How to analyse a business

Assessing a business lies at the heart of stock investing. Behind every stock is a business and the fortunes of the stock are closely tied to the fortunes of the business. If a business does well, it's highly likely that the stock will also do well.

Assessing a business is not something that can be covered in one page; there are full books available on this subject. The objective here is to give you a quick primer on what all it takes to assess a business. It requires both skill and experience to do so.

Business assessment can be broadly divided into two categories: quantitative and qualitative assessment. While quantitative assessment focuses on financial data, qualitative assessment looks at other non-data factors such as management quality, industry outlook, product appeal and so on.

Let's start with quantitative business assessment. Quantitative assessment deals with a company's finances. Financial statements are a window to a company's financial well-being. There are three major financial statements: balance sheet, income statement (or profit-and-loss statement) and cash-flow statement. See the April 2017 issue of Wealth Insight for an introduction of these and the May 2017 issue for an introduction to financial ratios. A company's annual report is a good source of financial data.

Qualitative assessment can take many forms and it is a function of one's experience in the field. Experienced investors can read the business environment much more accurately than a novice can. The June 2017 issue of Wealth Insight had an introduction to the assessment of the management.

Here are some other factors that one must check in qualitative analysis:

Scalability of business: A scalable business is one that can be extended and expanded. For instance, consider the market for consumer goods. As the market grows, demand for consumer goods automatically increases.

Strength of the brand: An established brand doesn't require much pushing; the products keep flying off the shelves on their own. Take the case of Maruti Suzuki. Maruti is a go-to name in the car segment. It's known for its wide distribution and affordable cars.

Presence of an impenetrable moat: A moat is a strategic advantage that a company has over others. A moat also means high barrieto entry. Consider Larsen & Toubro. The company has unparalleled expertise and capability to execute infrastructure projects that no other company can match. Hence, it has a moat.

Industry outlook: A business could be an outlier in its industry but it's never insulated from the industry-specific headwinds and competition. The sorry state of the Indian telecom sector means that even the largest player Bharti Airtel has been a disappointment for its investors.

Complexity of the business: How easy is it to understand what the company does? For instance, most people will have trouble understanding the intricacies of the software business. But understanding what ITC does is quite easy.

Overall image of the company: How is the company perceived? Do people complain of its products? Is the company battling multiple court cases? How aggressive is it? Paying attention to the overall image of a company helps as it is generally a sum total of all that is going on with it.