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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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• 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.

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What Is an Investment Thesis?

• Understanding the Thesis

Special Considerations

• What's Included?

The Bottom Line

• Portfolio Management

Investment Thesis: An Argument in Support of Investing Decisions

Charlene Rhinehart is a CPA , CFE, chair of an Illinois CPA Society committee, and has a degree in accounting and finance from DePaul University.

The term investment thesis refers to a reasoned argument for a particular investment strategy, backed up by research and analysis. Investment theses are commonly prepared by (and for) individual investors and businesses. These formal written documents may be prepared by analysts or other financial professionals for presentation to their clients.

Key Takeaways

• An investment thesis is a written document that recommends a new investment, based on research and analysis of its potential for profit.
• Individual investors can use this technique to investigate and select investments that meet their goals.
• Financial professionals use the investment thesis to pitch their ideas.

Understanding the Investment Thesis

As noted above, an investment thesis is a written document that provides information about a potential investment. It is a research- and analysis-based proposal that is usually drafted by an investment or financial professional to provide insight into investments and to pitch investment ideas. In some cases, the investor will draft their own investment thesis, as is the case with venture capitalists and private equity firms.

This thesis can be used as a strategic decision-making tool. Investors and companies can use a thesis to decide whether or not to pursue a particular investment, such as a stock or acquiring another company. Or it can be used as a way to look back and analyze why a particular decision was made in the first place—and whether it was the right one. Putting things in writing can have a huge impact on the direction of a potential investment.

Let's say an investor purchases a stock based on the investment thesis that the stock is undervalued . The thesis states that the investor plans to hold the stock for three years, during which its price will rise to reflect its true worth. At that point, the stock will be sold at a profit. A year later, the stock market crashes, and the investor's pick crashes with it. The investor recalls the investment thesis, relies on the integrity of its conclusions, and continues to hold the stock.

That is a sound strategy unless some event that is totally unexpected and entirely absent from the investment thesis occurs. Examples of these might include the 2007-2008 financial crisis or the Brexit vote that forced the United Kingdom out of the European Union (EU) in 2016. These were highly unexpected events, and they might affect someone's investment thesis.

If you think your investment thesis holds up, stick with it through thick and thin.

An investment thesis is generally formally documented, but there are no universal standards for the contents. Some require fast action and are not elaborate compositions. When a thesis concerns a big trend, such as a global macro perspective, the investment thesis may be well documented and might even include a fair amount of promotional materials for presentation to potential investing partners.

Portfolio management is now a science-based discipline, not unlike engineering or medicine. As in those fields, breakthroughs in basic theory, technology, and market structures continuously translate into improvements in products and in professional practices. The investment thesis has been strengthened with qualitative and quantitative methods that are now widely accepted.

As with any thesis, an idea may surface but it is methodical research that takes it from an abstract concept to a recommendation for action. In the world of investments, the thesis serves as a game plan.

What's Included in an Investment Thesis?

Although there's no industry standard, there are usually some common components to this document. Remember, an investment thesis is generally a proposal that is based on research and analysis. As such, it is meant to be a guide about the viability of a particular investment.

Most investment theses include (but aren't limited to) the following information:

• The investment in question
• The investment goal(s)
• Viability of the investment, including any trends that support the investment
• Potential downsides and risks that may be associated with the investment
• Costs and potential returns as well as any losses that may result

Some theses also try to answer some key questions, including:

• Does the investment align with the intended goal(s)?
• What could go wrong?
• What do the financial statements say?
• What is the growth potential of this investment?

Putting everything in writing can help investors make more informed decisions. For instance, a company's management team can use a thesis to decide whether or not to pursue the acquisition of a rival. The thesis may highlight whether the target's vision aligns with the acquirer or it may identify opportunities for growth in the market.

Keep in mind that the complexity of an investment thesis depends on the type of investor involved and the nature of the investment. So the investment thesis for a corporation looking to acquire a rival may be more in-depth and complicated compared to that of an individual investor who wants to develop an investment portfolio.

Examples of an Investment Thesis

Portfolio managers and investment companies often post information about their investment theses on their websites. The following are just two examples.

Morgan Stanley

Morgan Stanley ( MS ) is one of the world's leading financial services firms. It offers investment management services, investment banking, securities, and wealth management services. According to the company, it has five steps that make up its investment process, including idea generation, quality assessment, valuation, risk management , and portfolio construction.

When it comes to developing its investment thesis, the company tries to answer three questions as part of its quality assessment step:

• "Is the company a disruptor or is it insulated from disruptive change? 
• Does the company demonstrate financial strength with high returns on invested capital, high margins, strong cash conversion, low capital intensity and low leverage? 
• Are there environmental or social externalities not borne by the company, or governance and accounting risks that may alter the investment thesis?"

Connetic Ventures

Connetic Adventures is a venture capital firm that invests in early-stage companies. The company uses data to develop its investment thesis, which is made up of three pillars. According to its blog, there were three pillars or principles that contributed to Connetic's venture capital investment strategy. These included diversification, value, and follow-on—each of which comes with a pro and con.

Why Is an Investment Thesis Important?

An investment thesis is a written proposal or research-based analysis of why investors or companies should pursue an investment. In some cases, it may also serve as a historical guide as to whether the investment was a good move or not. Whatever the reason, an investment thesis allows investors to make better, more informed decisions about whether to put their money into a specific investment. This written document provides insight into what the investment is, the goals of the investment, any associated costs, the potential for returns, as well as any possible risks and losses that may result.

Who Should Have an Investment Thesis?

An investment thesis is important for anyone who wants to invest their money. Individual investors can use a thesis to decide whether to purchase stock in a particular company and what strategy they should use, whether it's a buy-and-hold strategy or one where they only have the stock for a short period of time. A company can craft its own investment thesis to help weigh out whether an acquisition or growth strategy is worthwhile.

How Do You Create an Investment Thesis?

It's important to put your investment thesis in writing. Seeing your proposal in print can help you make a better decision. When you're writing your investment thesis, be sure to be clear and concise. Make sure you do your research and include any facts and figures that can help you make your decision. Be sure to include your goals, the potential for upside, and any risks that you may come across. Try to ask and answer some key questions, including whether the investment meets your investment goals and what could go wrong if you go ahead with the deal.

It's always important to have a plan, especially when it comes to investing. After all, you are putting your money at risk. Having an investment thesis can help you make more informed decisions about whether a potential investment is worth your while. Make sure you put your thesis in writing and answer some key questions about your goals, costs, and potential outcomes. Having a concrete proposal in place can spell the difference between earning returns and losing all your money. And that's if your thesis supports the investment in the first place.

Harvard Business School. " Writing a Credible Investment Thesis ."

Lanturn. " What is an Investment Thesis and 3 Tips to Make One ."

Morgan Stanley. " Global Opportunity ."

Medium. " The Data That Built Our Fund's Investment Thesis ."

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The Impact Investor | ESG Investing Blog

Investing for financial return is only part of the equation.

How to Create an Investment Thesis [Step-By-Step Guide]

Updated on June 13, 2023

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One of the worst mistakes an investor can make is to sink their money into an investment without knowing why. While this may seem like the world’s most obvious mistake to avoid, it happens every day. Look no further than the stock market for plenty of examples of misguided optimism gone terribly wrong.

That’s where the idea of an investment thesis comes in. An investment thesis is a common tool used by venture capital investors and hedge funds as part of their investment strategy.

Most funds also use it on a regular basis to size up potential candidates during buy-side job interviews. But you don’t have to work at a venture capital fund or private equity firm to reap the benefits of creating an investment thesis of your own.

Table of Contents

What Is an Investment Thesis?

Materials needed to create a thesis for your investment strategy, a step-by-step guide to creating a solid investment thesis, step 1: start with the essentials, step 2: analyze the current market, step 3: analyze the company’s sector, step 4: analyze the company’s position within its sector, step 5: identify the catalyst, step 6: solidify your thesis with analysis, free tools to help strengthen your investment strategy.

An investment thesis is simply an argument for why you should make a specific investment. Whether it be a stock market investment or private equity, investment theses are all about creating a solid argument for why a certain acquisition is a good idea based on strategic planning and research.

While it takes a little more work upfront, a clear investment thesis can be a valuable tool for any investor. Not only does it ensure that you fully understand why you’re choosing to put your hard-earned money into certain stocks or other assets, but it can also help you develop a long-term plan.

Should an investment idea not go as planned, you can always go back to your investment thesis to see if it still holds the potential to work out. By considering all the information your thesis contains, you’ll have a much better idea of whether it’s best to cut your losses and sell, continue holding, or even add to your position.

An investment thesis includes everything you need to create a solid game plan, making it a foundational part of any stock pitch.

See Related : Best Socially Responsible Stocks To Invest In Today

One of the benefits of an investment thesis is that it can be as complex or as simple as you like. If you actually work at a venture capital firm , then you may want to develop a full-on venture capital investment thesis. But if you’re a retail investor just looking to solidify your investment strategy, then your thesis may be much more straightforward.

If you’re an individual investor, then all you really need to create an investment thesis is somewhere to write it out. Whether it be in a Google or Word doc or on a piece of paper, just make sure you have a place to record your thesis so that you can consult it down the line.

If you’re developing a venture capital investment thesis that you plan to present to an investment committee or potential employers, then there are plenty of great tools online that can help. Slideteam has thousands of templates that can help you create a killer investment thesis , as well as full-on stock pitch templates.

As mentioned earlier, an investment thesis holds the potential to help you plot out a strategy for pretty much any acquisition. But for the sake of simplicity, we’ll assume throughout the examples in the following steps that you’re an investor interested in going long on a stock that you plan to hold for at least a few months or years.

Venture capitalists looking to invest in companies or startups can also apply the same principles to other investment goals. Investors who are looking to short a certain stock should also be able to use these techniques to locate potential investments. The main difference, of course, is that you’ll be looking for bad news instead of good.

First things first. Before you get into doing the research that goes into an investment thesis or stock pitch, make sure you take the time to write out the basics. At the top of the page, include things like:

• The name of the company and its ticker symbol
• Today’s date
• How many shares of the company you already own, if any
• The current cost average for any shares you may already hold
• Whether the stock pays dividends and, if so, how often. You may also want to include the current ex-dividend and dividend payment dates.
• A brief summary of the company and what it does

See Related : How to Start Investing With Purpose

Now it’s time to take a look at the entire market and the direction it’s headed. Why? As Investors Business Daily points out,

“History shows 3 out of 4 stocks move in the same direction as the overall market, either up or down. So if you buy stocks when the market is trending higher, you have a 75% chance of being right. But if you buy when the market is trending lower, you have a 75% chance of being wrong.”

While the overall market direction is definitely an important factor to keep in mind, what you choose to do with this information will largely come down to your individual investing style. Investors Business Daily founder William O’Neil advised investors only to jump into the market when it was trending up.

Another approach, however, is known as contrarian investing, which revolves around going against market trends. Warren Buffett summed up the idea behind this strategy with his famous quote, “Be fearful when others are greedy, and greedy when others are fearful.” Or as Baron Rothschild more graphically put it, “Buy when there is blood in the streets, even if the blood is your own.”

Most investors who are looking for a faster return will likely be better off waiting to strike until the iron is hot. If you align more with the long-term contrarian philosophy, however, bleak macroeconomic outlooks may actually strike you as an ideal investment opportunity .

See Related: How to Invest in Private Equity: A Step-by-Step

Now that you’ve got a look at the overall market, it’s time to take a look at the sector your company fits into. The Global Industry Classification Standard (GICS) breaks down the entire market into 11 sectors. If you want to get even more specific, you can further break down companies into the GICS’s 24 industry groups, 69 industries, and 158 sub-industries.

Once you identify which group your company belongs to, you’ll then want to take a look at that sector’s performance. Fidelity provides a handy breakdown of the performance of various sectors over different time periods.

But why does it matter? Two reasons.

• Identifying which sectors various companies belong to can help you ensure that your portfolio is properly diversified
• The reason that sector ETFs tend to be so popular is that when a sector is trending, many of the stocks within that sector tend to move in unison. The reverse is also true. When a certain industry is lagging, the individual stock prices of the companies in that industry may be affected negatively. While this is not always the case, it’s a general rule of thumb to keep in mind.

The idea behind working sectors into your investment criteria is to give you an overview of what type of investment you’re about to make. If you’re a momentum trader, then you may want to shoot for companies within the strongest-performing sectors this year or even over the past few months.

If you’re a value investor, however, you may be more open to sectors that have historically experienced high growth, even if they are currently suffering due to the overall state of the economy. Some speculative investors may even be interested in an innovative industry with strong potential growth possibilities, even if its time has not yet come.

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If you want to up your odds of success even more, then you’ll want to compare the company you’re interested in against the performance of similar companies in the same industry.

These are the companies that tend to get the most attention from large, institutional investors who are in a position to significantly increase their market value. Institutional investors tend to have a huge amount of money in play and are far less likely to invest in a company without a proven track record.

When choosing an investment, they’ll almost always go with a global leader over a new business, regardless of its promise. However, they also consider intrinsic value, which considers how much a company’s stock is selling for now, as opposed to how much revenue the company stands to earn in the future. In other words, institutional investors are looking for companies that are stable enough to avoid surprises but that also stand to generate considerable capital in the future.

Why work this into your game plan? Because even if you don’t have millions of dollars to invest in a company, there may be hedge funds or venture capital firms out there that do. When these guys make an investment, it tends to be a big one that can actually move a company’s share price upward. Why not ride their coattails and enjoy a solid growth rate as they invest more money over time into proven winners?

That’s why it’s important to make sure that you see how a company stacks up against its closest competitors. If it’s an industry-leading business with a large market share, it’s likely to be a strong contender with solid fundamentals. If not, you may end up discovering competing companies that make sense to consider instead.

See Related : What is a Triple Bottom Line? Definition & Examples

At this point, hopefully, you’ve identified the best stock in the best sector based on your ideal investing style. Now it’s time to find out exactly why it deserves to become a part of your portfolio and for how long.

If a company has been experiencing impressive growth, then there’s bound to be a reason why.

• Is the company experiencing a major influx of business because it’s currently a leader in the hottest sector of the moment? Or is it a “good house in a bad neighborhood” that’s moving independently of the other stocks in its industry?
• How long has it been demonstrating growth?
• What appears to be the catalyst behind its movement? Does the stock owe its growth to strong management, recent world events, the approval of a new drug, the introduction of a hot new product, etc?

One mistake that far too many beginning investors make is assuming that short-term growth alone always indicates the potential for long-term profit. Unfortunately, this is not always the case. By figuring out exactly why a stock is moving, you’ll be far better positioned to decide how long to hold it before you sell.

A strong catalyst can cause the price of a stock to skyrocket overnight, even if it’s laid dormant for years. Even things like social media hype and rumors can cause a stock’s price to shoot up over the course of a given day. But woe to the investor that assumes these profits will last. Many are often left holding the bag when the price increase turns out to be part of a “ pump and dump .”

While many day traders can make a nice profit by capitalizing on these situations, such trades are best avoided altogether if you plan to hold a stock long-term. That’s why it’s so important to understand whether a stock is “in play” for the day or whether its growth can be attributed to more permanent factors that support the potential for a high return over time.

See Related : How to Become an Impact Investor [Step-By-Step Guide]

If you’re planning on investing a significant amount of capital in any stock, then a little research may be able to save you from a lot of heartache. Keep in mind that the focus of an investment thesis is to formulate a reasoned argument about why adding an asset to your portfolio is a good idea.

While all investments come with some level of risk, research can be an excellent risk mitigation strategy. There’s nothing worse than watching an investment fail due to an obvious factor you could have spotted with closer analysis. Don’t let it happen to you!

Fundamental analysis can help you ensure that your potential investments have the underlying traits that winning stocks are made of. While there’s a bit of a learning curve involved when you’re first starting out, here are some of the things you’ll want to focus on:

EPS stands for “earnings per share.” It’s a common financial indicator that basically tells you how much a company makes each time it sells a share of its stock. In this regard, a higher EPS is a good thing, but it’s important to look for solid EPS growth over time. Ideally, you’ll want to see consistent growth in a company’s EPS over the past three or more quarters.

Sales and Margins

Investing is all about putting your cash into successful companies, which is why sales and margins are key components to finding worthy investments. Sales indicate how much a business has made from (you guessed it) sales. Sales margin, also known as gross profit margin, is the amount of revenue a company actually gets to keep after you factor in overhead and other production costs. Ideally, a good investment will exhibit strong, consistent sales growth in recent years.

Return On Equity (ROE)

ROE is one of the more commonly used valuation metrics and is calculated by dividing the company’s net income/shareholders’ equity. ROE is basically a measure of how efficiently a company is using the capital it generates from equity fundraising to increase its own value. The higher the ROE, the more likely it is that a company operates with a focus on using its cash flow to increase its profits.

See Related : How to Do a Stakeholder Impact Analysis?

While these are just a few examples of various analysis methods to work into your investment thesis, they can go a long way toward locating solid companies worth investing in. Interested in learning more about technical and fundamental analysis? There are now plenty of great sites that can help you master the secrets of the training world.

In our opinion, Tradimo is one of the most underrated, as it provides tons of free classes for investors of all levels. Udemy also has some great classes that can help you learn how to beef up your investment thesis with as much quality information as possible.

But keep in mind that these are only suggestions. The most important part of any personal investment thesis is that it makes sense to you and can serve as a valuable tool to help you along your investing journey.

Related Resources

• Best Impact Investing Online Courses
• Best Green Apps for a More Sustainable Life
• Sustainable Investing vs Impact Investing: What’s the Difference?

Kyle Kroeger, esteemed Purdue University alum and accomplished finance professional, brings a decade of invaluable experience from diverse finance roles in both small and large firms. An astute investor himself, Kyle adeptly navigates the spheres of corporate and client-side finance, always guiding with a principal investor’s sharp acumen.

Hailing from a lineage of industrious Midwestern entrepreneurs and creatives, his business instincts are deeply ingrained. This background fuels his entrepreneurial spirit and underpins his commitment to responsible investment. As the Founder and Owner of The Impact Investor, Kyle fervently advocates for increased awareness of ethically invested funds, empowering individuals to make judicious investment decisions.

Striving to marry financial prudence with positive societal impact, Kyle imparts practical strategies for saving and investing, underlined by a robust ethos of conscientious capitalism. His ambition transcends personal gain, aiming instead to spark transformative global change through the power of responsible investment.

When not immersed in the world of finance, he’s continually captivated by the cultural richness of new cities, relishing the opportunity to learn from diverse societies. This passion for travel is eloquently documented on his site, ViaTravelers.com, where you can delve into his unique experiences via his author profile.

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How to Write an Investment Thesis

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NASDAQ: DUOL

Plus, a look at "one of the most obvious long-term trends out there" and more.

In this podcast, Motley Fool analyst Jason Moser discusses:

• Recognizing short-term catalysts.
• Why home improvement is "one of the most obvious long-term trends out there."
• Travel and return-to-work are two trends worth watching.

Then, using language-learning app Duolingo ( DUOL 0.41% ) as an example, Motley Fool analyst Alicia Alfiere shares key questions to ask when writing an investment thesis, including:

• What are its competitive advantages?
• Who's running the company?
• Will broader trends help or hurt?
• Stocks discussed: BKNG ( BKNG -0.43% ) , HD ( HD 0.55% ) , LOW ( LOW 0.45% ) ,  MSFT ( MSFT -0.61% ) , and DUOL.

To catch full episodes of all The Motley Fool's free podcasts, check out our  podcast center . To get started investing, check out our  quick-start guide to investing in stocks . A full transcript follows the video.

10 stocks we like better than Duolingo, Inc. When our award-winning analyst team has a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor , has tripled the market.*

They just revealed what they believe are the ten best stocks for investors to buy right now… and Duolingo, Inc. wasn't one of them! That's right -- they think these 10 stocks are even better buys.

See the 10 stocks

*Stock Advisor returns as of March 3, 2022

This video was recorded on March 7, 2022.

Chris Hill: Tell the DJ to queue up ZZ Top because we're talking about investing trends with legs. Motley Fool Money starts now. I'm Chris Hill joined by Motley Fool senior analyst Jason Moser. Thanks for being here.

Jason Moser: Hey, thanks for having me.

Chris Hill: Everybody loves a good trend, right?

Jason Moser: Sure.

Chris Hill: We're investors, we love a good trend. Lately, I don't know if you've noticed as the market has continued its grim slide of 2022, that doesn't stop potential trends from emerging here or there. I wanted to talk with you about how to figure out which trends have legs and which ones don't. I'll just start with an example of one that I think for me anyway, doesn't really have legs, and it goes under the umbrella of because of reasons, this industry has sold off tremendously. Therefore, it presents an opportunity for investors because it's trading below where it should be. The one that leaves to mind for me that's come up several times over the past two plus years is the Cruise Industry, and that may be a good short-term opportunity for some people. I'm not interested in that.

Because it's not an industry that I think has great long-term tailwinds behind it, I don't mean to pick on the Cruise Industry, but you know what I'm talking about. There are some trends that get a lot of attention, but it's for short-term reasons.

Jason Moser: Yeah, I'm glad you said short-term reasons because I agree with what you're saying. I think the way I typically try to break this down in my own mind, and I've talked before about the way that I invest. As a long-term investor, someone who typically like to be a net buyer of stocks, I'd like to buy, I don't really like selling. Typically I am looking for companies that I feel they're going to be relevant for decades. Figuring out and following the long-term trend in differentiating that between what I would call a short-term catalyst, and so I think that the Cruise example there is a good example of something where there's a short-term catalyst. Before 2020, I don't know that Cruise ships were really a place where I was interested in investing, it sounds you feel the same way. It's just not an industry that you're all that interested in. I think that's how I start to at least look at this, because you could look at the Cruise liners for example, and say, "well, I'm not all that interested." But by the same token, it does feel there's a short-term catalysts in place that could result in value for shareholders if things continue to improve. The travel industry in general has been shellacked, but things are starting to come back.

