture capital or private equity opportunity, you would follow the same outline.

Here's a simplified investment thesis for a new coffee shop:

People love coffee . Demand for the brewed beverage is on track to grow at a more than 8% annual rate through 2025, according to Statista. It also notes that, by 2025, 84% of coffee spending and 21% of the volume consumed will be outside the home. That growing market will benefit coffee shops.

This particular shop would be the first one in a trendy area of downtown that's undergoing a dramatic revitalization. While restaurant retail can be brutal, the group starting the coffee shop has opened several profitable locations around the city in recent years. Their past success, when combined with the coffee industry's growth, suggests this new shop should thrive. Because of that, you have a high conviction that this investment will earn a much greater return than if you invested the money in another retail opportunity. 

With this venture capital investment thesis we've:

• Identified the catalyst: Growing demand for out-of-home coffee consumption.
• Classified this particular investment opportunity's position within the catalyst: First mover in a trendy area.
• Determine all the risks facing this venture: Retail is brutal.
• Considered the conviction level: High compared to other retail opportunities.

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An investment thesis can make you a more successful investor

Thinking through and crafting a thoroughly researched investment thesis can help you make better informed investing decisions. While it's best to write one before you invest, you can also create one for existing holdings. The investment thesis will serve as a guide allowing you to measure whether the opportunity is living up to your thesis — suggesting you hold or buy more — or if that's no longer the case, and it's time to sell.  

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Writing a Credible Investment Thesis

Only a third of acquiring executives actually write down the reasons for doing a deal.

By David Harding and Sam Rovit

• November 15, 2004

Every deal your company proposes to do—big or small, strategic or tactical—should start with a clear statement how that particular deal would create value for your company. We call this the investment thesis. The investment thesis is no more or less than a definitive statement, based on a clear understanding of how money is made in your business, that outlines how adding this particular business to your portfolio will make your company more valuable. Many of the best acquirers write out their investment theses in black and white. Joe Trustey, managing partner of private equity and venture capital firm Summit Partners, describes the tool in one short sentence: "It tells me why I would want to own this business."

Perhaps you're rolling your eyes and saying to yourself, "Well, of course our company uses an investment thesis!" But unless you're in the private equity business—which in our experience is more disciplined in crafting investment theses than are corporate buyers—the odds aren't with you. For example, our survey of 250 senior executives across all industries revealed that only 29% of acquiring executives started out with an investment thesis (defined in that survey as a "sound reason for buying a company") that stood the test of time. More than 40% had no investment thesis whatsoever (!). Of those who did, fully half discovered within three years of closing the deal that their thesis was wrong.

Studies conducted by other firms support the conclusion that most companies are terrifyingly unclear about why they spend their shareholders' capital on acquisitions. A 2002 Accenture study, for example, found that 83% of executives surveyed admitted they were unable to distinguish between the value levers of M&A deals. In Booz Allen Hamilton's 1999 review of thirty-four frequent acquirers, which focused chiefly on integration, unsuccessful acquirers admitted that they fished in uncharted waters. They ranked "learning about new (and potentially related) business areas" as a top reason for making an acquisition. (Surely companies should know whether a business area is related to their core before they decide to buy into it!) Successful acquirers, by contrast, were more likely to cite "leading or responding to industry restructuring" as a reason for making an acquisition, suggesting that these companies had at least thought through the strategic implications of their moves.

Not that tipping one's hat to strategy is a cure-all. In our work with companies that are thinking about doing a deal, we often hear that the acquisition is intended for "strategic" reasons. That's simply not good enough. A credible investment thesis should describe a concrete benefit, rather than a vaguely stated strategic value.

A credible investment thesis should describe a concrete benefit, rather than a vaguely stated strategic value. This point needs underscoring. Justifying a deal as being "strategic" ex post facto is, in most cases, an invitation to inferior returns. Given how frequently we have heard weak "strategic" justifications after a deal has closed, it's worth passing along a warning from Craig Tall, vice chair of corporate development and strategic planning at Washington Mutual. In recent years, Tall's bank has made acquisitions a key part of a stunningly successful growth record. "When I see an expensive deal," Tall told us, "and they say it was a 'strategic' deal, it's a code for me that somebody paid too much."

