MODULE 5: COMPANY ANALYSIS: PAST AND PRESENT

Company Analysis: Past and Present

1. Think like this: before you value a stock, you need to know what this business actually is, how it makes money, where the cash leaks out, and whether management is putting capital into smart places or stupid places.
2. A proper company research report is not just “buy, hold, or sell.” It should tell you the company story, the industry setting, the financial engine, the valuation, and the risks that can make your thesis look foolish.
3. Initial report is the big onboarding document. Subsequent report is the update memo after earnings, guidance changes, or a change in recommendation.
4. Common items in a thorough report: Recommend Model Industry Value Risk RM_IVR
   • Security name, identifiers, recommendation, and target price.
5. A simple explanation of the business model and strategy.
6. Industry size, growth, competition, and external pressures.
7. Historical financial analysis and the forecast model.
8. Valuation using more than one lens.
9. Risks on both the downside and upside.
10. If a report jumps straight to valuation without telling you how the machine works, be suspicious. That is how people talked themselves into stories like WeWork, where the “tech platform” narrative sounded glamorous but the underlying business was still a very old-fashioned lease-long, rent-short office model.

1. To determine a business model, ask five boring questions and answer them brutally honestly: (What Whom Reach Payment Dependency (WWRPD))
2. What is the company selling? Product, service, subscription, brokerage, platform access, financing, or some mix.
3. To whom is it selling? Mass-market consumers, hospitals, governments, software developers, luxury buyers, small merchants.
4. How does it reach the customer? Stores, app, sales force, distributors, online marketplace. Customers reach out to Boeing while Spotify runs ads to reach customers via App Store.
5. How does it get paid? Upfront, subscription, commission, installment, advertising, membership. Boeing does a contract today and might get paid 5 years later, while Spotify will charge you in advance and deliver service later.
6. What does it rely on to operate? Suppliers, labor, brand, patents, warehouses, software, licenses, payment networks. Boeing relies on suppliers, patents, licenses, technology while Spotify relies on software and brand.
7. MoviePass looked like a subscription business, but the economics were upside down. Customers paid a low monthly fee while MoviePass reimbursed cinemas at near full ticket prices. The story sounded modern; the unit economics was broken. Think using the unit economics mental model: does the company recover the cost to make one unit (on average).
8. Information sources for business model work:
9. Annual report and quarterly filings.
10. Earnings calls and investor presentations.
11. Company website, stores, app, or physical properties.
12. Industry reports, trade publications, and general news.
13. Your own primary research such as store visits, surveys, or product checks.
14. Think Costco: low margins on merchandise, recurring membership income, limited assortment, fast inventory turnover, and a low-cost operating model. That is why membership fees matter so much. They are not side income. They are the cushion that makes the whole model attractive.

1. Revenue analysis starts after you understand the model. For most companies, revenue is the first line to attack because if your revenue forecast is wrong, the rest of the model becomes decorative nonsense.
2. There are two clean ways to break revenue down:
3. Bottom-up: start from units, stores, users, average selling price, subscriptions, or segment revenue.
4. Top-down: start from market size, market share, and broad drivers such as economic growth.
5. In plain English, bottom-up asks, “How many burgers did McDonald’s sell and at what price?” Top-down asks, “How big is the quick-service burger market and what share does McDonald’s own?”
6. Both views matter. Bottom-up helps you see the gears. Top-down stops you from writing fantasy. If your model says a company will double sales in a market that is barely growing, you had better have a very good market-share story.
7. Revenue formulas to keep in your head:

1. Watch for cannibalisation. If Starbucks opens too many stores in the same area, the new store may steal traffic from the old one. Total company revenue may rise, but store economics quietly get worse.
2. Pricing power is one of the most important ideas in equity analysis. It means the company can raise prices, or keep economic terms favorable, without killing demand.
3. Apple has pricing power. It can charge a premium for an iPhone because brand, ecosystem, and switching costs are real. A generic memory-chip producer usually has much less pricing power because the product is easier to compare and buyers can switch.
4. The acid test is not just “Did price go up?” The real test is: Did price go up without volume collapsing, and did margins hold or improve?
5. This is where famous consumer scandals teach a useful lesson. In the 1970s, Coca-Cola had enough brand power to push through price increases repeatedly. But when New Coke tried to tamper with the emotional bond customers had with the brand, consumers revolted. Pricing power is real, but brand trust is part of it.
6. If costs rise 5% and the company can raise prices only 2%, the firm is not in control. The customer or the industry is.

