The business valuation process is the fundamental part of decision-making when investing in the stock market through value investing. The structure of the valuation process is divided into 2 well differentiated parts, essential for a complete analysis, which we will see below.
The 2 parts of the business valuation process
The business valuation process is divided into 2 these two parts:
- Financial analysis
- Competitive Analysis
On the one hand, the financial analysis is based on the analysis of the annual accounts of the company. It is a fundamentally quantitative analysis, in which elements such as indebtedness, solvency, profitability or the equity of the company are analyzed.
On the other hand, competitive analysis focuses on examining the strengths and weaknesses of the company in the market. It is a much more qualitative type of analysis, it focuses on analyzing whether the company has long-term sustainable competitive advantages that allow it to survive and be profitable for its shareholders. To do this, the product sold by the company and its future prospects will be analyzed.
The combination of both types of analysis will help us to obtain the intrinsic value of the company. This figure will be the one we will use to make the decision to invest. If the price is lower than the intrinsic value and offers us a good safety margin, we will invest. Otherwise, we will stay out of it.
Is it necessary to perform both financial and competitive analysis?
It is not necessary, although it is highly recommended to avoid falling into value traps.
Classic value investing, with Benjamin Graham As a primary benchmark, it paid no attention to competitive analysis and focused solely on financial analysis. This was not a big problem for him to beat the market, but financial markets have changed quite a bit in recent decades.
Compared to Graham's time, the stock market has become a much more efficient market, so it is necessary to complement financial analysis with competitive analysis to obtain superior returns. Today, practically all large investors combine both types of analysis in the valuation process, so we must do the same to achieve our goal of outperforming the market in the long term.