And although sometimes the best offense is a good defense, this axiom does not really stand in for a valid investment thesis. On more than a few occasions, we have been witness to deals that were initiated because an investment banker uttered the Eight Magic Words: If you don't buy it, your competitors will.

Well, so be it. If a potential acquisition is not compelling to you on its own merits, let it go. Let your competitors put their good money down, and prove that their investment theses are strong.

Let's look at a case in point: [Clear Channel Communications' leaders Lowry, Mark and Randall] Mayses' decision to move from radios into outdoor advertising (billboards, to most of us). Based on our conversations with Randall Mays, we summarize their investment thesis for buying into the billboard business as follows:

Clear Channel's expansion into outdoor advertising leverages the company's core competencies in two ways: First, the local market sales force that is already in place to sell radio ads can now sell outdoor ads to many of the same buyers, and Clear Channel is uniquely positioned to sell both local and national advertisements. Second, similar to the radio industry twenty years ago, the outdoor advertising industry is fragmented and undercapitalized. Clear Channel has the capital needed to "roll up" a significant fraction of this industry, as well as the cash flow and management systems needed to reduce operating expenses across a consolidated business.

Note that in Clear Channel's investment thesis (at least as we've stated it), the benefits would be derived from three sources:

• Leveraging an existing sales force more extensively
• Using the balance sheet to roll up and fund an undercapitalized business
• Applying operating skills learned in the radio trade

Note also the emphasis on tangible and quantifiable results, which can be easily communicated and tested. All stakeholders, including investors, employees, debtors and vendors, should understand why a deal will make their company stronger. Does the investment thesis make sense only to those who know the company best? If so, that's probably a bad sign. Is senior management arguing that a deal's inherent genius is too complex to be understood by all stakeholders, or simply asserting that the deal is "strategic"? These, too, are probably bad signs.

Most of the best acquirers we've studied try to get the thesis down on paper as soon as possible. Getting it down in black and white—wrapping specific words around the ideas—allows them to circulate the thesis internally and to generate reactions early and often.

The perils of the "transformational" deal. Some readers may be wondering whether there isn't a less tangible, but equally credible, rationale for an investment thesis: the transformational deal. Such transactions, which became popular in the exuberant '90s, aim to turn companies (and sometimes even whole industries) on their head and "transform" them. In effect, they change a company's basis of competition through a dramatic redeployment of assets.

The roster of companies that have favored transformational deals includes Vivendi Universal, AOL Time Warner (which changed its name back to Time Warner in October 2003), Enron, Williams, and others. Perhaps that list alone is enough to turn our readers off the concept of the transformational deal. (We admit it: We keep wanting to put that word transformational in quotes.) But let's dig a little deeper.

Sometimes what looks like a successful transformational deal is really a case of mistaken identity. In search of effective transformations, people sometimes cite the examples of DuPont—which after World War I used M&A to transform itself from a maker of explosives into a broad-based leader in the chemicals industry—and General Motors, which, through the consolidation of several car companies, transformed the auto industry. But when you actually dissect the moves of such industry winners, you find that they worked their way down the same learning curve as the best-practice companies in our global study. GM never attempted the transformational deal; instead, it rolled up smaller car companies until it had the scale to take on a Ford—and win. DuPont was similarly patient; it broadened its product scope into a range of chemistry-based industries, acquisition by acquisition.

In a more recent example, Rexam PLC has transformed itself from a broad-based conglomerate into a global leader in packaging by actively managing its portfolio and growing its core business. Beginning in the late '90s, Rexam shed diverse businesses in cyclical industries and grew scale in cans. First it acquired Europe's largest beverage—can manufacturer, Sweden's PLM, in 1999. Then it bought U.S.-based packager American National Can in 2000, making itself the largest beverage-can maker in the world. In other words, Rexam acquired with a clear investment thesis in mind: to grow scale in can making or broaden geographic scope. The collective impact of these many small steps was transformation. 14

But what of the literal transformational deal? You saw the preceding list of companies. Our advice is unequivocal: Stay out of this high-stakes game. Recent efforts to transform companies via the megadeal have failed or faltered. The glamour is blinding, which only makes the route more treacherous and the destination less clear. If you go this route, you are very likely to destroy value for your shareholders.