There were a lot of questions early on in 2020 as to whether these major Cruise liners would even survive. They did a good job, I think of figuring out ways to survive and keeping their balance sheets in working order there, but I think for me, you see the benefit of a reopen and then say, alright, Cruise liners could benefit from that, the stock's been may start to reflect that optimism. But beyond that short-term catalyst, is there something there? Do you see more people clamoring to go on cruises as the years go by? I'm not convinced that's the case. I think it's a relevant industry. I think there are people who love to take cruises, but I think there are also a lot of risks that come with something like that. For me, it's trying to think about what direction the world is headed and I'll be honest with you, I'm sure you probably can relate to this as a parent. I looked at my kids, I have two daughters, they're are at sophomore junior and high school. I looked at them and their friends and what they're doing, what they're watching, the apps that they're using, ways that they're conducting their business, that to me starts to tell a little bit more about consumer behavior, trends that may be forming, things that matter to younger generations that will continue to matter even as they get older. I typically try to break it down between looking at a long-term trend versus a short-term catalysts in figuring out ways to discern between the two.

Chris Hill: If you think back to last year in the late spring, one of the big trends getting a lot of attention was what was referred to as the great reopening.

Jason Moser: Yeah.

Chris Hill: It seems we're at that point again, as Omicron levels continue to drop, vaccines continue to rise, more and more businesses, we talked about this last Friday on Motley Fool Money about some of the biggest tech companies in America opening up their offices, mask mandates coming down. You were talking to the folks at Cheddar, and I'm happy to share Jason Moser as a resource our with media outlets. [laughs] You're welcome Cheddar. But seriously, you were talking to them about this trend, weren't you?

Jason Moser: Yeah, we were talking about reopening, and to me it feels like reopening 2.0. We did go through a reopening before, where I think a lot of us are starting to get back out there and resuming somewhat normal behavior. This is the next iteration of that, where I think the wall start to come down and even more people start to go out and really get their lives back to normal. We were talking about ideas, investments, companies that will benefit from this next phase of reopening, and then what future they may have even beyond that, because I would look at reopening as definitely a short-term catalyst. This is not something where the long-term trend is for our economy to reopen, and so for me that doesn't mean that there aren't great ideas out there, that doesn't mean there's no money to be made, but by the same token, and I think, we said this a lot when we were talking about the stay at home stock, theme that we were delving into a couple of years ago. 

You want to make sure that regardless, these are businesses that you feel will continue to do well even beyond the short-term catalysts. Because this short-term catalyst will end, and then you want to make sure that you're not left holding the bag with the business that maybe isn't going to continue to benefit beyond just that catalyst. For me, there are a lot of different ways you can look at the companies that will benefit from this. I mean, you're talking about incremental traffic in all places, people going back to work, office buildings getting busier, the areas around the office buildings getting busier, malls getting busier, so what companies can you expect a benefit there? To me, there are a lot of different ways you can look at it. I think travel is one that stands out immediately just because so many people are ready-to-go do something. We saw some of the snap-back in travel earlier through the course of this last couple of years, but it does look things continue to get even better. 

I was looking through Booking Holdings, for example their most recent earnings call, they were talking about the fact that they are seeing the trends continuing to move in the right direction. They said the first half of February they saw meaningful improvement across all of their regions compared to January, but then they made this reference to gross bookings. They said gross bookings for the summer are higher than they were at this time in 2019, so that's encouraging for a number of different reasons and it sounds a lot of people are planning trips. I know that we are both planning to get a trip and I'm going to be going a few places here over the summer as well looking forward to that. But when you think about just the fact that gross bookings for the summer are higher than they were at this time in 2019, that's really encouraging. The nice thing about travel is it's truly a global opportunity. I think travel is going to continue to be a long-term trend that investors can benefit from, so Booking Holdings stands out as one way to look at this reopen 2.0.

Chris Hill: It is interesting. The difference, as you said, the long-term trend versus the short-term catalysts, because ultimately there has to be something sustainable. There has to be something about an underlying business that we as investors can see a pathway for growth. Which, and this may be just my preference, I always prefer organic growth as opposed to growth through acquisition. It's not to say that that doesn't work, there are plenty of businesses that have rewarded shareholders by going the route of acquisition. But to me, it's just preferable to see a business like I've talked before about Home Depot and Lowe's, and not that they do a tremendous amount of increasing their store count year-over-year, but you look at the way that they've grown out their online presence, their deliveries, that sort of thing, that's just easier for me to wrap my head around.

Jason Moser: Well, yeah. I think Home Depot and Lowe's, two very good examples of businesses that I think could certainly benefit here over the next several months as consumer traffic continues to pick up. We've seen the strength in the housing market over the past couple of years, and the neat thing about housing is whether you own or you rent, home improvement maintenance, all that stuff is always on the table. That's to me one of the most obvious long-term trends out there, because everybody needs a roof over their head. You look at Home Depot and Lowe's, the quarters that they just chalked up, to be able to maintain their gross margins in a time like this when inflation really is front and center, Lowe's actually expanded their gross margin very modestly. Home Depot, a little bit of pressure, but overall they've really been able to maintain prices very well and passes these costs along to consumers.

I think part of that is just due to the nature of the market that it serves, it's a necessary market. Then they love to throw the statistics out there, 50 percent of the homes here in the US are over 40 years old. A lot has changed in 40 years. The ways that we build houses, the ways that we've repair our homes and update and improve our homes. What that ultimately means is you get this massive installed housing base out there just in this country alone, that really requires a lot of what Home Depot and Lowe's are selling. They may not be the sexiest names in the world, and they may not like the world on fire in the near-term, but when you stretch the chart out, if you look at the way these companies performed through the years, 3, 5, 10 years, they are just tremendous performers. Lowe's in particularly, you look at what Marvin Ellison has done there, that has been just nothing short of spectacular. I think what we've got now is really two businesses there in Lowe's and Home Depot that you and I have likened before to MasterCard and Visa . It's almost like a which one should I pick? Why bother choosing? You could actually own both and get away with it just fine. It's not a bad idea, actually.

Chris Hill: Not a bad idea at all. Last thing and then I'll let you go. When you think about long-term trends, I suppose there are a couple of different ways you can think about them. One is to try and predict where the future is going and be right, not only about the direction, but the timing of how soon we're going to get there. I was on David Gardner's Rule Breaker investing podcast recently and on an episode that were set in the year 2052 and one of the jokes we made on that was that self-driving cars, still not a thing [laughs] and it may not be by the way. That's one way to do it, like OK, this is where the world is going. But another way to do it is to look at trends right now and say, OK, do I think this is going to be here in 20 years? You can say that about individual products, you can also say that about industries. It's why whenever someone has a new baby and he's like, I want to buy a stock for them. My answer is always Starbucks. Because I know that the way we drink coffee in 50 years is going to look a whole lot like the way we drink it now.

Jason Moser: [laughs] If it looks any different, Starbucks is probably going to be one of the companies that is innovating and iterating there. So you probably win either way. Yeah, I think to me, one of the trends that I think it's front and center right now for a lot of people is work, exactly how we're going to be working. We're talking about stay at home, now we're talking about reopen. It's been a weird two years. There're offices that never closed down and then there are other offices that just have closed down completely and you wonder what exactly the future holds. I look to a business like Microsoft, for example, and I think it's very telling that you've got a lot of these big tech companies that are reopening their offices. They're eager and excited to do that, and I think that's for a number of reasons. I think that you've seen some of the CEOs of these businesses, Twitter for example, they're talking about the fact that, yes, remote work is available, but it is harder. It makes things a lot more difficult. I'm sure probably you run into some challenges where remote work does make things harder. 

But by the same token, there are a lot of folks that like that, convenience in being able to go do what they want to do when they want to go do it, it certainly expands that work schedule. For me, I look at the absolutes as being probably what you want to avoid. If you're saying, well, we're just going to be a virtual-only company, you're probably leaving something on the table there. But if you say that, well, everybody has to be at the office all the time, well, you're leaving some talent out there that you might not be able to get otherwise. To me, the hybrid work environment, that's what seems like the future holds. You look at a company like Microsoft , a company that's responsible for getting so many of those tools that we've been able to use, whether you're Slack or Zoom or Microsoft Teams, Microsoft Teams and all of the tools that Microsoft provides, they help enable what ultimately I think we're going to see is the hybrid work environment where a lot of folks have the opportunity to do it however they want to do it, but companies still have a process and a philosophy in place that leaves everybody feeling included. I think that's probably one of the bigger challenges. I think that's going to be one of the things that companies will figure out as time goes on, is managing the remote and the physically present workforce together. Not saying that's an easy thing to do, but I think that's going to be something that companies are going to have to do. Because to me, again, it feels like you've take it to the extreme, if you go absolutes one way or the other, that to me seems to open up more challenges of opportunities the longer you play that out.

Chris Hill: Jason Moser, thanks for being here.

Jason Moser: Thank you.

Chris Hill: Remember back in high school when your English teacher taught you how to write a thesis statements, it's the main idea of your essay and you are not going to get an A without a strong thesis statement. It turns out that's one of those skills that comes in handy for investors like you and me. Here to talk through the nuts-and-bolts of an investment thesis is Motley Fool Senior Analyst, Alicia Alfiere. Thanks for being here.

Alicia Alfiere: Thanks for having me.

Chris Hill: Before we get into some of the key questions that can go into an investment thesis. Why do you think an exercise like this is helpful for us as investors?

Alicia Alfiere: First, when we think of an investment thesis, it's really a summary of what you think of the company and why you think it makes a good investment case, as well as some of the risks. It's really important, particularly now when we are seeing a lot of market volatility. The idea here is that I will help you cut through all the noise of that market volatility and focused on signals for your company and hopefully stop you from selling a company that's actually pretty good.

Chris Hill: I know that you've been using Duolingo, let's use that as an example here, and some of the key questions that people can ask when they are looking to build an investment thesis for any business, for any stock and it starts with really knowing the company.

Alicia Alfiere: This one sounds like a no-brainer, but there are actually companies out there that require a little bit extra time and research to be able to answer questions like, what does this company sell? Do? What problem are they solving? Who are their customers? How do they make money? That's really fundamental to understand. If we use Duolingo as an example here, Duolingo is a global mobile learning platform with the mission to develop the best educational content in the world and make it universally available. They offer a gamified approach to learning over 40 languages and they offer a lot of different solutions here. They have their flagship Duolingo Learning Language App, which is free. They have Duolingo Plus, which is a subscription. Duolingo English Test, which is a proficiency exam, and Duolingo for Schools. Essentially the problem that they're solving here, is making education accessible to the mobile generation and their lessons are pretty effective. According to their internal study, users with five Duolingo units were as proficient in reading and listening as students with four college semesters of language classes. Then in terms of how do they make money, again really important to understand. They make most of their money from their subscription products. The rest comes from the Premium Apps, so those are based revenues and revenues from their English tax.

Chris Hill: Every business has competition, so obviously it is worth spending a minute or two when you're putting together an investment thesis thinking about competitive advantages that a business might have.

Alicia Alfiere: Look at the competition within the industry. Is there a product or service sticky? Does the business have network effects? When we talk about network effects, think of a platform like Facebook. Where you have this virtuous circle of data which makes your users use it more, which brings in more data, which allows you to get more insights, [laughs] which again makes that product even more valuable. In terms of Duolingo they are in a highly competitive industry. Lots of options to learn new languages, whether it's a virtual or in-person classes, other apps and websites and there is substitution items that you could use as well like translator apps. But what advantages does Duolingo have? They have a strong brand, they have had over 500 million downloads and their flagship app is the top grossing app in the education category on Google Play and the Apple App Store. This strong brand recognition really helps to drive organic growth for them. 

They also have strong network effects so 41.7 million monthly active users, which includes a US contingent that actually out numbers. Total US high school foreign language learners which a massive amount here. They have over a half billion exercises completed daily on the platform and as a result of that strong network, Duolingo beliefs, they have the largest collection of language learning data, and they feed this virtual cycle of their network by using their collection of data, to make learning experiences more efficient and differentiated for its users. In terms of platform stickiness, over 50 percent of daily active users have used the app for more than seven days in a row, and one million users have an active stretch of longer than 365 days. Pretty impressive there, but there are some tricky parts here for paid subscribers, it's a bit more complicated. About 40 percent of annual subscribers renew their subscriptions after a year or about nine percent of monthly subscribers renew their subscription after one year. They got some work to do here.

Chris Hill: At the Motley Fool, we're not just interested in the business, we're interested in the management as well. It's worth spending time figuring out, hey, who are the people running this business?

Alicia Alfiere: Absolutely. Take a look at who are the co-founders, who is leading the Company? Do they have a long-term vision? What's their culture like? Remember their employees are what make a vision come to life. If employees don't buy in, it's going to be really hard for a company to grow. For Duolingo, it was founded by Luis von Ahn and Severin Hacker, two engineers who met at Carnegie Mellon. Luis is the CEO and Director, Severin is the CTO and Director. They're both heavily involved in the company, which we really like. For Luis growing up in Guatemalan, he saw how access to education can truly transform lives and when he met his kindred spirit in Safran the two embarked are creating an accessible, effective, and intelligent learning solution. While they started with languages, their long-term goal is to have language learning be just one of the education solutions that they offer. They've already started along this path. They have their Literacy App, Duolingo ABC, which teaches children how to read and they're working on an app to teach elementary school math. For culture, I like to look at website like Glassdoor to see what employees think. Do they like working there? Are they dedicated to vision? On Glassdoor, 93 percent of employees would recommend Duolingo to a friend and 97 percent approve of the CEO, so pretty solid results here.

Chris Hill: We say all the time investing is about the future. At some point when you're putting together an investment thesis, you got to check a couple of boxes in terms of what does the future look like for this business?

Alicia Alfiere: Yes. Think about the future. What's the market opportunity for them? Can they grow? How can they grow? Are there any broader trends that can help or hurt the company in the future? For Duolingo, they're a player in a growing market, the mobile learning space. Preferences for convenience, an on-demand services have driven a lot of consumers toward mobile solutions. Whether it's shopping or learning, and COVID accelerated the usage for mobile learning. Though the growth will probably edge away from some of that COVID highs, it's still expected to grow. Global language learning spending both online and offline, reached 61 billion in 2019 and is projected to grow to 115 billion by 2025. Within this market, online learning is growing fast. From 12 billion in 2019 to 47 billion in 2025. Perhaps the convenience and flexibility of mobile learning, as well as smartphone adoption overall, is broadening the demand for that language learning products. Since Duolingo's annual revenues were about 161 Million in 2020, they're only about 1.3 percent of the current market for online language learning, which gives them a ton of room to grow. They have a plan to grow, which is really important. They think that they could grow by increasing the number of users, converting free users to those paid subscription users, increasing subscription stickiness, which we already talked about, and expanding their solutions, beyond that language learning.

Chris Hill: We want to be bullish when we're thinking [laughs] about stock that we're considering adding to our portfolio. But at some point you have to put on the bare hat and think about what are the risks to this business?

Alicia Alfiere: Because every investment has risks, that's the nature of the beast and if you can't find one, you need to research more. Be curious, play the part of the skeptic and ask, what could go wrong. This is especially important in times of market volatility. For Duolingo, we already talked about some of the issues that they have here. Operating in a highly competitive environment and subscription retention numbers that could be better. But there's also another issue we didn't talk about, and that's low switching costs. What that means that it doesn't really cost a lot of money and it's not a huge hassle for users to simply change apps, or take in person costs instead and so that is another risk.

Chris Hill: You've clearly put in some work on Duolingo, tell me how the story ends. Is this stock you're adding to your portfolio or is it on your watchlist for right now?

Alicia Alfiere: Well, right now it's more on my watchlist. At the end of this process, what I like to do is summarize and actually, hey, what would the investment thesis look like? In this case, I would say Duolingo has gamified approach to learning, which has helped the company build a strong brand and benefit from strong network effects in some platform stickiness. With these competitive advantages, strong tailwinds from online education trends, a large market to expand into, and a plan for expansion, Duolingo is an intriguing company by subscription retention statistics and those low switching costs give me a bit of a pause for right now. I'm going to continue to follow them and research them because I find this company fascinating and a really value leadership's vision and plans for the future.

Chris Hill: Do you've more information about putting together your own investment thesis in our show notes. So check those out when you get a chance. Alicia Alfiere, thanks so much for being here.

Chris Hill: That's all for today, I will be coming up tomorrow, three analysts share some of the biggest investing lessons that they've learned over the past 20 years. As always, people on the program may have interest in the stocks they talk about and the Motley Fool may have formal recommendations for or against. So don't buy or sell stocks based solely on what you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.

Alicia Alfiere owns Microsoft. Chris Hill owns Home Depot, Lowe's, Microsoft, Starbucks, and Visa. Jason Moser owns Booking Holdings, Mastercard, Starbucks, and Visa. The Motley Fool owns and recommends Booking Holdings, Home Depot, Mastercard, Microsoft, Starbucks, Twitter, and Visa. The Motley Fool recommends Lowe's and recommends the following options: short April 2022 $100 calls on Starbucks. The Motley Fool has a disclosure policy .

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Investment Thesis: What It Is, How To Write One & Examples

An investment thesis formulates the characteristics and criteria that define a potentially profitable investment. It outlines the reasons behind the investment decision, including various criteria, financial outcomes, and strategies to manage risks. Essentially, it serves as a detailed plan for investors.  

What is an Investment Thesis?

An investment thesis serves as a strategic blueprint for investors, guiding their decisions and actions by providing the rationale behind their investment choices. Typically crafted by financial analysts, portfolio managers, or investment professionals, the process begins with a thorough assessment of market potential. This involves scrutinizing trends, growth forecasts, and demand dynamics to identify opportunities. The investment thesis validates the significance of these opportunities by highlighting unmet needs or areas of dissatisfaction within the market.

Furthermore, it quantifies potential gains through meticulous financial scrutiny, including revenue forecasts and return on investment assessments. Beyond identifying opportunities, the investment thesis also plays a crucial role in managing risks by employing risk management tactics such as diversification and contingency plans, helping investors navigate market fluctuations and operational hurdles effectively.

Key Takeaways

• An investment thesis defines the criteria for profitable investments, providing a detailed plan and rationale for investors.
• An investment thesis serves as a guiding framework for investment decisions, enhancing comprehension and facilitating well-informed choices.
• Key components of an investment thesis include identifying the investment opportunity, clarifying goals, evaluating viability and risks, and assessing growth potential.

Understanding the Investment Thesis

An investment thesis is akin to a detailed plan for potential investments, often formulated by finance experts. It entails extensive research and analysis to articulate investment ideas effectively. While typically authored by professionals such as venture capitalists or private equity firms, individuals may also develop their own. This document holds significant importance in facilitating well-informed investment decisions, aiding both investors and companies in evaluating opportunities such as stocks or acquisitions.

By elucidating the reasons for investment, the thesis serves as a guiding framework for investors’ decisions. It streamlines decision-making processes, enhances comprehension of underlying rationales, and provides a means for investors to gauge the performance of their investments. Moreover, an investment thesis functions as a roadmap, charting the course toward successful investments.

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How to write an Investment Thesis

Crafting an investment thesis is essential for all investors, whether individuals or professionals. An investment thesis serves as a guide for making choices, explaining the reasoning behind decisions, and providing a framework for assessing investment opportunities. Here is a simple guide with the most important steps for crafting a good investment thesis:

Examples of an Investment Thesis

Portfolio managers and investment companies frequently share their investment strategies on their websites. Here are three examples from prominent investors:

Andreessen Horowitz

Andreessen Horowitz, often referred to as a16z, is a prominent venture capital firm established in 2009 by Marc Andreessen and Ben Horowitz. Active in the private markets, the firm invests in various sectors including AI, healthcare, consumer goods, cryptocurrency, enterprise solutions, fintech, and gaming.

Their investment strategy revolves around observing consumer trends and investing where AI intersects with consumer products. They stress the importance of developing the right AI applications to attract funding, particularly in areas like productivity enhancement and specialized tasks.

In this example, the firm explores how Moore’s Law contrasts with Eroom's Law in healthcare costs. They propose leveraging AI to cut costs and enhance outcomes by gradually integrating it into workflows. Combining AI with life sciences advancements offers transformative opportunities, advocating for a gradual transition to revolutionize healthcare and life sciences. [1]

Goldman Sachs

Goldman Sachs is a global financial powerhouse operating in major financial hubs worldwide, offering services in investment banking, IPO underwriting, securities trading, wealth, and asset management.

The bank’s investment thesis has resulted in a $1 billion investment in companies led by diverse individuals through the “Launch With GS” program aimed at supporting diverse leadership. [2] Goldman Sach collaborates with clients to invest in diverse General Partners across various strategies and offers the Entrepreneur Cohort for growth, reflecting their commitment to diversity and inclusion for achieving strong investment returns and driving industry innovation. [3]

ARK Invest provides  ETFs focused on disruptive innovation like AI and blockchain. The firm remains committed to long-term growth, leveraging innovative strategies and deep research across various sectors, including cryptocurrencies.

The Ark Invest thesis revolves around disruptive innovation, targeting transformative technologies nearing tipping points. They focus on five innovation platforms: AI, Robotics, Energy Storage, DNA Sequencing, and Blockchain. Ark Invest’s approach blends top-down and bottom-up research for early innovation capture and long-term value creation. Emphasizing high-conviction bets, long-term investment, and industry focus, Ark Invest anticipates exponential growth to benefit from technological disruptions. [4]

What should be in an investment thesis?

As an important document, an investment thesis explains why an investment opportunity is expected to be profitable. It should include key components to thoroughly analyze and guide decision-making effectively. These 7 pieces of information are indispensable:

• The Investment in Question: Identify the reason and the investment opportunity under consideration.
• Investment Goal(s): Clarify the investment's aims and aspirations by defining its objectives and goals.
• Viability of the Investment: Evaluate the investment's potential, considering any favorable trends or factors.
• Potential Downsides and Risks: Address and analyze the risks associated with the investment, highlighting any potential challenges or drawbacks.
• Costs and Potential Returns: Evaluate the financial aspects of the investment, including costs, expected returns, and potential losses.
• Alignment with Intended Goals: Ensure that the investment aligns with the overall investment objectives and strategies.
• Growth Potential: Assess the growth prospects of the investment opportunity.

What is the difference between investment thesis and investment mandate?

