A Man's Search for Value

Title: Tools of the trade

To unearth overlooked equities with market-beating potential I will need to review a lot of companies, many of which I won’t be immediately familiar with. 

Given the volume of companies I’ll need to review, it would be inefficient to perform in-depth financial analysis on all opportunities that seem interesting at a high level. Therefore, I need a tool to help me check key assumptions and quickly determine if an opportunity is worth a deeper dive or is to be moved to the ‘too hard’ pile. 

I need a tool that:

1. Is quick to populate from readily available information
2. Can be consistently applied across all companies
3. Allows me to assess the long term free cash flow potential
4. Enables backtesting

My previous roles in venture capital provided me with exposure to hundreds of financial models, some of which were excellent and created by talented finance professionals. A common theme of the best models was simplicity. Regardless of how big or data rich the model, the best ones always surfaced the key inputs, variables and outputs in a clear and easily adjustable manner. 

Rather than re-invent the wheel, I have settled on basing my workings on Stuart Kirk’s DCF model that he recently shared with readers of the Financial Times. You can find the model and supporting article here and here.

This simple model allows me to focus on what matters. I have however already augmented Stuart’s model to include a comparison of the current price per share (PPS) versus that of the forecast PPS to help inform an entry price that will provide an appropriate margin of safety. I have also added an IRR and forecast return calculations that are linked to the most recent financial analysis. These latter features will only be used when I’ve made an investment in a company. 

I will also create an aggregated portfolio performance summary to benchmark my portfolio against some industry standard funds. This will be a reality check for my ego. I will divert a higher proportion of my funds to index funds if my stock picking performance is consistently lagging my benchmarks.

I imagine (and hope) that the model will evolve as I develop my skills. But I must be disciplined and make sure that any addition truly adds value and is not a superfluous distraction that detracts from the core variables that impact a company’s performance.

It’s important I’m aware of what the model doesn’t factor in. It’s all too easy to be distracted by numbers that add up, especially when it’s easy to manipulate the variables to provide an output driven by potential internal biases. 

When creating financial models and appraising investment opportunities I need to remember that past performance is not a reliable indicator of future performance, and what I think might happen may very well not happen, despite how much research I perform. There is always a wide range of possible outcomes, any of which could play out. I must size my positions accordingly.

For example, just because a company has delivered 20% annual revenue growth over the past X number of years does not mean the trend will continue. I must think critically about the future prospects of a company. What are opportunities and threats? Can its competitive advantage be maintained? What investment is required to catalyse or maintain performance? Can management continue to invest capital at a promising rate of return? Etc etc.

I will also consider if the new opportunity I’m appraising has a greater possibility of delivering more favourable returns than my current investments. There is always an opportunity cost.

Key takeaways from this month:

• Numbers only tell part of the story. The real skill lies in the ability to merge the numbers with qualitative insight to create a well rounded view of the potential performance of a company.
• More data doesn’t always equal better decisions. Identify what matters and focus on those variables.
• I must continually review my assumptions and backtest my workings. Both on invested and passed opportunities. I need to learn from real feedback to mitigate the risk of being blinkered by initial assumptions and biases.

Thanks for reading. I’ll be back with my third post within the next 4 weeks, hopefully sooner. In that time I’ll be devoting my efforts to building out my list of key qualitative questions to sit alongside my model, and identifying where to start hunting for opportunities.

P.S. – I’m currently tracking favourably to my initial goal of publishing one blog per calendar month in 2026. I’m finding writing so much fun and a great way to collate my thoughts, cement my learning and identify next steps.