By definition, the transformational deal can't have a clear investment thesis, and evidence from the movement of stock prices immediately following deal announcements suggests that the market prefers deals that have a clear investment thesis. In "Deals That Create Value," for example, McKinsey scrutinized stock price movements before and after 231 corporate transactions over a five-year period. The study concluded that the market prefers "expansionist" deals, in which a company "seeks to boost its market share by consolidating, by moving into new geographic regions, or by adding new distribution channels for existing products and services."

On average, McKinsey reported, deals of the "expansionist" variety earned a stock market premium in the days following their announcement. By contrast, "transformative" deals—whereby companies threw themselves bodily into a new line of business—destroyed an average of 5.3% of market value immediately after the deal's announcement. Translating these findings into our own terminology:

• Expansionist deals are more likely to have a clear investment thesis, while "transformative" deals often have no credible rationale.
• The market is likely to reward the former and punish the latter.
• The dilution/accretion debate. One more side discussion that comes to bear on the investment thesis: Deal making is often driven by what we'll call the dilution/accretion debate. We will argue that this debate must be taken into account as you develop your investment thesis, but your thesis making should not be driven by this debate.

Sometimes what looks like a successful transformational deal is really a case of mistaken identity. Simply put, a deal is dilutive if it causes the acquiring company to have lower earnings per share (EPS) than it had before the transaction. As they teach in Finance 101, this happens when the asset return on the purchased business is less than the cost of the debt or equity (e.g., through the issuance of new shares) needed to pay for the deal. Dilution can also occur when an asset is sold, because the earnings power of the business being sold is greater than the return on the alternative use of the proceeds (e.g., paying down debt, redeeming shares or buying something else). An accretive deal, of course, has the opposite outcomes.

But that's only the first of two shoes that may drop. The second shoe is, How will Wall Street respond? Will investors punish the company (or reward it) for its dilutive ways?

Aware of this two-shoes-dropping phenomenon, many CEOs and CFOs use the litmus test of earnings accretion/dilution as the first hurdle that should be put in front of every proposed deal. One of these skilled acquirers is Citigroup's [former] CFO Todd Thomson, who told us:

It's an incredibly powerful discipline to put in place a rule of thumb that deals have to be accretive within some [specific] period of time. At Citigroup, my rule of thumb is it has to be accretive within the first twelve months, in terms of EPS, and it has to reach our capital rate of return, which is over 20% return within three to four years. And it has to make sense both financially and strategically, which means it has to have at least as fast a growth rate as we expect from our businesses in general, which is 10 to 15% a year.

Now, not all of our deals meet that hurdle. But if I set that up to begin with, then if [a deal is] not going to meet that hurdle, people know they better make a heck of a compelling argument about why it doesn't have to be accretive in year one, or why it may take year four or five or six to be able to hit that return level.

Unfortunately, dilution is a problem that has to be wrestled with on a regular basis. As Mike Bertasso, the head of H. J. Heinz's Asia-Pacific businesses, told us, "If a business is accretive, it is probably low-growth and cheap for a reason. If it is dilutive, it's probably high-growth and attractive, and we can't afford it." Even if you can't afford them, steering clear of dilutive deals seems sensible enough, on the face of it. Why would a company's leaders ever knowingly take steps that would decrease their EPS?

The answer, of course, is to invest for the future. As part of the research leading up to this book, Bain looked at a hundred deals that involved EPS accretion and dilution. All the deals were large enough and public enough to have had an effect on the buyer's stock price. The result was surprising: First-year accretion and dilution did not matter to shareholders. In other words, there was no statistical correlation between future stock performance and whether the company did an accretive or dilutive deal. If anything, the dilutive deals slightly outperformed. Why? Because dilutive deals are almost always involved in buying higher-growth assets, and therefore by their nature pass Thomson's test of a "heck of a compelling argument."