An investment thesis is the reasoning behind an investment strategy, based on research and analysis, helping investors make informed decisions. Conversely, an investment mandate is a set of instructions given by an investor to a manager, guiding how to manage funds according to the investor’s goals, risk tolerance, and desired outcomes. Here are the key differences:

What is a trade thesis?

A trading thesis is essentially an idea or argument made by a trader or investor about a particular financial instrument, market or asset. This process explains the reasoning behind a trading decision, considering things like market trends, economic indicators, and technical or fundamental analysis. This thesis acts as a plan for understanding the reasons behind a trade and what factors are likely to influence its outcome, aiding in making informed decisions in financial markets. Having a clear trading thesis helps traders and investors clarify their strategy and evaluate the possible risks and rewards of a trade.

Article Source

• Andreessen Horowitz: “ AI at the Intersection: The a16z Investment Thesis on AI in Bio + Health ”
• Goldman Sachs: “ Launch With GS ”
• Goldman Sachs: “ Goldman Sachs Research ”
• Ark Invest: “ Big Ideas 2022 ”  

Writing a Credible Investment Thesis

by David Harding and Sam Rovit

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." 10

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 percent 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 percent 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 percent of executives surveyed admitted they were unable to distinguish between the value levers of M&A deals. 11 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. 12 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.

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." 13

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. 15 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 percent 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.

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 percent 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 percent 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. 16

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." 17 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."

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.

[ Buy this book ]

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.

How To Make An Investment Thesis: Ultimate Guide To Best Investment Decision

An Introduction to Investment Thesis

An investment thesis forms the basis of an investor's strategy and serves as a framework to direct investment choices as well as articulate the reasoning behind targeting assets or markets. A robust investment thesis clearly outlines the factors that will drive returns while minimizing risks. Developing a thought-out investment thesis is crucial for achieving success in investments.

This guide will take you through the components of creating a compelling investment thesis from beginning to end. We will discuss how to identify promising investment opportunities, analyze target companies, perform valuation modeling, build a portfolio, present the fund's thesis to potential investors, implement the thesis in investment activities, and adapt it as market conditions evolve. By adhering to a disciplined investment thesis, investors can consistently make informed decisions and make choices to outperform the market.

Identifying Investment Opportunities

The initial step in developing an investment thesis involves pinpointing areas of focus that will shape your investment decisions. This entails determining sectors, asset classes, geographical regions, or other frameworks on which you wish to concentrate your research and analysis.

When determining the area you want to focus on, there are four key questions and factors to consider;

• Your expertise and knowledge - It is best to concentrate on areas where you have experience or can gain expertise without stretching yourself
• Macroeconomic trends - Look out for trends that can have an impact. These trends could include shifts, advancements, policy changes, and more. Identify sectors, regions, or asset classes that are likely to benefit from these long-term shifts
• Market inefficiencies - Keep an eye out for market inefficiencies. Opportunities often arise in markets that are fragmented, complex, or experiencing changes
• Investment horizons - Consider the investment horizon required for investment theses. Some ideas may require a time frame to materialize their potential returns while others may offer shorter-term gains

Once you have determined your area of focus, it is crucial to conduct in-depth research on the macro trends shaping that market. Look for trends that will drive growth over the years rather than focusing solely on quarterly fluctuations mentioned in market reports. The objective is to identify factors that can positively impact revenues, margins, and valuations of well-positioned companies.

With an understanding of the landscape established through research, you can then search for companies positioned to take advantage of the identified trends. Look for firms, with products/services/customers/geographical reach or innovative strategies that give them an edge when it comes to capitalizing on these opportunities.

Analyzing the Company

For an investment thesis, it is crucial to assess the company you are considering for investment. This assessment should include an evaluation of the company's drivers of growth, its management team and strategy as well as potential risks and challenges.

Growth Drivers

When analyzing the market value of a company, you'll want to closely examine the products, customers, and competitive positioning that are fueling its growth.

• Products: Look at the company's current product portfolio and pipeline. Do they have innovative products that are gaining market share? How large is their total addressable market and how much of it have they penetrated so far?
• Customers: Evaluate who their key customers are and how loyal they are. Look at metrics like net dollar retention rate to understand how loyal their customers are
• Competition: Analyze the competitive landscape and the company's positioning. Do they have a durable competitive advantage? How do they compare to rivals on factors like pricing, product features, and customer experience?
• Scalability: Do margins get larger or smaller as a customer increases its size? In some cases, unprofitable companies become highly profitable with growth - in other cases, costs increase in line with revenues. 

Management and Strategy

The strategy and execution capabilities of management are critical to a company's success.

• Management Team: Research the background and track record of key executives. Do they have relevant industry experience and a history of generating returns?
• Strategy: Assess management's strategic priorities and plans to drive growth. Do they have a coherent plan to expand their market opportunity?
• Culture & Incentives: Assess how they attract and retain talent. Are employees actively involved and motivated to excel?

Assessing the management will help ascertain whether the company has the leadership to seize the upcoming opportunity.

Risks and Challenges

When conducting an analysis it's important to consider factors;

• Technology Shifts: Take into account innovations that could affect the company's market.
• Regulation: Consider possible changes in regulations that may impact the business model and financial aspects.
• Macro Trends: Look at shifts in the wider economic environment that could influence customer demand.

Thoroughly examining the company across these dimensions provides the information and perspective to build confidence in your investment thesis. It helps you understand the business model, growth trajectory, management capabilities, risks involved, and valuation potential.

Conducting Valuation

Whilst a company's valuation is largely based purely on how much an investor or acquirer is willing to pay, there are a number of methodologies that help to guide valuations:

Choosing the Appropriate Valuation Method

DCF valuation is typically preferred when assessing situations where reliable projections can be made. However, for early-stage or volatile companies, it may be more appropriate to consider comparable multiples based on similar industry peers.

Making Projections and Assumptions

When making projections and assumptions it is essential to conduct research to establish credible forecasts.

Projections should encompass metrics such as revenue growth, margins, capital expenditure requirements, and working capital needs. Additionally, explicit assumptions should be made regarding elements like market size, market share, pricing strategies, and costs among others. Conducting sensitivity analysis can help stress test these assumptions.

Ensuring Upside to Current Valuation

Once you have determined the value of a company you can compare this value against its market capitalization. Look for the ultimate goal of valuation is to support your thesis that the company is undervalued. If the current market price exceeds your estimate of value it may be prudent to reassess your assumptions and analysis. The greater the upside potential identified within your analysis the stronger your conviction becomes in considering an investment opportunity.

Constructing Your Portfolio

When constructing your portfolio based on your investment thesis, you should diversify your holdings and size your positions appropriately based on conviction and risk tolerance.

Diversification

Your investment thesis should guide how you diversify your portfolio. For example, if your thesis focuses on emerging market consumer stocks, you would want exposure across multiple countries and consumer product categories. Diversifying appropriately helps manage overall portfolio risk. You want to avoid overexposure to any single company, sector, or country.

Position Sizing

When determining position sizes within your portfolio, larger positions should be allocated to your highest conviction ideas based on your investment thesis. However, position size should also be constrained based on your risk tolerance. Larger positions will drive portfolio performance but also increase volatility. 

Rebalancing

As market conditions change, rebalancing your portfolio involves  realigning holdings in line with your investment thesis. If certain positions have increased significantly in size, trimming them down and reallocating to underweight areas can improve diversification and risk-adjusted returns. Revisiting your thesis and rebalancing at regular intervals instills discipline in sticking to your core investment tenets.

Presenting to Investors

When presenting your investment thesis to investors it's crucial to communicate and address important information right from the start. Your objective is to explain your insights and build confidence in your ability to generate returns.

To begin - guide investors through your thesis, research process, and valuation methodology. Elaborate on the trends you've identified and analyze the company's growth drivers and competitive position. Share how you arrived at your valuation.

Next, emphasize your "edge”. The expertise, relationships, or analytical skills that give you an advantage in assessing this opportunity. Provide examples of investments you've made in the past by leveraging an edge to establish credibility

Lastly, demonstrate your risk management abilities by addressing challenges and risks. Outline the assumptions underlying your thesis and discuss scenarios where they may not hold true. Describe how you plan to monitor and mitigate risks related to regulations, supply chains, customer demand, or management execution. 

Implementing the Thesis

Once you have developed an investment thesis the next step is executing trades to construct a portfolio that aligns with your thesis. It is crucial to approach this process with strategic planning in order to achieve results.

When making investments it is important to allocate positions based on your level of confidence in each holding while also ensuring diversification. Generally speculative or higher risk assets should be given allocations that don’t jeopardize the portfolio as a whole.

Ongoing portfolio management necessitates actively monitoring performance against the expectations outlined in your investment thesis. By keeping track of metrics, business drivers, and macroeconomic factors you can gauge whether your thesis remains valid.

As new data emerges over time adjustments and rebalancing of your portfolio will likely be required. This involves reducing exposure to holdings where the original thesis has weakened or deteriorated while increasing exposure to emerging opportunities. 

Continuously refining your portfolio ensures that it remains closely aligned with your investment thesis as market conditions evolve. Successful investors remain adaptable. Adjust their allocations while keeping their long-term perspectives intact.

Updating the Investment Thesis

As time progresses it is crucial to revisit and update your investment thesis accordingly.

Markets are constantly changing and it is crucial to stay updated with information that emerges. Your initial assumptions may not always hold true which can lead to poor investment decisions if you stick to an investment thesis.

To ensure the relevance of your investment thesis periodically reassess all your assumptions and projections. Take a look at your growth estimates, address any emerging threats, and analyze how market sentiment has shifted. If there have been changes in the investment narrative it's essential to update your thesis

Incorporate insights from sources such as earnings reports, industry conferences, macroeconomic data, and more. I. Objectively evaluate if adjustments need to be made based on the information at hand.

The key here is flexibility; being able to adapt to information sets good investors apart from the average ones. 

Common Mistakes to Avoid When Developing an Investment Thesis

To ensure the success of your investment thesis it's important to steer clear of pitfalls. Here are a few common ones;

Lack of Diversification

Having an overconcentration in a sector, geography, or asset type can leave a portfolio vulnerable. For example, an investment thesis focused solely on fast-growing US tech companies could miss opportunities in emerging markets. 

Biased Assumptions

It's easy to fall into the trap of making projections that confirm your existing bias about a company's growth potential. Avoid exaggerated assumptions that are not grounded in facts, and remember that “hope” has historically been a bad investment strategy 

Ignoring New Information

Markets and companies are dynamic, so no investment thesis holds true forever. Do not blindly stick to your original assumptions if new data suggests your thesis is no longer valid. Be ready to change course if your investment case deteriorates. Failing to adapt can turn gains into losses.

To summarize this guide - here are the most important factors in an investment thesis ;

• Identifying economic trends and sector-specific opportunities to focus on when making investments.
• Conducting a thorough analysis of potential companies, for your portfolio including their products, customers, competitors, and management.
• Using valuation models such as discounted cash flow (DCF) analysis to determine a target value based on your projections.
• Creating a diverse portfolio by considering your confidence level and risk tolerance for each position.
• Clearly presenting your investment strategy and unique advantage to inspire confidence in investors.
• Consistently implementing your investment strategy when making buy or sell decisions.
• Monitoring your portfolio and assumptions, updating the thesis as needed based on new data.

Creating a thoughtful investment thesis takes rigorous research and ongoing discipline. However, it also establishes a framework to capitalize on the upside potential of emerging trends. Investors who take the time to develop a compelling thesis are more apt to outperform the market. With the right blend of macro perspective and individual security analysis, your investment thesis can unlock substantial value creation.

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How to Create an Investment Thesis

What it is, why you want one, and how to create it.

One of the essential elements in a venture capital firm is the investment thesis. The thesis can come in many varieties, from broad and loosely defined focuses to a specific vertical and company stage. On the other hand, some investors choose to allocate capital without a core thesis driving their decisions and see success in this strategy. This post will define an investment thesis, why investors decide to develop one, and some tips on creating one.

What is an investment thesis?

Simply put, the investment thesis is an assumption made about a market, vertical, or trend that will drive the strategy for a particular firm or fund. Just as a startup will assume a problem or market need and build a product around solving that problem, an investor will consider various markets and trends and develop an investment strategy focused on that assumption.

Why develop an investment thesis?

The thesis is the driving force behind what a firm chooses to focus on to generate returns. It will be a fundamental part of how VCs decide what to look for in specific markets, source deals, and where they ultimately decide to invest their capital. The thesis helps keep a firm focused, allowing investors to work within particular parameters when they go about their business.

There are a couple of advantages to having a thesis-driven approach as a venture capital firm. It will drive relationships that the firm pursues. This relationship driver applies to how firms source deals from an investment standpoint and choose their limited partners. These relationships with experts in a particular vertical will help portfolio companies with mentorship, independent board seats, and talent sourcing.

A thesis compels VCs to be experts within their particular field. If a firm bases its thesis around FinTech, it will most likely have some expertise in that field. This knowledge will help them understand the marketplace, specific problems a startup is trying to solve and judge founder talent. The firm will also be a thought leader in the space by releasing analysis and reporting trends in the industry. Lastly, the firm's partners will be a better value-add to the companies within their portfolio, paving a quicker path for a startup's growth and success.

Example of a thesis

A16Z , a prominent Silicon Valley firm, has several different areas they invest in, from FinTech to Growth to Consumer focused startups. Below is their investment thesis for their FinTech portfolio:

"Fintech companies are innovating across broad categories — in banking, lending, insurance, real estate, and investing — both on the customer-facing side and in core infrastructure. We believe the combination of mobile, digital money, machine learning, and new data sources offers startups a unique opportunity to leapfrog outdated infrastructure and compete with incumbent financial institutions to reimagine the way we manage our finances." Source

We understand that the firm focuses on startups that use mobile and machine learning to innovate on financial management through this statement. This thesis has helped drive the firm's investments in Stripe (now valued at $36B) and Carta (currently valued at $3.3B).

For an awesome hub of investment thesis examples, check out this link !

How to build an investment thesis

When developing a thesis, there are vital things to keep in mind:

Markets : Start with market sizing to make sure that a particular industry is worth pursuing. We will discuss market sizing strategies in a future post.

Trends: Understand macro trends impacting the markets and industries that you determine are big enough to pursue.

Companies : Break down each company within a market that has upside potential. Look at recent companies that have seen success within your specific industry focus.

Exits : Make sure there is an exciting exit environment for companies in that particular segment. You want your investments to see a return through going public or M&A activity.

Tips on the above:

Things to think about defining in a thesis would be company stage, geography, vertical, or market.

People tend to want a fully-formed thesis right off the bat, but it's an iterative process. The scrum process might be three months, but the full process can take a year before talking about a thesis publicly.

Have a hunch on something that isn't fully formed and then test it out:

Go out and talk to entrepreneurs.

Talk to buyers of the technology.

Form relationships with ecosystem partners.

Incrementally improve your thesis based on feedback and results.

For some more tips and strategies on creating a thesis, check out this informative Medium post .

Final thoughts

The thesis can help you stay focused and is your north star. For startups, it will help them target your firm. For LPs, it will help them judge your conviction and investment strategy. When developing a thesis, think about taking on big problems and big ideas. There are so many significant issues to be solved globally, and we have a golden opportunity to help solve them. Think big, and don't limit yourself only to ideas on making returns for investors, but how to impact the world.

This story is from Sutton Capital contributor Zeb Hastings. For more information on Zeb’s work, please visit his  website .

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How to Develop Your Own Investment Thesis: A Critical Step for Aspiring Venture Capitalists

s an aspiring venture capitalist, you hold the key to unlock the untapped potential of startups, propelling them to soaring heights and reshaping industries. But in this electrifying landscape of opportunities, how do you navigate through the ever-changing tides? The answer lies in the essence of venture capital success: developing your own investment thesis.

What exactly is an Investment Thesis?

An investment thesis is your North Star, an illuminating beacon that guides you through the vast ocean of startups, helping you navigate toward the brightest prospects. It's a strategic framework, meticulously crafted to align your investment approach, criteria, and aspirations.

With an investment thesis, you define the types of companies you want to invest in, the industries you're interested in, and the stages of startups you believe have the most potential. It's like setting your preferences and priorities before you begin the journey.

Why is an investment thesis so critical for aspiring venture capitalists? The answer is simple—this well-defined roadmap sets you apart from the crowd and gives you the edge to thrive in this fiercely competitive world. It empowers you to make informed decisions, uncover hidden gems in the startup ecosystem, and unlock the true potential of visionary entrepreneurs.

In this blog post, we will explore the essential steps to create a compelling and potent investment thesis

Getting Started With Your Investment Thesis: Conducting Market Research

At the core of any successful investment thesis lies comprehensive market research. Understanding industry trends, evaluating market opportunities, and assessing the competitive landscape are vital steps to identify lucrative investment prospects. 

Keep a finger on the pulse of the business landscape and stay attuned to shifts and disruptions. Analyze the forces shaping various sectors, from cutting-edge technologies and regulatory changes to changes in consumer behavior. Identifying and understanding these trends will enable you to anticipate the future landscape, positioning you as an astute investor who can spot opportunities before they materialize.

With a keen understanding of industry trends, venture capitalists must evaluate market opportunities with a discerning eye. Look beyond the surface and assess the long-term growth potential of markets and industries. Identify white spaces and areas where innovation is likely to flourish. Be mindful of macroeconomic factors, such as GDP growth, inflation rates, and demographic shifts, as they can profoundly influence market dynamics. A comprehensive evaluation of market opportunities will empower you to focus your investments on ventures that have the potential to become tomorrow's industry leaders.

In the vibrant world of startups, competition is the norm. As such, to excel as a venture capitalist, you must also gain a panoramic view of the competitive landscape. Analyze existing players and their strengths, weaknesses, opportunities, and threats (SWOT analysis). Identify startups that have the potential to disrupt established markets and challenge the status quo. Furthermore, seek out market gaps, where unmet needs and underserved customer segments await innovative solutions. Investing in startups that address these gaps can lead to remarkable returns on investment and foster a positive impact on society.

Market research is not a mere exercise of intuition and speculation; it thrives on data-driven insights. Leverage data analytics, market reports, and industry research to augment your understanding of market trends. Embrace technology and data tools that can provide you with a wealth of information at your fingertips. By making data-driven decisions, you'll foster a more robust investment thesis and bolster your credibility as a venture capitalist.

While conducting market research, it's crucial to remember that the startup ecosystem is dynamic and ever-changing. Be prepared to pivot and adapt your investment thesis in response to new information and shifts in the market. Stay agile and flexible, allowing your investment strategy to evolve as you gain deeper insights. Successful venture capitalists are those who can navigate uncertainty, staying attuned to emerging trends and swiftly adjusting their course to capitalize on unforeseen opportunities.

Defining The Investment Criteria for your Investment Thesis

Once you've gathered market insights, now it’s the fun part - it's time to define your investment criteria. Determine the stages of startups you want to invest in, such as seed, early-stage, or late-stage companies. Consider the industries you're passionate about or have domain expertise in. 

Additionally, establish your preferred investment size and the level of diversification you aim to achieve within your portfolio. Having clear investment criteria will streamline your decision-making process and keep your investments focused on your goals.

Determining the Stages of Startups

Venture capitalists invest in startups at various stages of their lifecycle, each offering distinct opportunities and risks. Deciding which stage aligns best with your expertise and risk appetite is pivotal. Consider if you want to invest in seed-stage companies, which are in their infancy and require significant support, or if you prefer early-stage startups with a product and initial traction. Alternatively, you may focus on later-stage companies that are scaling and need capital to expand rapidly. Your chosen stage will dictate your involvement level and the potential return horizon of your investments.

Geographical Preferences and Target Industries

Venture capital is a global endeavor, and you can choose to invest locally, regionally, or even globally. Geographical preferences may be influenced by factors like your network, knowledge of specific markets, and comfort with regulatory environments. Moreover, identifying the industries you're passionate about or have domain expertise in is crucial. Investing in industries you understand well will allow you to provide strategic value to the startups you support, beyond just financial backing.

Investment Size and Portfolio Diversification

The size of your investments and portfolio diversification strategy are interlinked. Determine the average investment size you are comfortable with, as this will influence the types of startups you can back. Some venture capitalists prefer larger, concentrated bets on a select few startups, while others spread their investments across a broader range of smaller companies to diversify risk. Striking the right balance is key—too few investments can expose you to concentrated risk, while too many might dilute your ability to provide adequate support to each startup.

Alignment with Personal Values and Objectives

As an aspiring venture capitalist, your investment criteria should be in harmony with your personal values and long-term objectives. Consider what impact you want to make through your investments. Are you driven by social impact, environmental sustainability, or a particular mission? Aligning your investment criteria with your values will not only enhance your satisfaction as an investor but may also attract entrepreneurs who share your passion, fostering a mutually rewarding relationship.

Market Fit and Growth Potential

While defining your investment criteria, focus on identifying startups that exhibit strong market fit and immense growth potential. Market fit refers to the startup's ability to address a specific problem or need in the market effectively. Investigate whether the startup's product or service resonates with its target audience and has the potential for widespread adoption. Moreover, evaluate the scalability of the business model, as this will determine the startup's growth trajectory and its potential to become a market leader.

Synergy with Your Expertise and Network

Leverage your expertise and network to your advantage when defining your investment criteria. Aligning with startups that can benefit from your insights and connections will create a symbiotic relationship. As an investor, you can offer more than just financial support; your guidance and connections can be invaluable in helping startups navigate challenges and scale their businesses. Synergy with your expertise and network can significantly enhance your value proposition as a venture capitalist.

Balancing Risk and Return

Investing in startups inherently involves risk, and your investment criteria should reflect your risk appetite and tolerance. Strive for a balance between risk and potential return that aligns with your investment objectives. High-growth startups often carry higher risk, but they can also offer substantial rewards.

On the other hand, more established companies may provide a steadier return, albeit with potentially lower growth potential. Understanding this balance is essential in defining your investment criteria and building a well-rounded portfolio.

Balancing risk and potential returns is a fine art, and your investment thesis should outline how you plan to approach this delicate balance. Furthermore, learn to measure and quantify risk in the startup ecosystem using various risk assessment techniques to make informed investment choices.

