Whenever I come across a specific company, industry or idea for my value portfolio, I tend to look to this activity as my #1 priority. It is true that I’ll take a brief look at financial statements, ratios, stock charts or recent news on the company, but my main focus is always on fundamentals and concentrating on what I can learn about a company that’s relevant to its future success or imminent failure.
Any situational analysis (S.A.) helps an individual organize the abundance of accumulated information that so frequently tends to confuse, distract or cause frustration when analyzing a company or sector. There are a few reasons why I place such an important emphasis on this activity:
S.A.’s offer both simplicity and flexibility in the structure of the activity. You can modify, move, add or delete information over any period of time as you discover information that you feel is relevant. A Situational Analysis is comprehensive and looks at all aspects of a business; drawing your focus to factors you may have otherwise overlooked. Its organized and easy to access; including relevant qualitative and quantitative information effecting business operations past, present & future. It allows you to easily collaborate with peers where the sharing of information can be a valuable tool in gaining opinions relevant to you decision to buy, sell or hold a position. Finally, any S.A. performed on a specific company is then easy to compare against peers in the same industry, sector or group of stocks to gain a sense of relative strength or weakness.
It’s also important to focus on what an S.A. needs in order to properly perform its function:
– Stay focused
– Ignore information not relevant to components of the S.W.O.T.
– Able to withstand scrutiny when examined from an unbiased point of view (has to be able to be evaluated).
What are components of a S.A?
My Situational Analysis is comprised of four main components:
1. Internal Environment (S.W.O.T.)
2. Customer Environment (5W H)
3. External Environment (P.E.S.T.)
4. Competitive Environment
The Internal Environment of a company involves all activities of the business from an inside point of view: what factors affect the daily operations of the company. A S.W.O.T. is simply a four part comparison of a company’s internal environment that consists of Strengths, Weaknesses, Opportunities (for future success) and Threats (to future success). It’s important to not include any information from outside factors; we’re examining a company from within only and all other aspects are examined in the Situational Analysis later on in other components.
Suitable Examples of each:
Strength: streamlined supply chain management
Weakness: poorly trained & executed sales force
Opportunities: new strategic alliance with ABC Company
Threat: rising material and overhead costs
Not Suitable Examples of each:
Strength: get stuff to places fast
Weakness: crappy products
Opportunities: sell more stuff
Threats: head office might collapse because it’s old
(No joke: I’ve seen these!!!)
Remember that you want specific elements that affect the businesses everyday operations. The more specific you can be, the better focused the S.W.O.T. will be when completed. If you are having difficulty on where to start look to the company’s objectives, strategy, performance, resources, etc. (What does the company do best, worst, what could they do better, worse?)
The Customer Environment of a company should be something you always pay attention to during this analysis. This section incorporates all the relevant answers to my 5W H format: Who, What, Where, When, Why & How. You want to examine everything you possibly can about a company’s product or service and how their customer/consumer base interacts with that. Examples may be:
– Where do consumers get the product
– When do customers purchase the product
– What are customers buying
– How often do customers buy the product
– How does the company penetrate the market to get to its customers
– Why do consumers buy the product
– Who are their customers
This section will provide insight back into the S.W.O.T. analysis so you can add or modify more specific information that may be involved. The importance here is to understand the target market, its habits, tendencies, likes & dislikes associated with a wide range of specific activities.
The External Environment is usually the most difficult because it can be the hardest to find relevant information for; but is equally as important as the first two. This section is organized into a P.E.S.T. for the company and looks at all external factors outside of the daily operations of a business: Political, Economical, Social & Technological. What you want to look for here are external factors that may: influence the company’s business operations, legal or regulatory hindrance, emerging cultural trends, economic environment concerns or the changing needs of technology.
Suitable Examples of each:
Political: unionized workforce, government involvement & jurisdiction
Economical: tariffs, embargos and foreign tax rules
Social: cultural differences, community involvement
Technological: rapidly changing factors, patent infringement barriers
Not Suitable Examples of each:
Political: government is full of crooks
Economical: no one invests in this sector
Social: people want more red shirts
Technological: my phone dies when at my cottage
(Again: all things I’ve read before!!!)
The Competitive Environment is the last component of a Situational Analysis. This section examines any and all factors that competition (whether direct or indirect) has or could have on the business you’re researching. You want to answer the questions:
– Who are the competitors (direct & indirect)
– What competitive pressures is the business exposed to
– Limitations & Opportunities that competition currently or could provide
– Vulnerability of the business in comparison to competition
– What competitive advantage (if any) is the company up against
Once you’ve done a few dozen of these Situational Analyses, you’ll have a much better grasp on the fundamentals affecting the business from a variety of angles. If you adopt the format, eventually you’ll train yourself to look for these factors even without writing them all down. My own S.A.’s are extremely focused, maintained and revised when needed. They won’t guarantee better investment returns, but they’ll certainly make you a more aware and informed investor.
Best of luck.