As a rule, investors like to see their companies investing in growth. We believe that investors in the stock market do, in fact, look past reported EPS numbers in an effort to understand how the investment thesis will improve the business they already own. If the investment thesis holds up to this kind of scrutiny, then some short-term dilution is probably acceptable.

Reprinted with permission of Harvard Business School Press. Mastering the Merger: Four Critical Decisions That Make or Break the Deal , by David Harding and Sam Rovit. Copyright 2004 Bain & Company; All Rights Reserved.

David Harding (HBS MBA '84) is a director in Bain & Company's Boston office and is an expert in corporate strategy and organizational effectiveness.

Sam Rovit (HBS MBA '89) is a director in the Chicago office and leader of Bain & Company's Global Mergers and Acquisitions Practice.                                              

10. Joe Trustey, telephone interview by David Harding, Bain & Company. Boston: 13 May 2003. Subsequent comments by Trustey are also from this interview.

11. Accenture, "Accenture Survey Shows Executives Are Cautiously Optimistic Regarding Future Mergers and Acquisitions," Accenture Press Release, 30 May 2002.

12. John R. Harbison, Albert J. Viscio, and Amy T. Asin, "Making Acquisitions Work: Capturing Value After the Deal," Booz Allen & Hamilton Series of View-points on Alliances, 1999.

13. Craig Tall, telephone interview by Catherine Lemire, Bain & Company. Toronto: 1 October 2002.

14. Rolf Börjesson, interview by Tom Shannon, Bain & Company. London: 2001.

15. Hans Bieshaar, Jeremy Knight, and Alexander van Wassenaer, "Deals That Create Value," McKinsey Quarterly 1 (2001).

16. Todd Thomson, speaking on "Strategic M&A in an Opportunistic Environment." (Presentation at Bain & Company's Getting Back to Offense conference, New York City, 20 June 2002.)

17. Mike Bertasso, correspondence with David Harding, 15 December 2003.

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No matter who said it first, “cutting the flowers and watering the weeds” is a perfect analogy for a terrible investor weakness – selling winners too soon and holding on to losers.

“Over time, that will bias your portfolio to increase your weight of losers over winners,” says Katie Hudson, head of Australian equities research at Yarra Capital Management and co-portfolio manager of the UBS Australian Small Companies Fund. “Obviously something to avoid.”

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The Joy of Enterprise Management Incentives

The investment thesis explained: everything you need to know.

What's an investment thesis?

Key elements

Investment stage

Follow-on funds

Do your homework

Tailor your pitch

Be realistic

Embrace the long game

Highlight value

Prepare for investment

You've poured your heart and soul into your startup. Now you're ready to take the next big leap – securing venture capital (VC) funding. 

But here's the catch: VCs aren't just looking for great ideas. They're looking for great ideas that fit their specific investment strategy. 

Enter the investment thesis, which guides both how you select suitable VCs and how they decide whether you’re suitable for them.

Read on to uncover the ins and outs of investment theses, how they shape VC decisions, and how you can use this knowledge to your advantage when seeking funding for your company.

What is an investment fund thesis?

An investment thesis is a VC firm's core set of beliefs about the types of investments that will yield the best returns. It's a foundational philosophy that guides their investment decisions.

A typical investment thesis includes:

• Target sectors or technologies
• Preferred company stages (e.g., seed, early-stage, growth)
• Geographical focus
• Ideal company characteristics
• Market trends they believe will be important

The investment thesis informs how a VC firm evaluates opportunities, allocates its fund, and builds its portfolio. It's primarily based around the firm's expertise, market analysis, and predictions about future trends.

For companies trying to raise VC capital, effectively analysing and understanding a VC's investment thesis is an essential skill.

It helps you determine if your startup aligns with what the VC is looking for, increasing your chances of securing funding and building a productive long-term partnership. 

Not to mention, it will save you from wasting time pursuing the wrong VCs!

Key elements of an investment thesis

When researching VCs, here are the main components of their investment thesis to look out for:

1. Fund size

As noted, a fund's size significantly influences the types of investments it can make.