Identifying Key Performance Indicators (KPIs) for Your Investment Thesis

Key Performance Indicators are quantifiable metrics that provide critical insights into the performance and achievements of a business. By tracking relevant KPIs, venture capitalists can assess the overall health and direction of a startup, enabling them to support portfolio companies effectively. Moreover, KPIs offer a basis for comparison, allowing you to benchmark a startup's progress against its peers and industry standards.

Tailoring KPIs to Startup Stages and Industries

While KPIs share a common goal of tracking performance, their significance can vary significantly based on the stage and industry of a startup. For example, early-stage companies might prioritize metrics related to customer acquisition, retention, and product-market fit. In contrast, late-stage startups might focus on revenue growth, customer lifetime value, and profitability. Tailoring KPIs to suit the unique needs and challenges of each startup stage and industry is vital for meaningful performance assessment.

Selecting Actionable and Measurable Metrics

When identifying KPIs, seek metrics that are both actionable and measurable. Actionable KPIs provide clear guidance on how to improve performance, helping startups identify areas that need attention and enhancement. Measurable KPIs, on the other hand, are quantifiable, allowing you to track progress and changes over time. The ability to take action based on KPIs and measure their impact ensures a proactive approach to enhancing a startup's performance.

Common KPIs in Venture Capital

While KPIs can be highly specific to individual startups and industries, certain metrics have proven valuable across the venture capital landscape. Some common KPIs include:

Customer Acquisition Cost (CAC): The cost to acquire a new customer, helping evaluate marketing efficiency.

Monthly Recurring Revenue (MRR): Provides insight into the company's predictable revenue stream.

Customer Churn Rate: Measures customer retention and the ability to maintain long-term 

relationships.

Burn Rate: Tracks how quickly a startup is spending its capital, indicating runway and sustainability.

Gross and Net Profit Margins: Assessing revenue generation and cost efficiency.

Customer Lifetime Value (CLV): Estimates the value of a customer over their entire engagement with the startup.

The Power of Data-Driven Decision Making

KPIs are not merely numbers on a dashboard; they fuel data-driven decision-making. By continuously monitoring KPIs, you can identify strengths, weaknesses, and potential roadblocks. Data-driven insights enable you to provide tailored guidance and support to your portfolio companies, helping them navigate challenges and seize growth opportunities.

Building a Well-defined Due Diligence Process

A well-structured due diligence process empowers you to make informed decisions, mitigates risks, and will help you identify the startups that align best with your investment thesis!

Let's delve deeper into the key steps involved in building an effective due diligence process so you can include it on your Investment Thesis:

1. Defining Your Due Diligence Objectives

Start by clarifying your objectives for the due diligence process. What key aspects do you want to evaluate in potential startups? Identify the critical areas of focus, such as market opportunity, team capabilities, competitive landscape, financials, and scalability. Setting clear objectives ensures that you leave no stone unturned while assessing potential investments.

2. Gathering Essential Information

Begin the process by collecting comprehensive data and information about the startup under consideration. Request financial statements, market research, business plans, and any other relevant documentation. Engage in one-on-one discussions with the startup's founders and management team to gain insights into their vision, strategy, and execution plans. Gathering essential information lays the groundwork for a detailed evaluation.

3. Market Analysis

Conduct a thorough market analysis to assess the startup's positioning within its industry. Analyze market trends, potential for growth, competitive landscape, and potential threats. Understanding the market dynamics helps you gauge the startup's competitive advantage and potential for success.

4. Team Evaluation

Evaluate the startup's team to understand their expertise, experience, and alignment with the company's vision. Assess the cohesiveness and complementarity of the team, as a strong and capable team is a significant factor in a startup's success.

5. Financial Due Diligence

Perform rigorous financial due diligence to examine the startup's financial health and viability. Analyze revenue streams, cost structures, cash flow, and projections. Scrutinize financial ratios and indicators to assess the startup's financial sustainability and growth potential.

6. Product and Technology Assessment

Evaluate the startup's product or technology to gauge its uniqueness and potential market fit. Understand the value proposition it offers to customers and how it addresses market needs. Assess the scalability and defensibility of the product or technology to ensure long-term competitiveness.

7. Legal and Regulatory Review

Conduct a legal and regulatory review to identify any potential legal risks or compliance issues. Scrutinize contracts, licenses, intellectual property rights, and any pending legal disputes. Ensuring the startup operates within legal bounds safeguards your investment from unnecessary risks.

8. Customer and Partner Feedback

Gather feedback from customers, partners, and industry experts to gain external perspectives on the startup's product or service. Their insights can validate the startup's market fit, customer satisfaction, and potential for growth.

9. Risk Analysis

Identify and assess potential risks associated with the investment. Consider market risks, operational risks, technological risks, and competitive risks. A thorough risk analysis helps you make informed decisions about risk-reward trade-offs.

10. Decision-Making and Post-Investment Monitoring

Based on the findings from the due diligence process, make data-driven decisions on whether to invest in the startup. If you decide to proceed, establish a monitoring plan to track the startup's progress and performance after the investment. Continuously monitor the startup's performance against the initially defined objectives and pivot if needed.

Refining Your Thesis and Iterating

It’s also important to keep in mind that an investment thesis should not be static; it should evolve with your experiences and the changing market dynamics. Embrace flexibility and adaptability, and be open to learning from both successful and unsuccessful investments. As you gain insights from your portfolio companies and the market, update and refine your investment thesis to enhance its effectiveness continually!

Developing your own investment thesis is a critical step for aspiring venture capitalists. It provides you with a structured approach to identify and seize opportunities in the dynamic startup ecosystem. 

Through comprehensive market research, clear investment criteria, risk assessment, and an adaptable approach, your investment thesis will act as a guiding force throughout your venture capital journey. Embrace the continuous learning process, and don't hesitate to iterate and refine your thesis as you gain experience in the thrilling world of venture capital.

Interested in the full research paper?

You might also like, six top reason's why junior vcs quit their job, surviving the startup gauntlet: lessons in failure and success, 18 questions every vc should ask a founder during an introductory call, supporting founders, shaping industries: worklife ventures' strategic investments, 90 essential venture capital terms: a comprehensive glossary, the expanding role of venture capital: beyond funding to ecosystem building, about goingvc.

GoingVC is built around the idea of making venture capital education, investing, networks, and talent more accessible to those with the desire to succeed.

An Investment Thesis: The Key To Making More Money Long Term

In general, the longer you stay invested, the greater your chance of making money. To help you maintain a long-term investment approach, it's imperative to develop an investment thesis.

Drawing from my experience in investing since 1995, it's sometimes easy to get shaken out of a particular investment. Or it’s easier for some people to just keep their money sitting in cash out of fear of financial loss. I get it. I’ve lost plenty of money before because there are no guarantees when you take risk.

I observed panic selling during the 2000 dot bomb and 2008 global financial crisis, affecting both stock and real estate sellers. More recently, I witnessed panic selling at the beginning of the global pandemic in 2020. The events lead me to try and allay fears with the post, “ How to Predict the Stock Market Bottom like Nostradamus .”

Having a solid investment thesis, as long as it remains intact, will provide you with the courage and confidence to hold on for the long term.

The Importance Of Developing An Investment Thesis When Investing

Let me go through some examples of how having an investment thesis has helped me hold long-term and make more money overtime. Coming up with an investment thesis also helped me make a significant decision on a recent dilemma. At the end of this post, I'll also share what makes a good investment thesis.

If you are just starting out and are fearful of investing your hard-earned money, developing an investment thesis will help you take action. To beat inflation , you must continuously invest over the long term. If you don’t overcome your fear of investing, then you will likely fall way behind over time.

Please know that you don't have to be a great investor to make money. You just need to be a good-enough investor to significantly outperform a large part of the population that does not save and invest aggressively.

1) Heartland Real Estate Investment Thesis

In 2016, I published my post titled “ Focus on Trends: Why I'm Investing in the Heartland of America .” My investment thesis was based on the anticipation that more people would relocate to lower-cost areas of the country due to advancements in technology and the increasing ability to work from home. Additionally, I believed that Trump's victory would contribute to increased interest, funding, and expansion in red states.

Given the uncertainty of which specific real estate investment deal to pursue, I opted to invest in a couple of funds that focused on acquiring real estate in the heartland of America. Now, eight years and $954,000 later, I have generally witnessed positive returns on my investments. Texas properties, in particular, have performed quite well since 2016. However, as I shared in my post on private real estate investing after eight years , there have also been some duds as well.

Investing for such an extended period has been relatively straightforward. In the realm of private funds , the expected distributions typically span between 5-10 years.

Based on my investment thesis of a demographic shift to the heartland, I logically looked for real estate investment firms that had the same investment thesis. And I found one in 2016 in Fundrise. Fundrise predominantly invests in the Sunbelt region where valuations tend to be lower and rental yields tend to be higher.

2) San Francisco Real Estate Investment Thesis

When I arrived in San Francisco in 2001, I was amazed by the affordability of real estate compared to New York City. Properties were priced 20 to 30% lower, offering more space for the same cost or a similar property for less.

At that time, compensation in the finance industry was comparable between the two cities at my level. My investment thesis was that prices in SF would catch up to prices in Manhattan due to a better quality of life and the growth of technology.

Didn’t Want To Miss Out On The Tech Boom

My firm played a role in taking Facebook and Google public in the early 2000s. As a result, I anticipated a resurgence in Web 2.0. Lacking the skills or connections to enter the tech industry, I opted to invest in tech stocks and acquire rental properties instead.

Overall, San Francisco property prices have shown positive performance. The excitement of living in a big city attracts billions of people. However, the city's reputation suffered post-pandemic due to hesitancy by officials to address criminal activities and remove drug dealers downtown.

Thankfully, to stay in power, politicians must address corruption, tackle crime, clean up the city, and provide tax incentives for businesses to thrive. Citizens discontented with criminal activities are likely to vote out ideological politicians and judges who harm the community. Consequently, there is potential for the city's image to be restored post 2024 election, leading to a recovery in real estate prices.

Deja Vu With Artificial Intelligence

Since 2023 there has been an extraordinary surge in tech stock prices. Fueled by substantial bonuses and robust portfolios, I anticipate that a portion of this wealth will flow back into San Francisco Bay Area real estate. Redfin reports that luxury home prices are reaching all-time highs , attracting a significant number of all-cash buyers .

The rise of artificial intelligence (AI) is evoking a sense of déjà vu, reminiscent of 25 years ago when the internet promised to revolutionize the world. Today, it is equally apparent that AI will shape the world in the next two decades.

Despite the likelihood that most of us won't secure lucrative AI jobs due to intense competition, there's an opportunity for ordinary individuals to invest in AI companies. Beyond public companies like Nvidia, Microsoft, Google, and Facebook, private investments can be made through open-ended venture capital funds like the one offered by Fundrise.

Fundrise launched its venture capital product at the end of 2022, which was great timing given private company valuations had corrected. The investment minimum is only $10, so everybody can participate. You can see the holdings, and the fees are much lower than closed-end venture capital funds.

I am personally adopting this approach by investing in both public and private AI-related companies. My goal is to allocate $500,000 to these companies over the next five years. This strategy not only positions me for potential gains but also serves as a hedge against the challenges AI might pose for our children in terms of job opportunities.

AI Facilitated My Property Decision

In my previous post, “ Rent out, sell, or create a wellness center, ” I detailed my dilemma regarding what to do with my old house. At 46 years old, with two young children and already managing four rental properties, the prospect of overseeing another rental didn't appeal to me.

Being a landlord can be burdensome, particularly when dealing with challenging tenants or constant maintenance issues. Such responsibilities take away time that could be better spent on more enjoyable activities, like playing tennis or spending quality moments with my kids.

After reading through the comments on my post, which provided diverse opinions on the course of action, I weighed the options and arrived at a decision to rent out the house and hold it for the long term. The deciding factor was the formulation of an investment thesis.

Why Renting Out Is Better For Now

My investment thesis revolves around the belief that owning a single-family home on the west side of San Francisco is a sound decision. Local economic catalysts, including the opening of a large school in the fall of 2024 and the $4 billion renovation of the UCSF Parnassus Hospital by 2030 (expected to create 1400 new jobs), indicate a positive trajectory for real estate on the west side.

Remote work is here to stay. In addition, there is a demographic transition from downtown on the east side to the west side. The final catalyst for my decision to rent out is the anticipated wealth generated by Artificial Intelligence (AI) for employees and investors. As a result, I will suck it up as a landlord for the next 3-5 years and then reevaluate. The earliest I'd relocate to Honolulu, Hawaii is in 2030.

I spoke to Ben Miller, CEO of Fundrise , and he believes we're past the real estate market as do I. As a result, holding onto my property and renting it out makes even more sense.

3) The Vision Pro Investment Thesis For Apple

I've owned Apple stock since 2012 and it has done well. With the S&P 500 surpassing 4,900, I've faced increasing challenges in finding compelling stock investments. However, when the Vision Pro was unveiled on February 2, 2024, my interest was piqued.

At that time, Apple had just reported somewhat soft quarterly results, causing a dip in the stock. I contemplated whether this could be the opportunity to further invest in the company. After dedicating several hours to researching the Vision Pro, I concluded that the answer was affirmative.

Apple's new Vision Pro is a significant accessibility tool for the visually impaired . Approximately 2.2 billion people worldwide experience some form of visual impairment. While an estimated 237 million face moderate to severe impairment. Among them, 40 million are considered legally blind or completely blind. This figure is expected to rise to 115 million by 2050.

Consequently, I believe the Vision Pro holds the promise of greatly assisting a substantial portion of the global population in enhancing their vision and interaction capabilities. Considering the critical importance of sight, the demand for this product should be relatively inelastic for the visually impaired. Furthermore, Apple is likely to enhance the product over time and reduce its retail cost. I can’t wait for version 2 and 3.

An Example Of How The Vision Pro Can Help The Visually Impaired

If you have regular sight or can correct your myopia or hyperopia with glasses or contact lenses, then you might take for granted your vision. Seeing a small screen on your phone or the 10-point font size on a menu is usually not a problem. For for those with visual impairments, it can be.

This Vision Pro commercial succinctly captures one of its many benefits for the visually impaired.

Apple is already an outstanding company with intelligent employees and an impressive product line. Further, it is cash flow positive with substantial cash reserves and a dividend payout. My confidence in investing in Apple stock aligns with my confidence in the S&P 500. However, I anticipate additional upside potential, particularly with the introduction of the Vision Pro and how Apple with integrate artificial intelligence with all its products.

Note: The definition of legally blind means the inability to correct your visual accuity to at least 20/200 with corrective lenses. Most people can correct their visual acuity to 20/20 to 20/40 with glasses or contacts. Legally blind usually does not mean complete blindness, as many people who are legally blind still have some vision.

America The Great: The Ultimate Investment Thesis

I harbor a home country bias as an American patriot. I've resided in this country since 1991 and have payed six figures in taxes annually since 2003. My children were born on American soil. In addition, I've crafted over 2300 personal finance posts aimed primarily at aiding Americans in achieving financial freedom sooner. These experiences have fostered my deep connection and commitment to this nation.

I envision my final days in America, leaving behind a positive legacy . Consequently, my long-term outlook is bullish and biased on owning American assets.

The greatness of America, in my belief, stems from:

• Entrepreneurial spirit
• Strong work ethic
• A stable democratic government
• A robust legal system safeguarding intellectual property and individual rights
• A formidable defense industry ensuring citizens' protection
• A stable world currency
• Generally thoughtful and kind people aspiring to assist others globally in attaining freedom
• A history of unity during times of crisis, exemplified by events like 9/11 and the pandemic

While acknowledging America's challenges—crime, poverty, socioeconomic injustices—I consider it unwise to bet against its long-term excellence. The collective willpower of our nation, I believe, will drive ongoing positive improvements.

I advocate that everyone, globally, should find a way to own a piece of America . You can do so by buying the S&P 500 or U.S. physical real estate or private real estate.

In 50 years, when our grandchildren become adults, they will appreciate our foresight in investing in America today. Despite inevitable economic fluctuations, with a well-defined investment thesis, we stand to accumulate wealth beyond our current imagination.

What Makes A Good Investment Thesis

A good investment thesis is a well-researched and articulated rationale behind an investment decision. It serves as a comprehensive guide that outlines the reasons and expectations for choosing a particular investment. Here are key characteristics of a good investment thesis:

• Clear and Concise: The thesis should be easily understandable and to the point.
• Supported by Research: Ground your thesis in thorough research, including fundamental analysis, technical analysis, and an understanding of relevant economic and market trends.
• Alignment with Goals: Clearly state how the investment aligns with your overall financial goals and objectives. Whether it's capital appreciation, passive income generation , or risk mitigation, the thesis should reflect your goals.
• Identifies Investment Opportunity: Specify the investment opportunity or opportunities you have identified. This could involve a specific asset class, industry, sector, or individual securities.
• Analysis of Risks: Acknowledge and assess the risks, challenges, and uncertainties associated with the investment.
• Time Horizon: Clearly define your time horizon for the investment. Specify whether it's a short-term trade, a long-term hold, or something in between.
• Competitive Advantage: Understand what sets it apart from competitors and how it plans to sustain or enhance that advantage.
• Financial Metrics: Include relevant financial metrics supporting your investment decision. This may include valuation ratios, growth rates, profitability, and other key financial indicators.
• Scenario Analysis: Consider different scenarios and outcomes. A well-thought-out thesis anticipates how the investment might perform under various circumstances.
• Adaptable and Dynamic: Recognize that market conditions can change. A good investment thesis is adaptable and allows for adjustments based on new information or changing circumstances.
• Exit Strategy: Clearly outline your exit strategy. Know under what conditions you would sell or reduce your position.
• Communication: Share your thesis with others to find any blind spots, like I am with this post. Others should be able to understand your rationale and analysis.

Keeping updating your investment thesis over time

Having a good investment thesis won't guarantee success, but it's like a roadmap for your investments. Keep updating it based on what's happening in the market, and make sure you invest for the long term.

For example, after the failed assassination attempt on July 15, 2024, Trump will likely become the 47th president of the United States. As a result, there may be further upside with your investments in 2025 and beyond. Here's a detailed article on what Trump's presidency means for your money .

Investment theses can vary in quality, and sometimes you might get the investment right with the wrong thesis. The main thing is to have a good reason why you're investing, so you stick with it over time.

In 10 years, you'll probably end up with more money who keeps investing for the long haul, compared to someone who doesn't invest or tries to time the market. Decide which situation you want to have in the future.

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35 thoughts on “an investment thesis: the key to making more money long term”.

Folks investing should have an Investment Policy Statement (IPS).

Scope & Purpose: “The investment policy statement (IPS) will govern how the financial assets of ____________ are to be invested.”

RESPONSIBILITIES:

“__________ is responsible for coordinating updates to the IPS and responsible for monitoring the application of the IPS and shall notify ETFguide of the need for updates to the IPS and/or violations of the IPS implementation. _________ shall be responsible for approving the IPS and all subsequent revisions of it.

Changes in life circumstances including the birth of a child, retirement, disability, divorce, or family death will impact all future adjustments and responsibilities to this document.”

Research the subject and find a Financial Advisor (RIA) firm that prepares such IPS reports and go over your situation with them. Ron Delegge at ETFguide can prepare an IPS for you for a reasonable fee. You can find his firm online.

your quote sums up our last 40+ years of heavy real estate investing vs investing in equities.

“Since 1996, I’ve discovered that having a well-defined investment thesis increases the likelihood of consistently investing and holding onto investments during challenging periods. As the old saying goes, ‘time in the market is more important than timing the market.’ This lesson came to me the hard way during the first 10 years of my investing career.”

We were told many times that we would lose it all, go bankrupt, have to grovel to return to work & suffer the never ending torment of bad tenants & damages. We could write a book on it all, as it definitely was not easy, but since 1998 (& retired) we have been free & clear on every property since, have no debt since & live comfortably between three homes during the year after selling our 4th, a FL home of 31 years, just before H. Ian hit. love your articles & financial insight.

My California real estate thesis is this:

Despite numerous rent control efforts and the State’s (and most coastal counties’) hostility towards landlords, I think California residential real estate will be very lucrative for landlords assuming they have sufficient cash on hand to withstand vacancies, evictions, cash for keys, etc.

This is because rent control decreases landlord and developer participation in providing housing and thus leads to fewer units on the market. Fewer units on the market will increase rental prices.

Hi, like you I own and manage a few rental properties in the city, which is our primary income. Although the rental market here isn’t great, at least it’s stabilized. It’s like survive until 2025 and hopefully things will turn around in SF. These upcoming city elections, with a swell of moderate candidates will hopefully make a tangible difference in quality of life issues, which of course have hurt SF’s reputation worldwide.

I’m also bullish on the potential for the AI industry. But work from home is pervasive and I think downtown and soma are going to be challenged for several years. Also tech firms are less concentrated in the Bay Area now and getting more distributed in 2nd tier cities. The saving grace for SF is that many local neighborhoods are now more cleaned up and also have thriving foot traffic, if it’s the mission, inner sunset, etc. So I feel good about the future of good and established SF neighborhoods, which is where I own properties.

SF has roughly doubled in value every 10years, which is amazing. The first chart in this report is a good visual, https://www.bayareamarketreports.com/trend/3-recessions-2-bubbles-and-a-baby The main thing I need to wrap my head around is that I think the next 5-10 years will not have the amazing appreciation that we’ve had since the mid-late 90’s when I started investing. I honestly got used to that phenomenal rate growth, but I’m trying to set more modest expectations going forward.

How bullish are you on future SF appreciation? Do you think it will be anything like the last 30 years?

The market may simmer this year. But I think it’ll eventually go up again by a rate of 3.5 to 5% a year. If you look at the historical cycles, there’s generally about 4 to 5 years of flat lining.

Given we’re already at a high base, the growth rate of appreciation won’t be as high as in the past. That said, I think there’s gonna be another renaissance of Wealth being created over the next 10 to 20 years with new tech / AI.

What the cost of building materials, labor, and restrictive building should help push real estate prices higher.

Yeah 3.5-4.5% SF real estate returns over the next 5-10 years is probably realistic. 7% is unlikely, which is what we’ve gotten used to :) Without that outsized 7% equity return, and holding my properties debt free (no leverage), keeping them long term vs selling and going into the stock market becomes a much closer call.