1. Now come operating profitability and working capital. This is where you ask: after selling the stuff, how much money does the business actually keep, and how much cash gets trapped in the day-to-day machine?
2. Main profitability measures:
3. Gross margin = how much is left after direct cost of sales.
4. Earnings before interest, taxes, depreciation, and amortisation margin = profit before financing, tax, and the big non-cash wear-and-tear charges.
5. Earnings before interest and taxes margin = operating profit after depreciation and amortisation.
6. Gross margin is a rough clue about product economics. Operating margin tells you what survives after the full operating machine has eaten.
7. A luxury company like Hermès can keep very high margins because it has brutal pricing power and disciplined supply. A supermarket cannot. Its job is to sell huge volume on thin margins and survive through efficiency.
8. Fixed versus variable costs matter because they tell you how violently profit will move when sales move.
9. A software business often has high fixed cost up front and low variable cost per extra customer. Once the product is built, each extra subscription is beautiful. A hotel or airline also has heavy fixed costs, but with much uglier economics when demand falls because the empty room or empty seat dies that night.
10. That is why a downturn crushes high-fixed-cost businesses. The revenue falls quickly, but the costs do not politely follow.
11. Degree of operating leverage tells you how sensitive operating profit is to sales: $$ \text{Degree of Operating Leverage} = \frac{\% \text{ change in operating profit}}{\% \text{ change in sales}} $$
12. Working capital is the money stuck in receivables, inventory, and payables. It is boring, but it can quietly make a mediocre business look healthy or make a healthy business look sick.
13. Core working-capital rhythm: $$ \text{Cash Conversion Cycle} = \text{Days Sales Outstanding} + \text{Days of Inventory on Hand} - \text{Days Payables Outstanding} $$
14. Say those in plain English:
15. Days sales outstanding tells you how long customers take to pay.
16. Days of inventory on hand tells you how long inventory sits before sale.
17. Days payables outstanding tells you how long the company takes to pay suppliers.
18. Costco is a real-world case. Customers pay almost immediately at checkout, inventory moves fast, and suppliers often get paid later. That can create negative working capital, which means suppliers are partly financing the business. That is not distress. That is power.
19. Compare that with a troubled construction company waiting months to get paid while raw materials pile up and subcontractors demand cash. Same balance-sheet heading, completely different reality.
20. Do not worship negative working capital blindly. For a retailer, it can be great. For a struggling firm that delays payments because it is desperate, it is a warning sign.

1. Capital investments and capital structure come next. This is the section where you ask, “Management got capital from investors. Did they use it intelligently?”
2. Common sources of capital are operating cash flow, debt issuance, equity issuance, and asset sales.
3. Common uses of capital are capital expenditure, acquisitions, working capital build, debt repayment, dividends, and share repurchases.
4. Good analysts trace this almost like a detective story. If a company keeps issuing equity and then burns the cash on weak acquisitions, you are watching value destruction in slow motion.
5. AOL-Time Warner is the classic cautionary tale. Big strategic language, giant merger, terrible capital allocation outcome. The lesson is simple: a big deal is not the same thing as a smart deal.
6. The big question is whether the company earns more on invested capital than investors require.

1. If return on invested capital stays above weighted average cost of capital, management is creating value. If it stays below, the company may still report accounting profits while quietly destroying investor wealth.
2. Capital structure tells you how much of the business sits on debt versus equity. More debt can boost return on equity in good times, but it also makes bad times much uglier.
3. Degree of financial leverage measures how sensitive net income is to changes in operating income:

1. If a company already has high operating leverage, slapping on high debt is like driving faster on an icy road. You may get there sooner, but the crash is nastier.
2. This is why the curriculum example likes a conservative balance sheet. Thin operating margins plus heavy debt would be a stupid combination.
3. Final common-sense checklist for this module:
4. Understand the business model before touching valuation.
5. Break revenue into drivers you can explain out loud.
6. Judge pricing power through margins, not management poetry.
7. Treat working capital as a business-model clue, not just a formula box.
8. Judge management by capital allocation, not slide-deck confidence.

Revenue, Profitability, and Capital

1. To calculate margin always divide by Sales. For example: $\(\text{Contribution Margin} = \frac{\text{(P - Var. Cost)} \times \text{Qty}}{\text{Revenue}}\)$

1. Degree of Operating Leverage: By what percentage my operating profit moves with 1% change in sales $$ \text{DOL} = \frac{\Delta \% \text{EBIT}}{\Delta\% \text{Revenue}} $$
2. Degree of Financial Leverage By what percentage my net profit moves with 1% change in EBIT or operating profit $$ \text{DFL} = \frac{\Delta \% \text{PAT}}{\Delta\% \text{EBIT}} $$ Think in limits, suppose a firm is 0% leveraged, then \(\Delta \% \text{PAT} = \Delta \% \text{EBIT}\), which implies DFL = 1 (no financial leverage). High DFL means each borrowed buck magnifies outcomes: more upside when EBIT rises, more pain when it falls.
3. Total Leverage = \(DOL \times DFL\) $$ \text{TL} = \frac{\Delta \% \text{PAT}} {\Delta\% \text{Revenue}} $$