Larger funds need to write bigger checks and often target later-stage companies to move the needle on returns. Smaller funds typically focus on earlier stages, where smaller investments can yield outsized returns.

For example, a $500 million fund might focus on Series B and C rounds, while a $50 million fund might concentrate on seed and Series A investments.

2. Investment stage

VCs usually specialise in certain stages of a company's lifecycle.

Some VCs target smaller companies, offering smaller sums as low as £/$100K or less for early-stage, risky businesses. Others get involved once a business has raised seed and Series A funding.

Broadly speaking, early-stage VCs might be more comfortable with product risk and market uncertainty, while later-stage investors often look for proven traction and clear paths to profitability.

Again, this is often flexible. For example:

• AI startups have been raising immensely large seed and Series A funding, like the French company H, which recently raised $220 million months after its formation.
• US startup Safe Superintelligence Inc. similarly raised an eye-watering $1 billion despite having no product.

3. Industry focus

Many VCs specialise in specific industries or sectors where they have expertise or see particular potential. This could be broad (like "enterprise software") or niche (like "AI-powered fintech for SMEs").

Industry focus is often tied to the partners' backgrounds and the fund's thesis on where future growth opportunities lie.

For instance, a VC firm might focus on health tech because it believes in the sector's growth potential and has partnered with healthcare industry experience.

4. Geographic focus

Some VCs invest globally, while others focus on specific regions or even cities (this is common in US cities like San Francisco and New York).

This often aligns with where they have the strongest networks and can provide the most value beyond capital.

A VC's geographic focus might be influenced by factors like:

• Local ecosystem strength
• Regulatory environment
• Proximity for hands-on support
• Emerging market opportunities

5. Deal size and ownership targets

VCs typically have a range for their initial investments and targets for the percentage ownership they want to acquire.

This helps them manage their portfolio and ensure they have enough stake in their winners to drive fund returns.

For instance, a VC might aim to invest £/$2-5 million for a 15-20% ownership stake in their initial investment. This allows them to have meaningful influence while leaving room for future investors.

6. Follow-on strategy

Most VCs reserve capital to participate in future funding rounds of their portfolio companies. Understanding this provides insights into how they might support you beyond the initial investment.

Some VCs might reserve 50% or more of their fund for follow-on investments, while others might have a more limited follow-on strategy. This can impact how much support you can expect in future rounds.

Using this knowledge to approach VCs

VCs often see a company’s attempt to align with their thesis as a green flag. In fact, many say that failing to consider the thesis when reaching out to VCs is precisely how not to approach VCs. 

Josefa Marzo Pons from Kalonia Venture Partners explained:

If they have researched what kind of investments we make and it is a match it's a welcomed email.

Kate Brodock from Switch Futures similarly says:

You’d be shocked how many cold outreaches I get that are so clearly outside our thesis.

Here’s how to use your understanding of the thesis to increase your odds of VC outreach success:

1. Do your homework

Before reaching out to a VC, thoroughly research their investment thesis. This information is often available on their website or in interviews with the partners. As our friends at Connectd say:

The first step is always research. You need to have a clear understanding of the ecosystem, what kinds of investors are out there, and then decide who is best suited to your business.

2. Tailor your pitch

Highlight aspects of your startup that align with the VC's thesis. Show them why you're a perfect fit for their portfolio. Our free pitch deck template should put you in good stead.

3. Be realistic

If your startup doesn't align with a VC's thesis, it's probably not worth your time to pitch them. Focus on VCs whose theses match your profile.

4. Understand their perspective

When a VC asks questions or raises concerns, try to view it through the lens of their investment thesis. Are they trying to determine if you fit their strategy?

5. Prepare for the long game

VCs think in terms of fund lifecycles (typically 10 years). Be prepared to discuss your long-term vision and how it aligns with their thesis.

6. Highlight the value you bring

VCs are looking for companies that can provide outsized returns. Emphasise how your startup fits into their thesis in a way that could drive significant value.

A mutual fit matters

Ultimately, securing VC funding isn't just about the cash. It's about entering into a long-term partnership.

The VC's investment thesis should align not just with your current state, but with your long-term vision and goals.