My cash on cash on my RE is 3.5-4%, plus 3.5-4.5% expected appreciation totals 7-8.5% total returns, which is roughly in line with s&p 500 long term returns. Tax treatment favors RE, but then again with stocks you don’t need to deal with tenants and repairs. But of course the main issue is transferring my RE equity into stocks is bloody expensive, with sales expenses and capital gains of about 37%. So I’m still better off holding the RE. My only issue is that I’m heavily RE weighed, with only a small stocks portfolio. My plan has been to dollar cost average excess RE profits into stocks to better balance my portfolio.

I’ll just have to see what transpires over the next 2-3 years to our fair city, plus evaluate the macro economic picture. I guess this “sell RE, buy stocks” dilemma isn’t such a bad problem to have. But nevertheless it’s nice to have a “safe space” (sic) such as this blog where wealthy people can freely cry about their problems…IRW anytime I bring this up to people it’s like, “wait, let me get the worlds smallest violin to play for you” :)

Innovation Fund vs going after AI public companies like the following that are already established and surging YTD. Thinking the latter might be more attractive and with less risk.

Nividia TSMC Arm SoundHound

I don’t have thesis, only several points: -Only buy S&P 500 index with lowest fee. -No trading, hold for LONG time. – Maximize all tax deferred accounts. – No investment in a single company since I have no control over management. I bought and didn’t look at my account for years . I just recently checked and saw that it has 13% compounding interest making me millionaire.

Well done. Don’t forget to capitalize on your investments by selling on occasion to buy things you want and improve the quality of your life. Otherwise, there’s really no point to investing in stocks.

Is there a fundrise equivalent for non-US citizens? Thanks in advance. Dave

Hi Dave, I’m not aware of one. You can just invest in a public real estate ETF like VNQ or one of the publicly-traded REITs like O. Just know they are more volatile.

Just to clarify, Innovation Fund is not currently open to new investors but has a “waitlist.”

Also what is happening with publically traded companies in the AI thesis seems to me to mean that not really necessary to take on added risk of start-ups. just look at recent performance of ARM SMCi and NVDA. and that is just a few. i will continue inverting in a broad 10-12 public stocks and sure to gain solid and not massive returns. i look at it this way, if a start up here or there will do 10x and some will bust, leaving you with overall 3-4 times return, then i am likely to better with the established companies in a sector where the revolution has just begun. smci is up 3x in just a month.

That’s weird. I just checked with Fundrise and the Innovation Fund is open to investors.

“The Innovation Fund is OPEN to new investors. It is possible this person is unable to make a direct investment into the fund if they are an existing investor who is not a Pro member. This is something we’re working on.

But to reiterate the fund is open to new investors.

If you select the Venture Capital investment plan during signup you can invest in the Innovation Fund.”

I’m an existing investor and don’t believe I’m a pro member. I’m able to invest in the Innovation Fund.

i’m an existing investor but not a pro member and i am not able to invest in Innovation fund so must fall into that segment. it is not provided as an option when i select “browse investments” in my account. i then read a review of the fund from late 2023, i will try to post, and it did say that it wasn’t open to all yet. it did said all you needed was $10 to start.

You should reach out to them and let them know.

ASH01 – What are the 10-12 AI public companies you are targeting besides Nividia, smci and ARM? Thoughts on TSMC & SoundHound? I tend to agree with your thesis. Why take on the private risk when the public companies should still be in their infancy in terms of AI growth.

As discussed earlier, here is my investment thesis which could be quite controversial:

1. A portfolio of 50/50 real estate vs. stock. The stock portion should not be lower but could be much higher. Holding real estate is mostly for pleasure/need and rent. Rental properties are all places i would want to live. Once pleasure part of real estate is no longer needed, should graduate to stocks or to rental units.

2. Stocks is a mix of SP500 and Tech i.e. Nasdaq 100, XLK, VOOG and also exposure to single high performing stock. No international stock. No bonds. Mostly automated invested to cost average. Real estate rental income is the security in case stock market crashes.

3. Flexible and nimble approach. Whenever the market is down, try investing more and don’t withdraw funds.

4. No investment in private funds, real estate funds, bitcoin and other cryptos which i dont understand and have no transparency. No need to complicate.

Sounds good. What’s your investment thesis though for your tech stocks?

It’s a good mantra to not invest in what you don’t understand.

I really enjoy investing private funds (VC, VD, real estate) as it forces me to invest for the long term ~10 years. The capital calls also keep me investing even when I might not want to.

I am excited about building out, my artificial intelligence exposure, and I have one from the invested in Ripple, which has turned out to be maybe a 20-40X return. Maybe I can cash out just in time to buy a new car in 2027, when my current car is 12 years old.

Here’s an example of an AI company one of my private funds (Kleiner) is investing in. I’m pumped! https://techcrunch.com/2024/02/06/ambience-healthcare-raises-70m-for-its-ai-assistant-led-by-openai-and-kleiner-perkins/

I’m also excited about the AI investments in the Fundrise Innovation Fund , like Databricks.

Sounds good. As for tech, i have a single stock exposure due to my employment which is doing better than market and is a great company that does good work. So thesis for that is don’t fix what is working. As for the rest, my strategy is similar to most here – i Invest in 15-20% of stock portfolio in QQQ and lesser to XLK and VOOG which are Apple, Microsoft heavy – i believe i get enough AI and other exposure through these since i dont know what the next big thing will be.

One last point. I am very bullish about US Stocks for the following reasons:

1. European markets are not performing. On surface, it appears cheap to buy however not a single tech company in the top 100 European companies. 2. China stock market is not performing. Significant decline and volatility. Could be the beginning of a Japan like deflation and decline. 3. US is the center of AI and innovation. 4. Stock ownership, although at historical highs is still low among Americans being at approx 56%.

In couple years, i think everyone will want a piece of the US companies. Already evidenced by the fact that Shiller CAPE after 80s is much higher than historically has been. Could this lead to a bubble? Definitely – but it could well last 10-20 years and the fundamentals could also catch up in the meanwhile either due to AI generated earnings or something else and optimism pays when investing!

My best thesis was investing in semiconductor stocks. Roughly 5 years ago I noticed how almost everything needed a chip. My thesis proved itself out during the pandemic. You couldn’t get a car, dishwasher or any smart device because chips weren’t available. I bought AMD, NVDA, and Intel. 2 of them worked out pretty good. I was banking on the cloud and data centers to boom. That part worked out okay. I didn’t see any of the AI craze coming which has been hugely beneficial. Decent thesis and a ton of luck!

Nice! But what about the future?

Take a little profit and hold the rest for another 5 years. I realize we’re right in the middle of AI mania but everything I read and watch tells me we’re still in the early days of AI.

No matter what happens we’re still going to need more chips to power all our future ambitions

so interesting how almost nobody but nvda saw the AI craze coming. that one earnings report by them set this whole thing off about a year ago. such an interesting phenomenon. AI has been talked about for many years but then suddenly companies decide to try to make a product of it in a massive scale. nvda explosion in earning was because companies suddenly ordered their chips.

Yup, I spend hours a day watching cnbc, reading blogs and doing research and I truly didn’t know what AI could do or how much money companies could make off it. Luck is definitely a factor.

VTI + VXUS + long haul = chill

Agree, but it’s hard to retire earlier by just investing in the total stock market. There are two levels of wealth , the top-tier wealth did not get there by investing in ETFs or index funds.

100% agree with you on that front! BUT I do personally believe that 95% of people will accumulate more wealth through regular and automated index investing over time vs. active investment strategies such as picking 1:1 stocks. I would guess you also have a sizable audience base that loves the content but also leans toward simple investing strategies over the long haul and not constantly stressing about achieving the top tier of wealth. The content here can sometimes make you feel behind, overly stressed that you’ll never have enough, and stuck stressing about the future. I personally have to step back and remember it’s really about regular investing (in your strategies of choice) + time in the market and not timing the market. Which I personally think is a sound investment thesis! Love the content though to be clear. It’s really helped me think about allocation percentages and mortgage payoff strategies.

Yes, good points. For most people, buying a primary residence and regularly investing in an S&P 500 index fund is a great long-term strategy.

Personally, I like to always be challenged bc it’s fun. Even if I fail, I will likely have accumulated more than if I hadn’t pushed myself.

From my coaching days, the players who advance the most are pushed the hardest.

But good reminder to press the easy button once in a while for readers who may be burning out or feeling behind.

I love your clear and specific convictions in your investment thesis. That’s something I need to work on. Very cool on the Apple Vision Pro. I don’t have anything specific in my own investments. Although I do believe in long term real estate, stock, and tech exposure. Thanks for the list of steps on creating an investment thesis.

I’ve been investing since the mid-1980s. Every time I’ve evaluated my portfolio against a portfolio of index funds using backtesting of 5 years and more, the index funds (with expenses deducted) have beaten my portfolio’s performance over a 5+ year time horizon. I’ve finally realized that I have a lot more money today if I’d purchase a mix of three low-cost, passively managed index funds. My latest lesson occurred during the latest 5 year period in which my portfolio performed well. It did what it was designed to do (mitigate losses during down markets like 2022). I was only down 2% that year. Unfortunately, if I had invested in a mix of SCHD (50%), SCHG (25%), and SWPPX (25%), that portfolio would have crushed my performance by a wide margin. Yes, it lost more money in 2022 (around 14.75%) but dramatically exceeded its performance in the other four years. I’m done trying to be smart. I’m buying a mix of passive ETFs and accepting the market risk.

Thanks for posting that. You basically stated my “investment thesis”:

1. My assets must grow in order for me to keep up with long term inflation 2. Over the long haul it’s very difficult for me to outperform the market 3. Figuring out my my risk tolerance and indexing accordingly is probably my best bet

No different than you, it’s taken since the mid 1980’s for this reality to really set in…

Those are great points Vaughn. Keep the focus and stay invested for the long term!

Active funds underperform their benchmark passive index >95% of the time after 10 years. With retail investors its over 99% with average underperformance by 4% *annually*. The 1% that crush due to lucky pick with concentration are the reason people still do it, but I’d rather have a 99x higher chance to have a +4% CAGR *and* barely think about it.

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Investment Thesis: How To Write a Convincing Thesis

What is an investment thesis? This may seem like a simple question, but it's actually quite complex when considering all of the different factors that go into it. An investment thesis is essentially a roadmap for how you plan to invest your money. 

Now, that can seem like a daunting task, but don't worry, as we'll walk you through everything you need to know about writing an investment thesis. 

What is an investment thesis?

An investment thesis is a document that outlines your reasoning for investing in a particular security, or asset. It should include everything from your analysis of the business to your estimation of future growth potential.

If it is a personal thesis, it should also include your risk tolerance and investment goals. This is important because it will help you determine what type of investments are right for you.

For example, if you're retired and looking for income, you'll likely want to focus on dividend-paying stocks or bonds. On the other hand, if you're young and have a long time horizon, you may be more interested in growth stocks. Once you have a good understanding of your investment goals, you can start to develop your thesis. 

There are a few different ways to go about this, but one of the most important things to remember is that your thesis should be based on sound reasoning and evidence. 

For example, let's say you're considering investing in a small-cap stock. Your thesis might be something like, "I believe that this company has significant growth potential and is undervalued by the market. 

After researching this industry, reports have indicated that the sector is poised to grow by 25% over the next year. I believe this stock is a good buy at its current price." To support this thesis, you would need to do some research on the company's financials, industry trends, and competitive landscape. 

By developing structured investment theses in this way, you can make more informed decisions.

Why an investment thesis is important

An investment thesis is important because it helps to keep you focused and disciplined in your investing. It's easy to get caught up in the excitement of a hot new stock or the latest market trend. 

But if you don't have a solid thesis to guide your decisions, you may end up taking on too much risk. It helps you make financial decisions based on logical explanations. This increases the probability of success. All the best investors do it. It can be written on paper and privately held to reevaluate as time goes on. Some public fund managers might post on public websites to notify others. While others will simply have it written out in their memory bank. Either way, it’s a critical part of the investment process. 

Where can you find investment thesis examples?

Hedge fund websites are ripe with examples of investment thesis because they’re trying to market their strategies to attract new clients and capital. However, anyone can write an investment thesis. 

How to write an investment thesis

The best way to write an investment thesis is to start with an introduction. This should be followed by a section on the company's background and history. Next, you'll want to include a section on the current market conditions. 

After that, you'll need to discuss the positive and negative potential outcomes of investing in the company or asset. Finally, you'll want to provide your conclusion.

There are variations of this structure, but generally, it goes as follows: 

1. Introduction 

2. Positive Body 

3. Positive Body 

4. Positive Body 

5. Negative Body 

6. Negative Body 

7. Negative Body 

8. Conclusion

You can also structure the thesis by writing a negative body immediately after a positive one for a more dynamic back and forth. This can create a live debate in your head that can make the process more fun. 

3. Negative Body 

6. Positive Body 

When writing an investment thesis, it is important to be clear and concise . You will also want to make sure that your argument is easy to follow . Try to avoid using jargon or technical terms that might not be familiar to your audience. 

It is also important to back up your assertions with data and evidence . This will make your argument more persuasive and convince readers that you have done your research. Be sure to cite any sources that you use so that readers can check them for themselves.

Finally, remember that an investment thesis is not set in stone. As new information arises, you may need to revise your thesis . This is perfectly normal and shows that you are willing to adapt your opinion as new data becomes available.

What should an investment thesis include?

Here are some of the points your investment thesis should include:

• A clear description of the security or company you are investing in

By generally introducing what the company does, you set the stage for the rest of your investment thesis.

• A discussion of the overall market for this security or company

This is where you establish the opportunity that exists for this particular security or company. Is this market growing? What is the consumer sentiment for this market?

• An analysis of the competitive landscape

Who are the major players? What are their strengths and weaknesses? Is it possible that others will put the company out of business?

• An evaluation of the management team

Will this team run a great company to the ground or will they conduct intelligent business decisions?

• A financial analysis of the security or company

How close are they to bankruptcy? Are they profitable and does the product margin justify the current valuation?

• A discussion of the risks associated with the investment

By arguing against yourself, you can provide a more objective opinion.

• A conclusion that outlines your opinion on the investment

To summarize, do you believe this is a good or bad investment? 

• An actionable plan

What will you do if the thesis does not play out as expected? Are you allocating a certain amount of capital to this position?

When constructing an investment thesis, always remember to be as objective as possible. Investment theses are not about being right or wrong, they're about providing insights into a decision. Now that we've gone over what an investment thesis is and what it should include, let's take a look at how to conduct the research needed to write one. 

How do you do investment research?

There are a few ways to go about conducting investment research. The most important thing is to be as comprehensive as possible in your analysis. This means looking at all the available information and data, both good and bad.

Analyst reports

One way to do this is by reading analyst reports . These are written by professionals who have analyzed the security or company in question and have come to a conclusion about its investment potential. 

Read the company’s filings

Another way to research investment is by reading company filings and financial statements . This will give you a more in-depth look at the numbers behind the business. You can also use online resources such as Google Finance or Yahoo Finance to find information about a company's stock price, earnings, and other financial data.

Research the industry

Educating yourself on the broader industry trends is also helpful. This will give you a better understanding of the market in which the company operates. For example, if you're looking at a tech company, it would be beneficial to read about the latest trends in technology.

Attend industry conferences

You can also attend industry conferences or meetups to network with other professionals who might have insights into the company or security you're researching. 

Look at every source of information

Reading books, listening to podcasts, and watching documentaries on the industry can also be helpful. This will help expand your knowledge and give you a different perspective on the company or security you're researching.

Talk with customers

Last but not least, don't forget to talk to people who are using the product or service. This can give you valuable insights into whether or not the company is providing benefits to the marketplace. 

When conducting investment research, it's important to remember that there is no such thing as perfect information. The goal is to gather as much data as possible and then make an informed decision. 

Unless it is data points, you should understand that all other sources can be subject to bias and other personal agendas. Research is critical but you also need to know how to use it intelligently and you need to know how to think for yourself. 

Investment thesis vs investment strategy

The main difference between an investment thesis and an investment strategy is that an investment thesis focuses on a specific company or security, while an investment strategy is broader and can be applied to any security. 

For example, a strategy can be how to allocate the entire investment portfolio. A strategy could be an approach where the investor tries to benefit from the growth potential of technology but still maintains some income through dividends. 

Each investor will likely have their own investment strategy. An investment thesis could be a report on if a company's dividends are sustainable . A separate thesis within the strategy could be based on the tech company within the portfolio. 

Together with the broader investment strategy, investment theses can help an investor make better financial decisions.

Investment thesis: A sales pitch or fair research?

The investment thesis is a critical part of any investment decision. It is the document that outlines why you are investing in a particular security or company. 

Thesis reports can be very simple or quite complex, but they all serve the same purpose: to convince the reader that your investment is a good idea.  

If you are selling your fund's reasoning, to an LP or a group of co-investors, the investment thesis is your sales pitch. However, if you want to be seen as more trustworthy or would like to avoid biased investing, argue both sides of the investment. 

Describe the risks associated with it. Don't be afraid to challenge your own thesis. After all, if your investment thesis isn't sound, you could be left holding the bag .

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Jun 24, 2020, vc lab: vc investment thesis template.

In order to build a strong venture capital firm as a first-time fund manager, you need to start with a strong Investment Thesis. Find our worksheet here.

What is the Investment Thesis for a venture capital firm?

An Investment Thesis is the strategy by which a venture capital fund makes money for the fund investors, called Limited Partners or LPs. It identifies the stage, geography and focus of investments, as well as the unique differentiation of the firm.

What are Limited Partners?

Limited Partners, or LPs, are investors in venture capital funds, and there are a number of common categories, including family offices, pension funds, endowments, sovereign wealth funds and even corporates. LPs often have allocations for different stages of venture capital as an asset class, and these allocations are provided by their internal or external investment strategy managers.

Why is the Investment Thesis important for a venture capital firm?

An Investment Thesis is used to attract Limited Partners, and it guides the activities of the firm. Most LPs have investment criteria for their venture capital allocations that they are looking to meet, and a compelling Thesis allows LPs to see if a fund meets their desired allocation criteria.

What are New Managers?

New Managers are a category of venture capitalists that are launching a new venture capital firm. Even experienced venture capitalists get categorized as a New Manager if they are launching a new firm. Many categories of LPs are restricted from investing into New Managers, including pension funds, endowments, sovereign wealth funds and even corporates. This is because New Managers do not have a track record and because the new firms run into common problems of any new business.

What is the most common Limited Partner for a New Manager?

Most New Managers raise capital from family offices, which are the investment operations of wealthy individuals and families. Small to mid-sized family offices are often led by a wealthy individual, such as an entrepreneur that has had a large exit, and these individuals make the decision to invest into a fund. Family offices often have an agenda and a focus that can align with a compelling Investment Thesis, allowing New Managers to more easily get meetings. 

How do you write a compelling Investment Thesis?

There are multiple components to a compelling Investment Thesis that we have compiled into a simple to follow format. A good Thesis can often take months to develop, iterating on feedback from the market, advisors, and fund investors. In order to start this process, we have created a simple template for creating a venture capital Investment Thesis below.

“[Fund Name] is launching a [$x MM] [Stage] venture fund in [Country / City] to back [Geography] [Sector / Market Companies] [with Secret Sauce]”

Below you can see tips for each component in [brackets]:

• [Fund Name] When getting started, we recommend using a last name or color, like ‘Ressi Ventures’ or ‘Orange Fund,’ since the Thesis will evolve many times over the first months. After you feel that you have a final Thesis, then choose a name that represents your fund.
• [$x MM] This is the size of committed capital by LPs to the fund. You will be able to raise a fund that is 10 times the size of what you think you can easily close from contacts that you already have. So, if you think that you can easily raise $500,000 from friends, acquaintances and other contacts, then your first fund size maximum is $5 MM.
• [Stage] Stage is usually based on fund size, and, for New Managers, the options are angel (<$5 MM), pre-seed ($5 MM to $15 MM), seed ($15 MM to $50 MM) and Series A (>$50 MM). It is easier to have a larger fund doing an earlier stage, such as a $100 MM angel fund, than it is to have a smaller amount of money for a later stage, such as a $10 MM Series A fund.
• [Country / City] This is the city or country where the New Managers are living or plan to live while running the fund. Now, most funds have a life of at least 10 years, so make sure to pick a city or country where you and your fellow New Managers plan to be for some time. In addition, if you are living in a large country, then it is better to specify a city or region. “East Coast” is better than the United States.
• [Geography] This is the region where the fund will invest in portfolio companies. If the Geography is not specified, then it is assumed that the funding will be local. This is particularly important for New Managers, who often try to be too broad and then do not appear credible. For example, it is unrealistic to assume that a New Manager with a small fund will do cross border deals that require complex legal management. 
• [Sector / Market Companies] This is the type of companies that the fund will focus on investing in, such as FinTech, digital health, SaaS or marketplaces. Ideally, when choosing a sector or market in a geography, the opportunity will be obvious to the right LPs, such as "East Coast Fintech companies” or “German SaaS companies.” 
• [with Secret Sauce] ’Secret Sauce’ is your insight into a sector or market opportunity based on your in-depth experience. For example, “West Coast heath startups based on my 15 years leading the largest health tech angel group in San Diego while practicing neurosurgery.” The secret sauce needs to show why you are uniquely qualified to create this fund, and, if the market opportunity is not obvious, it should also show why the market opportunity is important right now.

What is a sample Investment Thesis?

Using the above template, here are some clear and concise thesis examples:

• “Purple Ventures is launching a $5 MM angel fund in Brussels to back European government technology startups that leverage the partner’s experience in various political and bureaucratic leadership roles across the EU.”
• “Found Capital is a $15 MM Seed fund in Lagos to back African mobile payment and fintech companies sourced from the partners network built while working as startup ambassadors at Google, PayPal and Microsoft in Africa.”
• “Sven Fund is a $100 MM Series A fund in Singapore to back blockchain startups in Asia that are building dynamic supply chain systems, which is a market segment where the partner had the largest recent exit in the region.”

How specific should your Investment Thesis be?

