Complete business analysis step by step process to select a company for investing. Example of PI Industries and the agrochemical sector
One of the most asked question among my blog reader is to know the complete process I use to analyse a business. Today, I will share the complete analysis for a business – PI Industries in a step by step process.
Please note that it is not a recommendation to invest in PI Industries. I am not a SEBI registered broker to recommend any stock. I have chosen PI Industries to help my readers understand how one should analyse a business. Still, I will not talk about the price information, and everything I am sharing here is already available in the public domain.
So now, without much ado, let’s begin.
Step 1: Rejection
The first step to analyse a business is to reject the company for investment without too much effort.
If I can reject the wrong businesses, it saves time and energy to spend on good companies.
So the first set of rules that I use for rejecting a business are using the financial ratios and investment checklist.
- ROCE of consistently above 15%
- Debt to Equity ratio of under 0.5
- Operating Profit Margin or OPM in at least double-digit.
- Consistent EPS Growth for 3,5, and 10 years.
- Promoter Holding depending on how large a company is.
- What is the Cash Flow to Net Profit Ratio?
Again, I make exceptions in the above set depending on how I see the business’s future more than the past.
For example, in Burger King’s case, the next 3 to 4 years’ growth is expected to be more than 50%. So if I am convinced for growth, I may allow exceptions on some parameters like ROCE, OPM etc.
I never take lightly on the debt to equity, though.
I learned it by missing the investment opportunity of Avenue Supermart or DMart. It has a low OPM of under 10%, which made me pass the investment opportunity.
However, I realised some business could compromise the margin for very high growth. So, now I am also ready to compromise on some params for higher growth.
Step 2: Sector Analysis or Opportunity Analysis
Once the business passes the basic financial parameters, it is an ok business to invest in.
However, I try to understand the business’s complete supply chain how it fits into the chain within the sector it serves.
It is essential because now my view towards business is that if I have to start this particular business, I need to know what I need to know.
In the case of PI Industries, we assume it is an agri-chemical company. The truth is, it is a company with expertise in specialise molecule manufacturing along with sales in India.
To understand what is molecule manufacturing, we have to dig deep into the sector to understand it.
Some companies research a molecule that the market needs. These companies are called innovators.
Once the company completes the research, they patent the molecule. With the patent, the company also files its name that becomes their partner to manufacture the molecule in bulk.
PI Industries is a company that has been a partner with many such innovators as their manufacturing partner. Furthermore, PI also becomes a partner in the sales and marketing of the final product in India. It means there aren’t any other company that can manufacture the same molecule in India.
With decades of experience behind them, PI Industries is the choice of a manufacturer for most innovators. Further, innovators are so satisfied with the partnership with PI that they continue to give new molecules and more and more manufacturing orders of existing molecules to PI Industries.
So the sector opportunity is enormous, and PI Industries still has a long way to go.
Step 3: Business Analysis
Finally, we will do the actual analysis of the business. I use my business checklist to analyse the company.
The critical aspect to consider when analysing a business is to understand how fierce is the competition.
Because I prefer to invest in a unique business with little competition, it is essential to understand its actual competition. The peers that we see online aren’t enough.
So I look for
- Pricing Power of Business
- Entry Barriers for New Entrants
- Sustainability of Growth
- Sector Leadership or Market Share
- Operating History
- Management Pedigree
- Subsidiaries and Related Party Transactions
Anything and everything that can help me understand the working of a business.
Let me share some critical points for PI Industries that has helped me to understand the business better.
Pricing Power of Business
The company is the backend manufacturer of molecules patented by the global RnD players, mainly in the agri-chem sector. Players remain with the manufacturer for years and decades.
The reason being the process to switch requires a lot of paperwork. Furthermore, the expertise to manufacture the molecule takes a long time to acquire. PI being in the business for decades, has developed the expertise to demand a better price for the process.
Global RnD players patent molecules. With the patent, the company that will be manufacturing the molecule is also registered.
So if the innovator company wants to switch the manufacturer, it requires a lot of paperwork. Furthermore, the expertise of the manufacturing of the molecule is also a must.
PI provides complete manufacturing expertise as well as sales and marketing in India. Unique and niche business.
The innovators use the products PI manufactures. As the innovators patent more and more molecules, they are passed on for manufacturing to PI.
I see the growth for the next decade here.
Furthermore, PI Industries is reducing the cost with technology and expertise to manufacture the molecule more efficiently. As the cost decreases, it benefits the innovators, and they provide more and more orders to PI.
PI Industries is a sector leader in manufacturing patented molecules in the agrochemical sector.
Furthermore, being a manufacturing partner for the innovators and handling sales and marketing of the same in India does mean no other company can manufacture it nor sell it.
Research and Innovation
We assume the innovator companies only do research, but that is not true.
Every patented molecule requires a different process to manufacture. PI Industries has the expertise to manufacture such molecule, and it comes with constant innovation.
Furthermore, the company is innovating on reducing the cost and improve operational efficiency.
Operating History and Management Pedigree
The best way to understand the management pedigree is to check the annual reports for the worst performing years.
How the company handles bad times tells you a lot about the management. You have to read companies current as well as past annual reports.
It will also give you the details of the related parties transactions.
I need to know a lot of things when I want to create a company like PI Industries. Once I know that then only I become a business partner in the company.
When I am investing in a company, I invest as if I am doing that business.
When I am investing in a company, I invest as if I am doing that business. what a great thought one should imbibe prior to investing in any company share! Thanks dear Shabbir. I have put all my children and friends into your web for becoming real investor not just trader in stock market. May the almighty give you all that you wishes.
Shabbir Bhimani says
Glad you like that thought.