Don't be afraid to ask VCs about their thesis and how they see your company fitting into their portfolio.

This demonstrates your savviness as a founder and helps ensure that any partnership you enter is built on mutual understanding and aligned interests.

The long and short of it is that:

It's not about impressing every VC out there but finding the ones whose investment thesis matches your startup's potential, saving you time and energy in the process. 

Prepare your company for investment with Vestd

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Our platform simplifies cap tables , share issues, and vesting schedules, letting you focus on what matters most – growing your business. 

Give Vestd a try for free and see how we can streamline your equity admin while you work on impressing those perfectly-matched VCs.

The first steps to finding an investor for your startup

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Finding Your Niche

William Blair Investment Management’s William Heaphy and Matthew Fleming explain how their strategy is built to win in both up and down markets, why their portfolio companies are often attractive takeover targets, how they battle investment-thesis “creep,” and what they think the market seems to be missing today in Hillenbrand, Carter’s and Perficient.

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Ackman Emerges Victorious Over Herbalife

• Herbalife has reached a settlement with the FTC.
• The company is not deemed a pyramid scheme, and gets off with just a $200 million fine.
• Except there are also 31 pages of painful measures the company has to take.
• It is very unlikely the company's business will remain unscathed by these requirements.
• Herbalife stock should be down, not up.

Herbalife ( NYSE: HLF ) has reached a settlement with the FTC. The headlines, so far, seem rather positive, focusing on Herbalife not being shut down as a pyramid scheme. But I just went through the 31 page agreement between the FTC and Herbalife about how Herbalife will restructure, and it does not look good for the company at all.

I'm going to quote what I deem some of the worst (from Herbalife's perspective) parts of the agreement. All emphasis added is mine:

Any Multi-Level Compensation paid to a Participant for a given period shall be generated solely by the following categories of transactions ("Rewardable Transactions") occurring in the same period or, during such Participant's first six months as a Business Opportunity Participant, the three months prior to that period: a. Sales to Preferred Customers whom the Participant has personally recruited or sponsored b. Sales to Preferred Customers in the Participant's Downline; c. Profitable Retail Sales of the Participant's Downline, as calculated by Defendants using the information collected pursuant to Subsection I.C; and d. All or a portion of Rewardable Personal Consumption transactions, determined pursuant to Subsection I.E., of the Participant's Downline; provided that the Rewardable Personal Consumption transactions included in a Participant's Rewardable Transactions shall be limited such that no more than one-third of the total value of the Participant's Multi-Level Compensation may be attributable to or generated by such transactions.

Preferred customers are customers that do not participate in the business opportunity. The agreement makes it much more difficult for Herbalife to initially sell a batch of product to a customer who believes it is a business opportunity but later qualify that customer as if he or she purchased the product as a "normal consumer".

A Business Opportunity Participant's classification cannot change to Preferred Customer except upon the Participant's written

This article was written by

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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For background, I have been an analyst in a few LO equity shops (ranging from large to very small) and have been okay with getting interviews and going through the initial rounds. I can talk through my investment approach and process, and reasonably answer questions about that.

Where I am getting stuck is the case study round. It is a situation of either looking at a stock of their choosing (most common) or of my choice (much less common) and a submission deadline that is typically 1 or 2 weeks away. Models have not been required but if they are optional, I include one. Post submission is a presentation or talking through of my thesis followed by Q&A. I use the CSIMA newsletter pitch layout though opt for full paragraphs instead of dot points; I think these reports (of 5-10 pages including appendix) can be a way to assess a candidate's writing ability. A couple of analyst friends go through my drafts and provide edits and suggestions.

So my question for those on the other side of the table or anyone really: what are the key elements are you looking for in a case study to assess a candidate? What separates a good case study from an okay one?

One lesson I learned after pouring 40 hours into a case study and getting rejected is that they want actionable ideas and ideas that are outside of the box. If you are matching sell side expectations then your work is useless, no matter how much you believe it is justified. My recommendation was to not invest because it was fairly priced and apparently that is one of the worst things you can do... So a big recommendation from me is don't even sneak a look at sellside expectations until you have your model and assumptions done and defended.