A compelling Investment Thesis is very specific about stage, geography and focus to align with the allocation requirements of Limited Partners. A common problem is that New Managers are often afraid to be specific, since they feel it will limit their ability to do hot deals. A Thesis states the intention of a firm to pursue certain kinds of investments, but often is not legally binding in the firm or in the fund agreements. So, an Investment Thesis has the effect of gravity. Venture capitalists often can do deals that are far away from the Thesis, but they have less attraction.

How do you refine your Investment Thesis?

You will be refining your Thesis heavily for the first few months when forming your fund. The measure of a great thesis is how easily it can attract meetings with LPs, but the first person that you need to satisfy with your thesis is yourself.

Here is an initial exercise to get started that should take about 30 minutes to an hour.

• First, use the template above and try to write three versions of a potential venture fund thesis. As mentioned above, be as concise and specific as possible.
• Next, read each of them aloud while recording a video of yourself. Speak conversationally (in the same way you might casually pitch the idea to someone in an elevator), and in one video "take". 
• Then, watch the videos and ask yourself if you would realistically invest in that thesis. How clear was the message? How confident was the delivery? What questions come to mind?
• Finally, revise the thesis and video until you are satisfied with your work. Resist the urge to make the one-sentence thesis a one-page thesis. Remember: brevity is the key. 

Download this VC Investment Thesis Worksheet

What are the next steps.

This is just one part of the first steps to starting a venture capital firm, which include: 

• Review Our VC Investment Thesis Template
• Determining Your Venture Capital Fund Size
• Selecting a Venture Fund Area of Focus
• Building a Strong Value Proposition for a VC Firm

We will be adding separate guides for each of these sections shortly on our main How to Start a Venture Capital Firm Guide . 

This content is provided by VC Lab, the YC for VC. Learn more about the industry-leading and free programs at: https://GoVCLab.com If you have questions about venture capital, ask the leading AI for VC, Decile Base. The Decile Base venture AI offers a fund lawyer, accountant, and tax specialist on demand. https://DecileHub.com/base VC Lab is a part of Decile Group. Decile Group is unlocking the potential of venture capital with a full-stack platform that empowers emerging managers to launch top-performing funds 3x faster through training, tools, and capital. https://DecileGroup.com

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July 29, 2024

How to Develop a Strong Investment Thesis in Early Stage

Johannes Gebendorfer

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A well-crafted investment thesis can help investors clarify their goals and evaluate potential investments, ultimately leading to a successful performance of the fund.

What exactly is an investment thesis, and why is it so important?

An investment thesis is a concise statement that outlines an investor's belief about the potential returns and risks of a particular investment. It is a framework that helps investors make decisions about what to buy, sell, or hold in their portfolio, and it is based on a thorough analysis of a company's financials, market conditions, and competitive landscape.

A well-crafted investment thesis can serve as a valuable guide for investors to focus on their long-term goals and avoid making impulsive or reactive decisions based on short-term market fluctuations. By clearly defining their investment goals and criteria, investors can avoid being swayed by emotions or biases and instead make rational and thoughtful decisions.

How can private investors develop a strong investment thesis? 

Here are eight steps to follow:

1. Start by identifying the specific industry or market that you want to invest in. This should be based on your own interests, expertise, and goals as an investor.

2. Research the current state of the market , including trends, challenges, and opportunities. This will help you identify potential investment opportunities and develop a more informed investment thesis.

3. Evaluate the potential investment opportunities in the market, including the founding team, product, and business model of the startups. Look for startups that have strong potential for growth and differentiation in the market.

4. Develop a set of hypotheses or assumptions about the potential returns and risks of investing in early stage startups in the chosen market. This should be based on your research and analysis, and should include both the potential upsides and risks of the investment.

5. Test your hypotheses by gathering additional information and data, and by seeking the perspectives of other experienced investors. This may involve conducting interviews, attending industry conferences, or seeking out expert opinions.

6. Refine your thesis as needed based on the information and insights you gather. Be prepared to adjust your assumptions and expectations as new information becomes available.

7. Communicate your investment thesis clearly and concisely to others, including potential partners or investors. This should include a detailed explanation of your reasoning and a solid plan for realizing the potential returns of the investment.

8. Monitor the performance of the startups you invest in closely, and be prepared to adjust your thesis or exit the investment if it no longer aligns with your goals or if the underlying assumptions change.

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Once you have developed your investment thesis, the bunch OS allows you to open standardized investment entities that are a) easy to understand, b) can be managed fully digitally and c) have significantly lower setup and management costs. We are on a mission to enable those who dare to take risks. Talk to us about how to get started with bunch .

We are excited to keep you posted throughout our journey to build the operating system for private market investors . While public markets have come a long way from the time when stock investments were made on costly phone calls, private markets are lagging behind. We want to take out the friction and free up time for fund managers, investors, and founders, allowing them to focus on the projects tackling the challenges of tomorrow. ‍ Subscribe to our newsletter here .

Disclaimer: The content presented herein is solely for informational and discussion purposes only. It is not intended to serve as legal, tax or financial advice or as an endorsement of any investment strategy. bunch does not provide legal, tax or financial advice. Readers should not base their investment decisions on the content presented herein or any other bunch-generated content alone and should seek appropriate professional advice. Nothing contained herein shall constitute or imply an offer to sell, purchase or enter into any transaction in respect of securities. The content contained herein is subject to change without notice. While we aim to present accurate and up-to-date information as part of bunch’s content, we undertake no obligation to update our content from time to time.

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Johannes is leading strategic projects at bunch with a particular focus on the German market and the offerings around funds. Prior to joining bunch, he worked for one of Europe's largest and most active Venture Capital funds, building a portfolio of FinTech companies before switching to the operator side.

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S T R E E T OF W A L L S

Building an investment thesis.

Now that you understand what characteristics make up attractive long and short ideas, it is time to explain how to formulate an investment thesis. Being able to construct a real and actionable investment idea is in the heart and soul of an analyst’s work in the hedge fund industry. Building a successful thesis begins with (1) rigorous due diligence at the Micro level, (2) aligning that view with the Macro environment, and (3) understanding the overall trade setup.

Good Company Qualities

• High return on capital
• Barriers to entry
• Growing industry
• High margins relative to competition

Good Management

• High insider ownership
• Well respected
• Clean accounting
• Infrequent restating of earnings
• Not overly promotional
• Good allocators of capital

All of these qualities are obvious and won’t differentiate your pitch, but they are qualities you will have to talk about, so make sure you understand them well.

Target Price = Your Earnings Estimate × Multiple

Company Earnings

• Will the company beat earnings expectiations in the next quarter or in the next year?
• If so, what are the catalysts that will cause the Company to beat earnings (e.g., higher revenue, higher margins, lower interest expense, share buybacks, etc.)? Paint the picture of how, when, and why there will be a catalyst that supports your view. Providing an opinion without fully understanding and explaining the relevant value drivers will be a recipe for failure.
• What’s your confidence the company will beat earnings? What’s the probability?
• What’s your margin of safety? What can go wrong?
• Does your pitch rely on multiple expansion? Why? Where is the company trading relative to its historical multiple? Should the multiple trade at a premium or discount given how the company has changed over the years, and where we are now in the business cycle?
• Where is the company trading relative to its peer group? If the entire market has seen multiple expansion, then is it fair that this company should too? In other words, is it expensive or cheap relative to itself historically and/or its peers, and can you explain why this might be wrong?
• What catalyst is going to cause this multiple to start expanding? Again, paint the picture of how, when, and why there will be a catalyst that supports your view.
• What is your confidence in multiple expansion? What’s the probability?

Target Price:

Your target price is the product of a forecasted earnings metric multiplied by the expected multiple. This multiple can be P/E, EV/EBITDA, EV/Sales, FCF/Market Cap, or any other reasonable metric. Some metrics are industry-specific and more valuable for those industries than the aforementioned general ones.

Regardless, if you provide a target price, you need to explain how you arrived at this target, and the stages of your thought process to get there. for example, if you claim that a stock is going to have +50% upside, but feel they won’t beat consensus earnings, then you are calling for +50% multiple expansion, pure and simple.

Although not ideal, stocks in industries with bleak macroeconomic outlooks can still be good investments. It is important to understand what is taking place at the company level, sub-sector level, industry level, and national level. This approach will help you determine whether you are investing in a “good house in a bad neighborhood.”

• How has the stock performed heading into the catalyst, i.e, before you put the trade on? If it has already gone up 10% recently, for instance, it will be much harder to outperform on the catalyst.
• How crowded is the trade? Are a lot of hedge funds already invested in the name? One easy way to determine this is to speak to a sell-side research analyst and ask whether they are getting a lot of calls from other funds regarding the company.
• Is the general public bullish or bearish? If you are researching a short pitch, it is key to check for existing short interest (SI function on Bloomberg). If it is a long, you should review the list of major holders of the stock (HDS function on Bloomberg). If the top holders are several hedge funds, then the stock pitch is likely overcrowded and may not be actionable. One of the biggest mistakes in a hedge fund interview is to pitch a stock that every hedge fund has already heard of and evaluated.

Crowded names can still work, but investors must tread lightly. When the market sells off or there is a change in sentiment, crowded names typically perform the worst. To check this, there is an index on Bloomberg of high hedge fund ownership stocks; you can use it to see whether your idea is on that list to make sure it isn’t already an overcrowded trade idea.

Other technical tools that can help evaluate the setup for a stock include RSI (relative strength index) and moving averages. The RSI is a momentum indicator—below 30 is considered oversold and above 70 is considered overbought.

Ideally, you want a stock that has recently underperformed its peers, is lightly owned by hedge funds, and is heading into a catalyst that you think will have a positive surprise . By contrast, a crowded name that has already outperformed based on the expectation of a positive catalyst will likely get a limited reaction if and when the catalyst does occur. For example, it is very common for companies to beat earnings expectations but not to experience an increase in their stock prices, because the general public or hedge funds are already expecting the earnings surprise. In today’s hyper-competitive market, one needs a truly different variant perception in order to outperform the market.

Other Investing Thoughts

• What constitutes a good investment idea? What does that phrase even mean? The answer is that it means something different to every person–that is what provides opportunities in a market. That is why some investors own a stock and others short it. If everyone agreed on what makes a good investment then everyone would own the same stocks.
• How much should you make per idea? Investors do not even agree on this principle. Developing frameworks for investing will help you follow a set of guidelines that you can refine over the years through experience, and as part of that, you will learn to determine what the expected profit and acceptable risk for a particular investment are.

Value Investing Framework

• Benjamin Graham defined the first basic tenant of value investing as follows: when the price of a security diverges from its intrinsic value (its corresponding cash flows), a value investor should work to exploit that divergence.
• The second basic tenant of value investing is the margin of safety: a security should preferably be purchased at a deep discount to its intrinsic value, to help limit the amount of downside risk the investment has.

Street of Walls Investing Framework

• It is very easy to get ideas from other investment professionals, but it will be very obvious in your pitch whether you have done the analytic work yourself or not.
• This is typically discovered when you are questioned on your assumptions in the model. If you built the model yourself, you can likely defend the assumptions much more intelligently.

Industry Analysis

Market size and growth.

Study the market size and growth of the company’s core industry. Even though you may be studying the beverage industry, the manufacturing companies and distribution companies have very different dynamics. The beverage manufacturers may not be growing much faster than CPI, but the distributors may be going through a massive consolidation period and therefore have earnings that are growing at a much faster pace.

Historical Industry Returns

A security may be cheap and look attractive, but that may be because the returns of the company and the industry are not attractive. For example, the stock Owens Corning (OC) traded at 8x earnings for a long time. This sounds inexpensive, but it was ultimately justified because operating margins were in the single digits. Eventually, however, industry did consolidate and operating margins expanded to 20%. Thereafter, the company’s earnings multiple expanded into the low teens.

Unit Economics

Most bottom-up, fundamental analysis is used to study the unit economics of a company. For example, what does it cost to make and sell one unit of output, and what is the profit on that unit? What are the pricing and volume trends? It is important to understand the value drivers clearly in order to build a detailed operating model for your pitch.

Competitive Positioning

• Do certain companies control industry pricing?
• How sustainable is the company’s competitive advantage?
• Are there high or low switching costs?
• Does branding matter
• Are there regulatory protections, such as tariffs?
• What important considerations are there with respect to the company’s customers and suppliers?

Cyclical / Seasonal

An industry may be in a strong growth period and look very attractive, but it may also be at the peak of a cycle that is possibly about to turn substantially negative. For example, the housing industry looked extremely attractive in the early 2000s, but crashed and was extremely unattractive into the late 2000s and beyond. This is due to both an economic downturn and a systematic overbuilding of homes that collapsed in the middle of the decade. In addition to the economic/business cycle, certain industries have drivers of cyclicality that are very specific. One example of this is the Oil & Gas industry—the price of oil alone can have a huge impact on a Oil & Gas company’s earnings potential.

It is also important to understand the seasonality of the business. Retailers tend to sell more product during the fourth quarter of the year, because of the holiday shopping season. Therefore, it may be wrong to extrapolate a trend in March and April if the majority of the company’s sales take place in the later months.

Investment Considerations

When you start working for a hedge fund you will quickly learn that each fund has their own unique investment style. Some hedge funds simply will not invest in companies that have weak management teams. It does not matter how attractive the opportunity or valuation is—the fund simply won’t invest. This principle often results from an investor getting burned from a bad management decision, such as a bad acquisition, or a focus on short-term earnings at the expense of long-term objectives. After gaining experience analyzing companies, you will eventually develop your own philosophy. Still, bear in mind that other investors may have an opinion on this topic that differs from yours, and you need to consider the philosophies of your teammates when evaluating an investment idea.

In studying management teams, you should look at the management team’s track record and understand both the buy-side and sell-side opinion on the management team. Study the company’s internal philosophy: how do they allocate capital? Is the current management team following what the company has always done? Another key to understanding how a management team will probably act is to study how the members are compensated. Is their compensation tied to revenue or earnings, return on capital, or some other metric? How much stock does the management team currently own? How much risk are they taking? Are they buying or selling stock? How many options do they have outstanding?

Study both relative and absolute valuation. A stock may appear cheap when compared to a stock in another sector, but very expensive against its peers. Thus, different investment situations call for different valuation metrics to be used.

One example of this principle is that it is completely unhelpful to use P/E if the company has no earnings (or negative earnings). You should also study the rate of growth of the earnings metric you chose. A company may look expensive at 30x earnings, but if it is doubling revenue every year and tripling earnings, it may not be so expensive after all. In fact, if you believe that this trend can continue, it may be an excellent long investment idea.

• Is there a difference between your earnings estimates and those of the street?
• If not, is your thesis really interesting, or is it just a “consensus trade”?
• What are the key events that the street will care about? Is it an earnings release, a new product release, or something more unusual?
• Does the street care about what happens next quarter or are they more focused on the potential signing of a big contract that could take place at any time?

Donald Rumsfeld once said there are “Known unknowns and unknown unknowns.” Some risks are riskier than others. How does the company control for this? How do you as the investor assess the downside risk from this?

• What has to happen for the downside case to play out?
• What has to happen in order to lose some benchmark amount, say 20% or more?
• If that event plays out, what will happen to the multiple? Will it go down or actually expand?
• All in all, what is the probability of a downside event and what is the maximum potential loss you might face in such a scenario?

Catalysts are extremely important in identifying when you are going to “get paid.” This is a crucial factor in sizing positions. If a catalyst is expected to take place in the near future, you probably want to have your position fully sized immediately. If not, it may make sense to taper into a position.

Framework for Investing: Large Market Movements

Rising Markets: The typical reaction to a rising stock price is to “chase” the returns. That means when a stock continuously goes up, day after day, the investor feels like he or she is missing an opportunity, and will be inclined to buy the stock. This pile-on mentality causes more investors to become a part of the action. This is a classic, human reaction to a strongly outperforming stock, and it can often lead to poor returns due to an undisciplined approach and the fickle nature of the market.

The same thing can happen when a stock continues to drop in price. Investors tend to panic and sell at exactly the worst time. During the heat of the battle, people tend to get emotional and sell their best stocks out of fear.

• Tell yourself it is normal to react this way when you are losing a lot of money. Fear is normal: both the fear of missing an opportunity and the fear of continuing to lose more money.
• Ask yourself, “Has my investment thesis changed?” If it has, then sell, but if it has not, then ignore your fears and hold the position.
• Have strict target prices in place. This will help you exit a position once your target has been achieved, and thereby avoid the trap of trying to “ride a winner.”

Here is a related excerpt written by Benjamin Graham, from The Intelligent Investor:

• “Imagine that in some private business you own a small share that costs you $1,000. One of your partners, named Mr. Market, is very obliging indeed. Every day he tells you what he thinks your interest is worth and furthermore offers either to buy you out or to sell you an additional interest on that basis. Sometimes his idea of value appears plausible and justified by business developments and prospects, as you know them. Often, on the other hand, the value he proposes seems to you a little short of silly.
• If you are a prudent investor or a sensible businessman, will you let Mr. Market’s daily communication determine your view of the value of $1,000 interest in the enterprise? Only in case you agree with him, or in case you want to trade with him. You may be happy to sell out to him when he quotes you a ridiculously high price, and equally happy to buy from him when his price is low. But the rest of the time you will be wiser to form your own ideas of the value of your holdings, based on full reports from the company about its operations and financial position.”

Trading Considerations

The liquidity of a single stock is not a reason for a fundamental investor to buy a stock, but it can definitely be a reason for an investor not to buy a stock. The less liquid a stock is, the riskier the position becomes, as it is difficult to exit an illiquid position—especially during turbulent market conditions, when liquidity is often demanded.

In order to determine how liquid a stock is, you need to see how many shares trade on a regular basis. For example, if the average daily volume of a $10 stock is 1 million shares, then the stock trades $10 million per day. If you have a $1 million hedge fund, and you want to take a 10% position, you will need to buy $100,000 worth of stock, or 10,000 shares. If you wanted to buy all of that stock in 1 day you could, as you would only account for 1% of the daily volume ($100,000 in stock to be purchased ÷ $10,000,000 daily volume = 1%). A reasonable rule of thumb is that you do not want to account for more than 10-15% of a stock’s daily trading volume if you do not want to influence its price. So in this example, you could buy up to $1,500,000 worth of stock per day without moving the share price. If you were to buy $2,000,000 of stock in 1 day, or 20% of the daily volume, you would likely cause the stock price to increase (at least temporarily). If your desired position is much larger, then it could take many days to accumulate the desired position – and similarly, it could take a long time to unwind the position when you want to exit. This makes the investment much more risky.

Therefore, a stock may have fantastic management, excellent earnings growth, and an attractive price, but if there is no liquidity you probably simply cannot buy it.

Shareholder Base

You may think that you have found a gem: a rare and precious investment opportunity that no other hedge fund is talking about. Fortunately, that notion is relatively easy to confirm or disprove. To check and see whether other sophisticated investors are involved in the company you’re researching, you can pull up the company’s quarterly holdings report on Bloomberg and see who the largest shareholders are.

For example, suppose that W.R. Grace (GRA) offers an exciting investment opportunity, according to your analysis. However, looking at the holders list, you determine that other hedge funds are well aware of this opportunity, as the top shareholders include large hedge funds such as Lone Pine, York Capital, TPG Axon, and Hound Partners.

It may not be a bad thing that other hedge funds are involved. You will probably be invested in a good company in this case, as large hedge funds rarely get involved in unsound investment ideas. That being said, crowded trades can, again, be very risky. First, if the market is already anticipating good news, it may be that the good news is already baked into the stock price. Second, if bad news comes out, then everyone will likely be forced to run for the exits at the same time. This will lead to adverse price movement that could destroy your holding.

Hedge funds in general tend to be short-term focused, so it could turn into a situation where one investor exits swiftly and triggers a domino-effect panic, crushing other investors in the wake.

Looking at charts can be very deceiving and can create misleading signals. For example, the stock chart below shows a quickly rising stock price, but that does not mean it is expensive. It may be cheap relative to its own history, the rest of the sector, or the market as a whole. The entire stock market might have been going up rapidly, or the sector as a whole might have had a big rally, and relative to the sector the stock underperformed, so it may actually be cheap on a relative basis.

You may also want to compare several valuation metrics simultaneously. For example, a company may look expensive on a Price/Earnings basis but cheap on an EV/EBITDA basis.

In the graph below, you can see that Factset Research Systems (FDS) is trading at 20x P/E. Relative to the market that is high, but relative to its own history, that is a normal trading ratio.

Business Model Questions

It is just as important to understand the industry in which a company operates as it is to understand the company itself. For example, if you are studying a homebuilder, it is important to understand the companies the homebuilders buy supplies from. If the building products companies are raising their prices and the homebuilder cannot raise prices, the builders are going to see their margins compress. Therefore, it is important to scan what is happening with related companies across the industry and sector to get a sense of the overall dynamic affecting the company’s earnings potential.

Homebuilding Industry: Related Participants

• Building Materials – USG, EXP, VMC, SHW
• Home Builders – LEN, DHI, KBH
• Building Products – WHR, MAS
• Furniture – TPX, LZB, ETH
• Extensions – Lawn care – SMG
• Mortgage Originator – BAC, C
• Insurance Provider – PRU, MET

A change by the mortgage originator will likely have an impact on the entire industry. If Bank of America (BAC) tightens its origination standards, then people will buy fewer homes; homebuilders will buy less carpet to go inside the homes; fewer beds will be sold; etc. Therefore, before considering an investment in a homebuilder or related entity, it would behoove you to perform checks to see what else is occurring in related industries and sectors across the value chain.

Business Model Advantages

Barriers to entry.

Companies with barriers to entry have a huge advantage relative to companies that do not. These barriers can occur for a variety of reasons, but some of the most common include economies of scale, substantial investment requirements, technological innovation, favorable government regulation, and networking effects. eBay, for example, is an extremely difficult company to compete against, because the company has established a formidable position as the largest Internet-based auction site available. Both buyers and sellers are unlikely to go to other sites, because both realize that eBay offers more individuals on the other side of the aisle to transact with. This makes it hard for new auction companies to compete with eBay effectively.

Companies in most industries will claim that they have high barriers to entry, but time will often show that a company earning significantly higher than its cost of capital will attract competitors. Put simply, if the company is earning outsized returns on the capital it invests, then it will attract competitor investment seeking to earn comparable returns. This competitive investment will result in increased production and sales competition, and diminished profit-earning potential will surely follow in the future.

