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How to Analyse a Company's Business Model

It is essential for medium and long term equity investors to understand how a company makes money before buying their stock. Owning a stock entitles the investor to part ownership of the business. Fundamental analysis provides the tools to assess the quality of the investment. 

 

An investor is considering buying a local business - a toy store. Should the investor base the decision entirely on the seller's earnings last year and the profit forecast next year?

That will not be wise. There are many additional considerations to take into account e.g.:

  • Who supplies toys to the store? At what price?
  • What does the competition pay for the same or similar products?
  • Are there alternative suppliers in the event of a main supplier going out of business, or having supply problems?
  • What is the current demand for the store's products and services?
  • Who are the main customers?
  • What is the industry outlook? Are sales increasing or decreasing year on year?

This information begins to describe the store’s business model, competitive position and industry outlook.

Ironically, most investors will evaluate these factors if they wanted to buy a business. Yet, only a few investors analyse these aspects of the company when buying their stock. These investors make informed decisions in the market and reap the rewards. 

Understanding the company’s business model serves as an indicator of the profit potential of its stock.

Start by gathering basic information about the company and related industry. Take the following factors into consideration when evaluating a company’s profit potential. 

 

1. What is the Company’s Main Business?

The first step is to identify how the company makes money. What are their main sources of income generation i.e. what products and services do they sell? This information is readily available in the public domain, usually via the company's website and financial statements. Market analysts also provide extensive coverage on listed companies and their product and services.

This forms the preliminary stage for analysing a company's business model to gain a better understanding their operations.

 

 

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