You make a good point. It's the so-called 'variant perception' that is going to drive your thesis and hopefully be a differentiator.

I learnt to make either a buy or sell call; neutral is a big fat yawn. And as in shorting, never say sell based solely on valuation - there should be other supportive factors.

Thanks for your reply.

And as in shorting, never say sell based solely on valuation - there should be other supportive factors.

Should also be the case with going long. Valuation is an absolutely horrendous timing tool; should be considered a condition, not a catalyst, that you use as a favorable or unfavorable backdrop for catalysts on the horizon. Good luck.

Following. This will be very useful for the broader group.

This isn't fair but picking the right name to pitch is half the battle. And it's very difficult if you're not already in the loop. Most stocks are correctly priced most of the time. So you have to find one where 1) you have a differentiated view and 2) there are upcoming catalysts to validate that view (investor days, earnings, new product launch, new mgmt team, etc.). 

As far as the actual pitch, keep it short and focus on your key points. Chances are if you need more than 1 page you either don't understand the thesis well enough or it sucks. PM's want to quickly read a pitch, understand it, and spend 2 hours asking questions vs having to read 5 or 10 pages.  BTW that doesn't mean do less work and you should definitely come with an appendix of charts or other information to support your answers during Q&A. 90%+ of the pitch should be spent on your points of differentiation and supporting evidence. Your bullet points should look something like this:

• XYZ channel checks in test markets show a 15% lift, and industry experts believe...
• New factory is being opened which will increase capacity in XYZ commodity and reduce prices...
• mgmt messaged on last EPS call that/talked to them at a recent conference and they said..

Leave valuation for last unless there is a catalyst you can point to that will change it. Companies can stay cheap/expensive for a lot longer than you can have a job. Also have some kind of risk reward framework (e.g. if you're right there is 50% upside and if we're wrong there is 25% downside). Hopefully you can see what I did with the bullets above. Have concise theses with numbers showing difference vs street followed by sub-bullets with supporting evidence.

Thanks for the reply.

I intuitively think about the thesis in terms of the 3-4 key points and will not deny there is a temptation to use up the word/page limit if there is one. But your points of differentiation is a good one (if you have access to consensus numbers).

On catalysts, would you say that depends on the PM or that manager's investment process? For example, a LO may not care so much for catalysts compared to a HF .

RE catalysts: maybe...and just to preface I've sat in both LO and HF seats.  I think there are a lot of problems when investing without catalysts (invites laziness, thesis creep, etc.) but I won't expand here. Also how do you have points of differentiation without a catalyst? I think they're two sides of the same coin. If the market is thinking A, then there needs to be some event to change their mind and think B right? To your point, a LO catalyst will probably be much further out, but I think when you boil down the analyst job at either LO or HF , it's about figuring out where numbers should be relative to consensus. So when a LO says AMZN will beat numbers in 2025, or the top line CAGR of company X between now and 2030 is 15% and street is modeling 10%, I still view that as a catalyst. 

As it relates to an interview, presenting the pitch in terms of catalysts is an easy way to show that you can think like an analyst and the idea is actionable. Put yourself in the shoes of a PM. Assuming they have a team of good analysts who can be trusted to pick stocks, their main focus becomes timing, sizing, and risk mgmt. It becomes 100x harder to do those things when you have no idea what you're playing for on names and you have no idea what the investment timeline is. 

Agree with the above on keeping things simple. Some case studies try to throw the kitchen sink at the issue to show depth. I think having a few key points that drive the investment is critical. For example, say 85% of ebitda is from one segment; don't focus on the segment that only contributes 15% its relatively irreverent in the big picture, especially for a case study. I've seem too many case studies that are too complex for such a short conversation. I've also found it surprising how many people with great resumes and experience produce just horrible case studies - sloppy, too much time on the wrong areas, too much time focused on the company not analysis. Company overview should be short and sweet not some long and complex thing. 

Also, of note, I don't think a case study is the end all be all for an offer - I think its just a hurdle and box to check. A bad one loses you the job but a good one does not get you the job. That is my opinion/experience. 

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