Cost Advantages

The low-cost producer can have a huge advantage over its competition. In industries with large legacy assets, such as cement or coal production, the players with the newest assets are typically the lowest cost providers, and that allows for lower pricing often results in greater market share.

Alternatively, there is also a learning curve that can create the reverse effect, wherein the older industry participants have lower costs as the newer players are still “figuring it out.”

Customer Habits

Repeat purchase items, such as paper or office supplies, can create a strong advantage for the producer. The more entrenched companies become within their customer bases, the higher the switching costs for those customers. For example, a large technology roll-out may effectively lock a customer in to the provider’s products, as it costs too much to execute a complete technology overhaul to switch to a different vendor.

Economies of Scale

Companies with large fixed costs need scale in order to make a profit. The larger the fixed costs, the larger the scale needs to be. Incremental margins can be very high once a company crosses a certain threshold and is able to sufficiently leverage its cost base. This can make a company highly attractive and cause a company to trade at a high multiple, once the threshold production level has been achieved. This phenomenon is sometimes referred to as “operating leverage.”

Oligopolies, or Monopolistic Competition

Functioning oligopolies can act similar to monopolies, in terms of locking in outsized profit margins from its business. These situations should not take place for long according to basic economic theory, but they can and quite often do. For example, the roofing industry has greatly consolidated in recent years, so that four players currently control 80% of the roofing shingle manufacturing market. When one of the four manufacturers raises its prices, the other three can easily follow. For the past five years, none of the players has broken from the pack and tried to steal market share from the other three by offering a lower price. As a result, the industry has seen its operating margins grow from 8% to 20% in recent years. Whether this increase in margin is sustainable over the long term remains to be seen.

Expected Return

What is a “good” return for a portfolio? How do you know? What is a good return for an individual investment?

The Academic Approach

Expected Rate of Return = Risk-free return + Beta × (Expected Market Return – Risk-free return)

This is the equation from the Capital Asset Pricing Model (CAPM), which you will learn in school—but try pitching this to a portfolio manager at a hedge fund. He or she will likely tell you to get lost!

Theoretically this makes perfect sense, but most hedge funds don’t use this as a hurdle rate. Most funds target a 20% return—though very few are capable of actually achieving that return consistently.

The Practical Hedge Fund Approach

A more practical approach is to study what percentage of the time you will make money and lose money on your investments. From there, you need to understand how much you make when you are right and how much you lose when you are wrong. Here is an example of this framework:

As you can see:

Average Return per Idea = (% Right × Avg. Return When Right) + (% Wrong × Avg. Loss When Wrong)

% Right is often referred to as your “Hit Rate,” and Average Return When Right is often referred to as your “Slugging Rate.” The magnitude of your wins relative to that of your losses is referred to as your “Win/Loss Ratio.”

The best analysts are right about 60% of the time. Most people think they will be right closer to 75%, but the sad truth is that most investors will not do much better than 50%. You can still make money being right only 50% of the time, but you have to be very disciplined about cutting your losses. That is why maintaining a 2-to-1 Win/Loss ratio is so important.

Here is what is so troubling about the example given above: a fantastic analyst who is right 60% of the time, makes a 30% return when right, and maintains a 2-to-1 Win/Loss ratio, will only earn an average return of 12% per idea. However, as we noted, most hedge funds try to earn 20%, so how can they do this?

One possible solution is to employ leverage, but from an analyst’s perspective, he/she typically does not have control over this. So how can an analyst generate a higher return per idea?

A higher Hit Rate is very difficult to achieve. Also, achieving greater than a 2-to-1 Win/Loss ratio is also not realistic, as it would require tighter stop-loss controls that may result in the premature exit of lucrative investments simply because they took an initial “hit” before panning out.

Therefore the only real area to control is the Slugging Rate. If this is the lever, then the analyst cannot afford to invest in stocks that will only earn 10%, 20%, or even 30%. It is just not a high enough annualized return. At a 40% Slugging Rate, the analyst can get closer to the elusive 20% total return hurdle.

40% thus tends to be a “sweet spot” for many hedge fund analysts, as a minimum hurdle rate of return for putting on a position. If the investment only has a 6-month duration, then the return only needs to be 20%, which is roughly 40% on an annualized basis.

Searching for 40% Returns

What needs to happen in order for a stock price to increase? Either earnings need to expand, or the multiple needs to expand, or a combination of the two. The first step is to look at where the sell-side estimates are for the current year and two years into the future. If AAPL is trading at $611 today and is expected to earn $54 in 2013 and $63 in 2014, it is trading at 11x P/E and 10x P/E in 2013 and 2014. In order for the stock to reach $855, or 40% higher, you might project earnings to be 20% higher than the street in 2013 at ~$65, and for the multiple to expand by 20% to ~13x. Or, you might predict stronger earnings growth and less multiple expansion, or vice versa.

As you can see, it pays to think through different scenarios needed to achieve your target return.

A common mistake analysts make is to say that they believe a stock will appreciate by an amount but have earnings expectations that equal or are very similar to those of sell-side earnings estimates. That means that for the investment thesis to prove correct, the stock must increase entirely due to multiple expansion. That is generally viewed as a “low-quality” thesis, as expansion in a valuation multiple is more difficult to predict and gain confidence in than is growth in earnings.

Home » Blog » Fund Management » What is an Investment Thesis and 3 Tips to Make One

What is an Investment Thesis and 3 Tips to Make One

• July 10, 2022
• Lanturn Content Team
• Fund Management

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Whether you are a start-up founder or a first-time fund manager, learning how to write an investment thesis, can greatly assist you in attracting venture capital. Venture capital is a promising route, it can provide you with access to cash and expert advisors who can assist with day-to-day operations. Furthermore, venture capitalists can help guide you on your journey towards becoming the next big thing. In this article, we will provide you with tips for crafting an investment thesis, and offer insights into fund management and investing.

As a business-friendly region for aspiring fund managers and startups, Singapore is no stranger to venture capital, as evidenced by the total number of Singapore-based startups backed by venture capital reaching  S$11.2 billion in the first nine months of 2021 , doubling the whole amount raised in 2020. Although the number is predicted to increase in the coming years, it is crucial to remember that venture capital investors are highly selective; they will not invest in a company without thorough due diligence and vetting.

What is an investment thesis?

Would you invest in a business with no vision, guiding principles, or viability? Most likely, you will pass on the idea, no matter how much return is promised. This is why an investment thesis becomes crucial.

An investment thesis is a proposal that venture capitalists and investors make regarding a particular investment or entire asset class before investing in it. The thesis states their belief about why a particular investment will give them a good return in the future. Therefore, meticulous research is required to predict potential growth and determine the current market sentiment. If the thesis remains valid, then the investment should be continued, even in a downturn. Meanwhile, if the thesis turns out to be false, the asset can be sold and the investor can move on.

If you are a startup founder seeking investment, you must check if the goal of your startup is aligned with the investment thesis of the investor even before you pitch to them, so as not to waste time. For example, if your startup is about saving the climate, you should find an investor whose investment thesis is about impact investing. Other examples of investment thesis could be about a positive outlook on crypto or about investing in real estate.

You can  get a fundraising consultant  to help you with this.

How to make an investment thesis?

An investment thesis is not something that can be done on a whim. It must be well-thought-out. Here are three steps that you should take in creating an investment thesis:

Determine the cause of the trend

In crafting an investment thesis, you should elaborate on the trends that support your view of why this new venture would be a success. For instance, if you want people to back your new fintech venture, you may want to state that in today’s digital age, people are increasingly spending their time online and becoming dependent on mobile devices, including when it comes to their finances. They want everything to be instant and within reach, just by the tap of a finger.

This presents an opportunity for fintech to fill the demand, especially as mobile and internet penetration continues to increase worldwide. This section should support your view on why investing in fintech will pay off down the line. Remember to include market size potential or appetite for the service to bolster your argument.

Moreover, you should assess whether the industry itself has a place in the foreseeable future. As the world becomes more interconnected, it can be said that the probability of digital banking and fintech adoption is relatively high. Such a view was further realised during the pandemic when lockdowns and social distancing measures meant customers needed to find a new way to fulfil their financial needs — ultimately leading to a boom in fintech usage.

Assess the existing trend

After researching the cause of a given trend and market sentiment, it is time to make the case for why investors should back companies that will fit the investment thesis.

For instance, people started to rely on their smartphones, which became all-encompassing devices that answered every need at about the same time that internet penetration seemed to increase every year. It was in this environment that Grab, a booking platform for taxis in Southeast Asia, first started. Since then, they have transformed into the Super App that it is known for today, providing car rides, food, and even grocery shopping and investing services.

Becoming the first in Southeast Asia allowed Grab to establish market share and dominance long before other competitors. While it is true that Gojek was established in 2010, they relied on traditional call centre service for the first few years of operations and just started using an app in 2015. Additionally, they did not expand their Southeast Asia operations until much later, unlike Grab, which expanded to Singapore a year into operations.

This applies to all businesses and startups, not just digital native companies. For example, if you want to open a coffee shop, you must know the potential market in your area and list down the reasons why your coffee shop has potential. Perhaps it is located in a trendy and upcoming neighbourhood surrounded by commercial and residential properties, or you have a Korean-inspired flavour, piggybacking on the buzz surrounding anything Korean nowadays.

By highlighting these differentiating factors in your investment thesis, you effectively showcase why your venture has a competitive edge and the potential to succeed amidst the existing trend. This will attract investor interest and support for your startup.

Consider the risks involved

While starting a business may offer you a fantastic upside, it is still a risky endeavour. Even if you have the experience, starting something new does not always go according to plan. Therefore, it is often said that becoming an entrepreneur is not for the faint of heart. Not everyone has the stomach to ride the ups and downs of establishing a new venture.

You may have grand plans in your head, but executing them into reality is a different ball game. That is why you need to list the possible worst-case scenarios that might occur in your startup and how you will address them to minimise their risk. This will give your investors confidence in your business, meaning that your business is not a flash-in-the-pan startup idea but a well-thought-out one with viability in the future.

Harking back to the fintech example, the risks could be cyber-attacks on the platform or hesitancy to adopt digital platforms, particularly among older generations, which may impact market reach and investment return. Your investment thesis should include ways to deal with such incidents, including hiring and training security experts and regularly holding workshops for seniors in urban and rural areas.

An investment thesis is a written document that explains why you believe investing in a specific asset will yield a good return in the long run. The belief should be backed by comprehensive research and analysis, not driven by a fear of missing out on the current investment trends or following the tips of an influencer. The document will function as a guide or reference to keep your emotions in check on the roller coaster ride of investing.

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• Feb 27, 2023

How to Write the Perfect Investment Thesis

For investment managers, finding investment opportunities is only half the challenge. Often the harder part is raising funds. To do this they need to create the perfect investment thesis to set out a convincing argument as to why their investment strategy will generate a return on investment for their clients. In this article, we’ll explore the importance of crafting a perfect investment thesis and provide insights into how to write one.

What is an Investment Thesis?

An investment thesis outlines a fund manager’s investment strategy and rationale for investing in a particular market or niche. It’s a crucial document that investment managers use to provide investors with the information and data they need to decide whether or not to invest in a fund. It can be turned into a variety of marketing materials for the fund including white papers, one-pagers, and investment decks.

The investment thesis should be concise and articulate the investment logic and framework for why a particular market or niche presents an attractive investment. It should outline the investment strategy and how it aligns with the fund manager’s hypothesis. The thesis should also address potential risks and benefits to investors.

Successful investment theses typically include an analysis of market trends, an assessment of the competitive landscape, and an explanation of why the investment opportunity presents an attractive opportunity.

In 2013, Ron Baron, a fund manager, invested in Tesla. At the time the stock was trading at $25 per share. However, Baron believed that electric cars were the future , and he was convinced that Tesla would become the leader in the EV industry. Ten years later, Tesla’s stock is trading at over $200 per share, making it one of the most successful investments in recent years.

Step-by-Step Guide to Writing the Perfect Investment Thesis

Crafting the perfect investment thesis is not an easy task. It requires a great deal of research, analysis, and writing skills. Follow our step-by-step guide to write a perfect investment thesis.

Step 1: Define Your Investment Strategy

Determine your investment goals and objectives.

To define your investment strategy, you need to first need to understand your investment goals and objectives. Are you looking to invest in high-growth companies or established companies that generate a stable return? What is your investment horizon? What is risk profile? How much capital do you need to raise?

Identify investment opportunities

Once you have defined your investment goals and objectives, you need to identify your target market and investment opportunities in that market.

Define your investment strategy

Having determined your goals, risk tolerance and capital requirements you need to create a high-level investment strategy. This is a set of principles that will help the fund achieve its investment goals and guide investment decisions. This can be refined as you conduct market research and receive feedback from investors and industry-peers.

Step 2: Conducting Market Research

An investment thesis that is not backed by data is just opinion. To write the perfect investment thesis you need to conduct market research. This includes analyzing market trends, identifying potential risks and benefits, and conducting competitive analysis.

How to analyze market trends using data

To analyze market trends, you need to collect and analyze data. Data can come from a variety of sources including industry reports, financial statements, and news articles to identify trends in the market. You can also use tools such as Google Trends to identify search trends for specific keywords. There are also opportunities to use official data to back up claims, for example census data to prove an investment thesis based on demographic trends.

A variety of alternative data sources are available. these include:

Web scraping : Scraping data from online sources including social media sites, e-commerce or news stories. This data can be analyzed using natural language processing techniques (categorization, sentiment analysis).

Open data : There is a growing trend of organizations making data freely available. Good examples include traffic patterns on metro networks such as TFL in London .

Sensors and satellites : A growing industry of data providers is providing access to alternative data sources. From satellite data showing agricultural production to IoT sensor devices.

Polls and Surveys : Surveys provide insights into the collective consciousness. From tangible economic behaviors such as buying and shopping habits, customers expectations, information on personal finances, to social and political views.

Identifying market opportunities and potential risks

Having analyzed market trends, you need to identify market opportunities and potential risks. Investors need to be aware of different types of investment risks, such as market risk, credit risk, and liquidity risk associated with your investment thesis. A thorough analysis of potential risks helps investors make informed decisions and ensure that the investment is aligned to their risk appetite. The analysis should cover both systematic and unsystematic risks, There are a variety of statistical methods than can be used to measure risk and volatility including standard deviation, Sharpe ratio, beta, value at risk (VaR), conditional value at risk (CVaR), and R-squared.

Conducting competitive analysis

You may also want to include a competitive analysis. This looks at the competition in your target market. Who are the main players in the industry, their strengths, weaknesses, and competitive advantage.

Step 3: Developing Your Investment Hypothesis

The best investment theses include a well structured investment hypothesis. An investment hypothesis summarises why an investment opportunity exists in a given market. It should be based on your research and analysis and articulated in a clear and concise manner.

What is an investment hypothesis?

An investment hypothesis is a proposed explanation for a specific investment opportunity. It’s a statement that describes the investment opportunity and how it aligns with the investment manager’s investment goals and objectives.

Formulating an investment hypothesis based on your research and analysis

To develop a strong investment hypothesis, you need to review the data and information collected during your market research. Using this you need to identify key trends, opportunities, and risks and determine an investment strategy that allows you to achieve investment goals and objectives. This is the time to revisit and critique your initial investment strategy.

H4: Articulating the investment thesis in a clear and concise manner

Once you have developed your investment hypothesis, you need to articulate it in a clear and concise manner. This includes a clear investment logic and analytical framework for why a particular market or niche presents an attractive investment. You should also outline the investment strategy and how it aligns with your hypothesis.

Step 4: Writing the Investment Thesis

Having created the perfect investment thesis you need to structure the thesis and include key elements to make it persuasive.

The structure and format of a successful investment thesis

A successful investment thesis typically follows a structure that includes an executive summary, market analysis, investment hypothesis, investment strategy, and potential risks and benefits. The thesis should also include data and visual aids, such as graphs and charts.

Key elements to include in your investment thesis

To make your investment thesis persuasive, you need to include key elements such as a clear articulation of the investment opportunity, a detailed explanation of the investment hypothesis, an overview of the investment strategy, and describe the risks and benefits for potential investors.

Writing with clarity and brevity

To make your investment thesis easy to read and understand, you need to write with clarity and brevity. Use simple language and avoid jargon. Keep the thesis concise and to the point.

What type of resources and marketing materials do you need to create

Having defined your investment thesis you know need to create a variety of marketing materials in order to present to potential investors. These will vary depending on the type of investors and the regulatory framework you operate under. Some common investor marketing materials include:

Investor decks

An investor deck is a summary of your investment thesis. It should include a summary of your investment hypothesis, market opportunity with data, investment strategy, expected outcomes, risks, and benefits to investors. The investor deck should be concise and easy to understand. Avoid lengthy text and present the opportunity using relevant data points. Employing a professional designer will maximize the impact of your investment thesis.

The structure of an investment deck forces you to focus only on the key points, consequently a clear analytical framework or investment logic is essential.

White papers

A white paper is a more detailed description of your investment thesis. It should include an in-depth analysis of the market trends, competitive landscape, and investment opportunity. The white paper should also include an overview of your investment strategy and potential risks and benefits.

Investment one-pager

An investment one-pager is a brief summary of your investment hypothesis, market opportunity, and risks and benefits. It should be a one-page document that investors can quickly review to understand your investment opportunity.

Step 5: Refining and Perfecting Your Investment Thesis

The final step in writing a perfect investment thesis is to refine and perfect it. You need to continuously refine and improve your thesis to ensure it’s persuasive and effective.

Revising and editing your investment thesis

Once you have written your investment thesis, you need to revise and edit it. Review the thesis for grammar, punctuation, and spelling errors. Ensure that the thesis is clear, concise, and persuasive. Nothing will damage your credibility more than easily fixed errors or incorrect data.

Seek feedback from peers and industry experts

You should seek feedback from peers and industry experts to ensure that your investment thesis is persuasive and effective. Aim to get feedback from colleagues, mentors, or industry experts all of whom can offer a unique outside perspective.

Continuously refining and improving your investment thesis

Investment managers should continuously refine and improve their investment thesis. They should review the thesis periodically and update it as needed to reflect changes in the market or investment strategy.

Crafting a perfect investment thesis is a crucial task for investment and fund managers. The investment thesis is a document that outlines the investment strategy and rationale for investing in a particular market or niche. A good investment thesis provides investors with a clear understanding of the investment opportunity, the risks and benefits, and the potential return on investment.

To write a perfect investment thesis, investment managers need to define their investment strategy, conduct market research, develop an investment hypothesis, craft the thesis, and refine and perfect it. They should also create marketing materials such as an investor deck, white paper, and investment one-pager to summarize their investment opportunity. Investment managers should continuously refine and improve their investment thesis to ensure it’s persuasive and effective.

How Interpretive Economics can help you write the perfect investment thesis

At Interpretive Economics, we help investment managers, asset managers, venture capital, family offices and other investment professionals create a variety of investment marketing materials including investment white papers, investor decks and investment one-pagers. We are experts at economic analysis, sourcing and analyzing data and crafting investment hypotheses. Get in touch to see how we can help you create the perfect investment thesis.

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How to Write an Investment Thesis in Private Equity

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Recent years have posed significant challenges for M&A activity, with private equity deal volume experiencing a stark 46% decline compared to the previous year in 2022. Similarly, venture capital deals globally saw a notable 42% decrease in the first 11 months. Moreover, the mounting dry powder, surpassing $1 trillion USD in the US alone, underscores the urgency for firms to adapt their business strategies to thrive in 2023 and beyond.

Amidst this landscape, transitioning to a direct sourcing model alongside intermediary deals is imperative. However, economic uncertainties compel firms to further refine their outbound strategies to capitalize on opportunities efficiently. Dealmakers face the crucial task of optimizing their time and focusing on strategic investments that align with their objectives. Crafting a compelling investment thesis becomes paramount, guiding direct deal sourcing efforts and enabling firms to differentiate themselves in a competitive market.

Read on to discover how a meticulously crafted investment thesis can drive success in direct deal sourcing strategies.

What Is an Investment Thesis in Private Equity?

An investment thesis is, quite literally, a thesis statement. It's succinct, yet comprehensive enough to serve as your firm's guiding principle to both source and secure ideal investments. 

Imagine you're back in school and writing a term paper. Remember how a thesis was treated as a single defining statement that guided the development of your entire paper? The same is true of an investment thesis for your private equity firm. Unlike your term paper, however, firms often have more than one thesis because they often focus on multiple types of deals at once. 

Dealmakers' theses can also be broken down into two specific types: top-down and bottom-up. A top-down investment thesis is something that helps your team understand and seek out ideal investment targets when sourcing.

Top-Down Investment Thesis for Venture Capital Example:

‍ "This $10MM seed fund focuses on US-based cannabis startups that are furthering the industry through technology and infrastructure research and development that can leverage our partners' vast experience in the logistics and supply chain sectors."

Once your firm has identified an ideal company that fits its top-down thesis, it's time to create a bottom-up version. Far more direct and specific in nature, a bottom-up investment thesis includes everything from particular information about the target company including financial statements and forecasting, future business plans, funding strategy reasoning, industry trends, etc. as well as why your firm is the best choice.

‍ Bottom-Up Investment Thesis for Private Equity Example:

‍ "Smith Partners is seeking to invest a $20MM Series A round in Asclepius, Inc. to aid in their rapid growth and contributions to the advancement of the healthcare industry. Their dedication to modernization combined with SP's vast network of cutting-edge automation manufacturers and forward-thinking healthcare providers make this partnership particularly exciting."

A bottom-up thesis would then continue into specifics about the company, detailing financial and employee records, proprietary knowledge or advantages such as patents, and more about what your firm brings to the transaction. A final bottom-up thesis can take many different forms: e.g., a comprehensive document, presentation, or video.

The key to both a top-down and bottom-up investment thesis is specificity. Every thesis your firm creates should be valid only for your firm . The combination of geographic location, sector or industry, company stage or type, fund size, reasons behind the investment or focus, and your firm's specific differentiators should make each of your theses unique.

Steps for Building an Investment Thesis Framework

Creating an investment thesis framework will help your firm draft theses more quickly and make sure all of the necessary information is included. Answering the following series of questions is a good place to start building a framework for both top-down and bottom-up theses:

• What is the goal of this thesis? This answer takes one of two forms: to find new target investment opportunities or to secure a potential deal. But before you can detail the rest of the thesis, you must know your end goal. ‍
• What are the basic parameters of your ideal deal? Once you have your overall goal, sort out the basics first: overall available capital, company demographics (e.g., location, size, industry), etc. ‍
• What are the influencing internal factors? What is your firm hoping to get from a deal that would fit this thesis? Do you need to bridge a valuation gap in your portfolio, for example? ‍
• What are the influencing external factors? If you've ever gone through a thematic sourcing exercise, this will feel similar. While your thesis should not be nearly as large in scope as a thematic investing strategy, socioeconomic or industry trends can be a driving factor for why your firm is looking at this type of investment and should be called out in your thesis. ‍
• Why your firm? While this is the simplest question, it's not only the most difficult to answer but also the most important. Your differentiator "what only your firm can offer to the industry or target company" and why you are particularly suited to this segment of the market (in a top-down thesis) or specific deal (in a bottom-up thesis) is the key to crafting a successful investment thesis in private equity. ‍
• Why this deal? For a bottom-up thesis, you must detail why this deal should be transacted: - Why this company? Is it the founder that instills confidence? Do they have intellectual property that makes the deal worthwhile? How are their financials impacting this decision? - Why now? - What does the future look like and what are your plans post-transaction? - What is the eventual exit strategy? When would you plan for that to happen? - How does this deal impact your portfolio?

The framework you build from answering these questions can then be refined into a single statement or document that serves as your thesis. But be prepared to make iterations. You must continually refine your theses as you gather more data, learn more about your ideal investment, and the world continues to evolve and change.

Putting Your Investment Thesis to Work

Once your firm establishes a thesis, it's time to leverage it effectively. Remember, a well-crafted thesis serves as a guide for qualifying opportunities and determining their potential value. Integrating your top-down criteria into a robust deal sourcing platform facilitates market mapping, identifies relevant conferences, enables direct sourcing, and offers comprehensive insights into target companies and their competitive landscape.

With over 190,000 sources and millions of data points, Sourcescrub's deal sourcing platform has consistently enhanced research productivity by 42.8% and expanded deal sourcing pipelines by 36%. Let's chat to explore how we can assist you in developing and executing your investment theses in any industry landscape.

Originally posted on “January 10, 2023”

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Value investing in all its forms - From Graham & Dodd, to Buffett & Munger, to their philosophical descendants today

What makes a good investment thesis?

I'm a non-professional investor but I really love (trying) to write investment theses to help me better understand the companies I'm investing in. I think I have an issue where I feel like I'm just summarizing their annual reports, which I'm currently trying to work on improving.

With all this said, I was wondering if you had any tips you'd provide to someone trying to get better and/or if you've read any investment theses that have stood out to you in the past?

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Whether you're thinking about pursuing an advanced degree in education or are already in such a program, one thing you will need to be prepared for...

Writing a winning thesis or dissertation: guidance for an education graduate student.

Posted on July 31, 2024 on Graduate School , Seahawk Nation

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Whether you’re thinking about pursuing an advanced degree in education or are already in such a program, one thing you will need to be prepared for is writing a thesis or dissertation. In most graduate-level education programs, a thesis or dissertation is the culmination of years of challenging work, serving as your own independent research that marks the final step before earning your graduate degree.

If writing a dissertation or thesis sounds like a daunting task, it does not have to be. With a little preparation and some best practices in mind, you can approach writing a thesis or dissertation with confidence.

Understanding the Thesis and Dissertation Process

Before writing a thesis or dissertation, it’s important to understand their general scope and purpose, along with some key differences between a thesis and a dissertation. After all, while there are some similarities between the two, a dissertation and a thesis are not the same thing.

Defining the Scope and Purpose

The primary purpose of a thesis or dissertation in an education graduate program is for students to demonstrate what they have learned in their respective programs while applying their own research, theory, analysis and synthesis. Ultimately, the author of a thesis or dissertation should successfully contribute something new to the existing topic. In dissertations specifically, students may also be required to articulate, discuss and defend their research orally in front of professors or other faculty members. This oral defense is not required for a master’s thesis.

Differences Between Thesis and Dissertation

When it comes to writing a thesis or a dissertation, the terms “dissertation” and “thesis” are sometimes used interchangeably. That said, it is crucial to understand that these are two different things. Generally, a dissertation is primarily focused on filling a gap in existing literature or extending upon current research regarding a specific topic. The goal is to analyze literature to the point of saturation and determine where there is a need for further research. In a dissertation, a doctoral student will then explain where the problem exists given current research and develop a research study to explore or evaluate the problem, thus filling the gap and contributing meaningfully to the field.

On the other hand, a thesis is more of a presentation of information that’s already out there with no obligation to conduct additional research.

Choosing the Right Topic

One of the most important aspects of drafting a great thesis or dissertation begins with choosing the right topic. Here, it is paramount to select a topic that not only interests you but is relevant to your future professional goals and aspirations. After all, there’s a good chance you may use your thesis or dissertation as a basis for future work or further research.

Considering Current Research Trends

In selecting a topic, you will also want to consider current research trends in your field. What is trending in the realm of education and what could you contribute to existing research? There are research gaps or questions that remain unanswered about certain educational topics that could be addressed through your research.

Research and Proposal Development

In most graduate programs, you will need to write and present a research proposal before you can really get started on your thesis or dissertation. Most research proposals are reviewed and approved by a professor or other faculty.

Conducting a Literature Review

A literature review is to discover the research available on your research topic. This review should detail each source you plan to use in your own research with plenty of detail. More specifically, a literature review is a comprehensive summary of the current literature on a given topic that demonstrates the need for additional research to be conducted. Literature reviews comprise a major portion of a proposal, including a summary of each source as it relates to the need for additional research.

Finding Reliable Sources

Quality is vital when it comes to selecting literature for your research or literature review. Ideally, your literature review should include plenty of recent and reputable sources that come from academic journals, books, articles and even other dissertations.

Developing a Research Proposal

Once you have a better understanding for what is already out there, you can craft a research proposal that discusses your specific research topic, the current problem, the purpose behind your research, the methodology you plan to use and the relevant literature that further defends a need for your topic to be investigated.

Methodology Selection

An important part of your research proposal will be your methodology selection, which will explain exactly how you plan to go about your research. For example, will your research be qualitative, quantitative or a mix of both and why? How will the methodology you choose answer your research questions?

Writing and Structuring Your Thesis or Dissertation

After your research proposal is approved, you will have the green light to begin working on your thesis or dissertation. You will receive feedback or thesis guidance from the faculty member who reviewed your proposal. It is important to reflect on the feedback and make revisions as needed.

Creating an Outline

One of the most helpful things you can do as you get started with your dissertation or thesis is to create an outline. This allows you to develop the most critical aspects of your final project that include your thesis, your main points and other key details to ensure that they flow logically.

For reference, an outline for a dissertation will typically include the following:

• Introduction of existing research
• Review of literature
• Conceptual framework
• Methodology
• Results or findings
• Interpretations, conclusions or recommendations for future research

Structuring Arguments

In creating an outline, include designated sections for each of your main points with specific research, statistics, or other data to support it. This will ensure that your arguments are made clearly and that your thought process is clear.

Writing Tips and Strategies

Even if writing is not necessarily your strong suit, you will need to be able to put together a cohesive document for your thesis or dissertation. There are some basic strategies worth keeping in mind to help you get started.

First, it can be helpful to write your introduction and conclusion paragraphs last once you have completed all your research. While it might seem counterintuitive to do it this way, it can help set the tone for the rest of your writing. Likewise, this strategy ensures that you include your main points while preparing your readers for the information to come.

Additionally, meet with your advisor or faculty sponsor regularly to gain valuable feedback and keep your project on track.

Data Collection and Analysis

Whether you are writing a thesis or dissertation, you will need to do a fair amount of your own qualitative or quantitative research. It’s important to understand the various data collection methods available to you, plus the best practices for analyzing and interpreting data.

Choosing Data Collection Methods

There are two main types of data collection:

• Quantitative data  - Refers to hard data that is numerical in nature, such as statistics and percentages.
• Qualitative data  - Refers to information that is non-numerical, such as interviews and focus groups.
• Mixed methods – Refer to a combination of both quantitative and qualitative data.

Analyzing and Interpreting Data

Once you have all the data you need to write your thesis or dissertation, the challenging part is often analyzing and interpreting the data to apply to your own research. The most important thing to keep in mind when looking at hard data is how it relates back to your research and specific research questions.

When working with quantitative data, it can also be helpful to look for specific trends and correlations that you can share in your research.

Reviewing and Editing Your Work

Once you have completed the first draft of your thesis or dissertation, the process of reviewing, revising and editing your work before submission is important to ensure that the document is free of errors and that it effectively communicates your main points to the reader.

Peer Review and Feedback

One of the best ways to improve upon the first draft of your dissertation or thesis is through peer review and feedback. By having others read your draft and provide feedback, you can gain some valuable insights into how your arguments are being interpreted. Even if the person you ask to read your draft is not familiar with the subject matter, they can still provide useful feedback on the organization of the information, structure and grammar/spelling.

Proofreading and Final Edits

It may take several rounds of revisions before your dissertation or thesis is approved. Even when you feel like the entire thing is ready to submit, it is important to complete another round of proofreading and editing to be sure that the entire document is polished and in the best shape possible. This includes not just running a basic spell check but taking the time to read your paper word for word.

Formatting Guidelines

In most education programs, you will be instructed to use the  American Psychological Association (APA) style when writing and formatting your thesis or dissertation. It is important to follow all formatting guidelines here, especially as they relate to citations or references.

Preparing for the Defense

In many doctorate programs and some graduate programs, students will also be expected to defend their dissertations in front of other scholars, usually professors or other faculty from the department. This process can be daunting, even for those who know their research well and have crafted thoughtful dissertations.

Crafting Your Presentation

In preparing for a dissertation defense, it is imperative to craft a presentation that covers the basics of your dissertation topic, how you researched it and what your findings were. Following your presentation, you can expect to be asked questions by those in attendance about your topic and other aspects of your research.

Practicing Your Defense

The best way to prepare for a dissertation defense is to practice as much as possible. This way, you will be prepared for the kinds of questions that may be asked, and you will feel a little more confident when completing your defense.

Mock Sessions

Mock defense sessions can be especially helpful for practicing your presentation and answering questions from a real crowd. Do not hesitate to ask your fellow students or even some trusted professors to practice with you to provide feedback or ask questions.

Handling Questions

One of the most difficult aspects of defending a dissertation is often answering questions from the audience. One important tip to keep in mind here is to prepare some answers in advance to some of the questions you think might be asked during your dissertation defense. This way, you will be completely prepared to knock these out of the park.

Ready to Pursue an Advanced Degree?

As you can see, there is a lot that goes into writing a dissertation or thesis as part of your graduate education program. With this dissertation guidance in mind, you will be prepared to craft and even defend your thesis or dissertation with success.

Still looking for the right graduate education program to suit your interests and professional goals? Keiser University is proud to offer a number of advanced degrees in education, including our  Master of Science in Education, Teaching and Learning  program. If you’re interested in earning your doctorate degree, we also offer a  Doctor of Education  and a  Doctor of Philosophy in Educational Leadership .

Learn more about any of the graduate programs offered at Keiser University by  contacting a graduate admissions counselor today, or get started with your online application  for enrollment.

Jessica Kircher

B. Riley Financial: Bad News Comes In Threes

• B. Riley Financial, Inc. faces severe financial challenges with escalating interest expense and substantial asset write-offs.
• The company's complex structure and speculative investments amplify its risk profile.
• B. Riley Financial's estimated cash inflows from various segments may not be enough to cover its interest expenses, putting the company in a challenging financial position.

Investment Thesis

With the significant drop in B. Riley Financial, Inc. ( NASDAQ: RILY ) shares, it's hard not to feel emotional, perhaps cheated and gaslighted. But, I believe, at least to those following me on Seeking Alpha, we all understood the risks when we chose to invest, driven by the potential for extraordinary returns.

Since I began covering this stock in early 2023, I've always presented RILY as a speculative trade. My only buy rating in January 2024 rested on the assumption that management would maintain dividends while turning around its business. But at the same time, I understood the odds and was aware of the risks. I noted in the same article the narrow dividend safety cushion, with nearly all operating cash flows going to pay dividends and interest, with RILY retaining little to offset non-cash mark-to-market losses.

I knew that management's focus on vulture investing was risky, potentially damaging the reputation of its investing banking arm. Their transformation into a holding company by acquiring businesses outside their core expertise also posed significant risks, as I highlighted in March 2023. I was aware of the complexities of their structure, and the issues with accounting and internal controls, which I pointed out in May 2023. I also noted that management might not be as skilled as they claim to be, questioning their assertions of generating extraordinary returns from acquiring declining consumer and telecom companies in my August 2023 article.

RILY is one of the most speculative companies I've covered in my career, a warning that you shouldn't take lightly, considering that I invest in space telecommunication and solid-state battery companies.

With the recent news of dividend suspension and the massive asset write-offs, I believe that a rating downgrade is warranted, with risks outweighing potential rewards.

Bad News Comes in Threes

Bad news comes in threes. Earlier this morning (August 8), RILY issued a press release announcing the suspension of all dividends and preliminary loss per share between $14 - $15, mostly from loan write-offs reportedly tied to The Franchise Group and its ex-CEO Brian Kahn. This is more critical than another issue floating on news media that the SEC is investigating RILY for improper risk disclosures. RILY is highly leveraged, and its loan portfolio is funded by debt. While its assets write-offs are non-cash losses, the lingering interest expense tied to the debt initially used to fund these investments squeezes margins.

The company estimates $370 million of debt write-offs in Q2. That's $50 million in interest income gone, based on a 13.5% interest typically charged by RILY, while $27.75 million of associated interest expense lingers on the income statement (based on an average interest expense of 7.75%).

The company expects a delay in releasing its quarterly statements, and most likely, we won't know exactly the extent of the damage a couple of months from today.

How Much Cash Does RILY Generate Each Year

Most of RILY's losses are write-offs tied to its bad investment decisions. The question is, would it generate enough cash to pay its debt? Here is a rough estimate of cash inflows per segment.

Capital Markets Segment

The Capital Markets segment, which includes revenue from RILY's investment banking activities, including IPOs, loan and equity underwriting, and brokerage services, stood at $445,000 last quarter. Still, when adjusting for non-cash items, such as Trading loss and fair value adjustments on its loans, the segment's income stood at $32 million. For simplicity, we exclude the impact of cyclical in this analysis and annualized this figure at $128 million. Obviously, we also excluded the risk that RILY might be subsidizing its borrowers so they continue paying interest, a common strategy among troubled lenders. We also don't account for Payment In Kind interest income, and assume all interest income is cash, which again might not be accurate.

Wealth Management Segment

RILY's wealth management includes fees it collects for managing roughly $30 billion in assets on behalf of its clients. RILY succeeded in turning around this business, which was largely unprofitable, with personnel costs exceeding the fees it collects. This changed in the past quarter, with the company reporting 1.7 million in segment income last quarter, or 6.8 million annualized.

Auction and Liquidation Segment

RILY is looking to sell its Auction and Liquidation segment, which offers liquidation services for troubled companies, mainly retail companies closing branches. The segment is a lot more risky and competitive than many think. RILY borrows cash to buy the inventory of its retail customers and then proceeds to sell them, or in some instances gives guarantees of a certain sale price. If RILY fails to sell the inventory, it is responsible for making up for the balance to its customers. In Q1 24, the Auction and Liquidation segment generated 2 million in net income, or 8 million annualized. Non-cash items are minimal, so, there are no adjustments here.

Financial Consulting

Financial consulting generates revenue from bankruptcy advice, asset value assessment, forensic accounting, and other financial services. In Q1 24, RILY generated 6.1 million from Financial Consulting services or 24 million annualized, most of which are cash inflows.

Communications and Consumer Product Segments

RILY's communications segment includes its odd VoIP, DSL, and Broadband business. In Q1 24, this segment generated about 8 million in segment income.

The Consumer Products segment includes Targus, a computer accessories company that sells items such as bags for laptops and mouse pads. The segment is struggling with deepening losses. When adjusting for non-cash items, these segments generated $12.5 million in segment income or $48 million annualized. This excludes write-offs, depreciation, and amortization of $8 million.

Other revenue of $27 million in Q1 2024, and associated expenses of 11 million adds net income of $16 million or 66 annualized. But then, this is weighed against corporate expenses of 33.6 million (134 annualized).

So, the adjusted EBITDA estimate for 2024 stands at roughly $147 million. This hardly covers the interest expense of $180 million, not to mention the preferred stock dividend of 8 million annually, putting RILY in a very challenging financial position.

Final Thoughts and How I Might Be Wrong

Holders of RILY's debt trading on the Nasdaq under ( NASDAQ: RILYP , RILYP , NASDAQ: RILYM , NASDAQ: RILYG , NASDAQ: RILYK , NASDAQ: RILYN , NASDAQ: RILYT ), should be mindful of the financial challenges facing RILY. While most of its losses are non-cash write-offs tied to its bad investment decisions, these assets are funded through debt held by investors. These asset write-offs signal a loss of future revenue, squeezing margins to the point that RILY now doesn't have enough to pay its annual interest.

RILYO matured in May. Next is RILYM which matures next year, with a principal balance of $146 million, followed by a wave of maturities in 2026; RILYG, RILYK, and RILYN, with a principal balance of $721 million, which will be harder to refinance. The most risky are RILYZ and RILYT maturing 2028, with a principal balance of $671 million. By that time, it was very difficult to know where RILY would be. The current trajectory doesn't instill confidence. This is why I believe that if you ever want to invest in RILY, which, I think, is a very speculative endeavor, RILYM notes maturing next year offer the best chance of actually getting paid on maturity. The notes are down 16% today, trading at $20 per share, with a yield to maturity of 33%.

I don't see a rebound happening soon, but I might be wrong. RILY is very complex, with different assets performing distinctly. The analysis also doesn't account for seasonality and cyclical. For example, the auction business is lumpy, and our figures might have overestimated the Auction and Liquidation segment's adjusted EBITDA. On the other hand, the Capital Markets segment suffered from slowing capital markets activity in Q1 24, A trend that might change as we progress through the year, which might prove our annualized EBITDA figures an underestimate of actual results. So, basically, we assume that these deltas between actual and estimated results, if materialized, would offset each other. Nonetheless, a $180 million in interest expense is not something to scoff at, and directionally, RILY's persistent asset write-offs, including a whopping $370 million estimated in Q2 24, signal more trouble down the road, further lending me confidence in this assessment.

This article was written by

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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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How to Turn Your TFSA Into a Gold Mine Starting With $10,000

You can get a lot of passive income by holding dividend stocks like the Toronto-Dominion Bank (TSX:TD) in a TFSA.

Image source: Getty Images

Do you know that the tax-free savings account (TFSA) is one of the most powerful wealth building instruments in Canada?

It’s true. Shielding your dividends, interest and capital gains from taxation, a TFSA significantly boosts your total returns compared to holding investments in a taxable account.

To some extent, the Registered Retirement Savings Plan (RRSP) shares these benefits. However, RRSP funds become taxable when withdrawn, whereas TFSA money is never taxable (provided you abide by the account rules). It’s for this reason that the TFSA is perhaps the best account to hold investments in, turning your portfolio into a tax-free “gold mine” of passive income. In this article, I will explore how you can establish a gold mine of your own, starting with as little as $10,000.

Find out your contribution limit

The first step in building a $10,000 TFSA “gold mine” is to find out whether you are eligible to do it. Your available TFSA contribution room is determined by how many years worth of new contribution room accumulated since you turned 18, and the annual amounts. If you turn/turned 18 this year, you have only $7,000 worth of contribution room. If you were born in 1991 or earlier, you have $95,000 worth of contribution room (assuming you haven’t used any). You can find out your exact amount of TFSA contribution room on CRA MyAccount, which can be accessed on the Canada Revenue Agency (CRA) website.

Deposit funds

Once you know your TFSA contribution limit, you can safely deposit funds. I say “safely” because the cost of contributing more than you’re allowed to is a 1% monthly tax. You want to retain your TFSA’s tax-free status, as this quality is what makes your TFSA worth investing in. So, only once you have checked your contribution limit on CRA MyAccount should you deposit funds. If you are 19 and haven’t made any contributions yet, you should be able to deposit the $10,000 mentioned at the start of this article.

Invest in income-bearing investments

Once you have a TFSA funded, you need to decide what to invest in. In general, dividend stocks and interest bearing bonds are good TFSA holdings. Stocks that offer only capital gains do not make the best use of the TFSA’s tax shelter, because you can defer paying taxes on them for a very long time. If you hold a non-dividend stock for life, you never pay taxes on it at all!

So, dividend stocks and bonds are ideal TFSA holdings.

Consider The Toronto-Dominion Bank ( TSX:TD ), for example. It’s a dividend stock with a 5.1% yield at today’s prices. If you invest $10,000 in it, you get $513 in annual dividend income. By holding the stock in a TFSA, you can avoid paying taxes on those dividends, as well as on any capital gains you may realize by selling the stock.

How much money can you save by holding TD in a TFSA?

First, let’s figure out how much tax you’d pay on TD shares in a taxable account. For this exercise, we will assume that you live in Ontario.

Canadian dividends are “grossed up” by 38%, so the $513 in dividends becomes $708 for tax purposes. If your marginal tax rate is 33%, you’d pay $236 in taxes on $708 in employment income. However, since this is dividend income, it is reduced by two dividend tax credits: the 15% federal credit ($106.2) and the 10% Ontario credit ($70.80). So the $236 tax is reduced to $59. That’s quite a bit of savings right there from the dividend tax credit. However, by holding TD in a TFSA, you pay $0 in taxes. So, you save $59.

As you can see, holding dividend stocks in a TFSA can save you a lot of money in taxes. So be sure to hold at least some of your investments inside one. It’s just a plain logical thing to do!

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