Investment Thesis

1. What is an Investment Thesis?

Investment thesis is an important part of a stock pitch. It is a reasoned argument for an investment strategy, backed by research and analysis, and is used in all investment banking front office roles, along with private equity, hedge funds, and venture capital. The ultimate goal of an investment thesis is to present why an investment is worth its costs.

The structure of a stock pitch

1.1. Investment thesis is an integral part in buy-side interview

In buy-side interviews like private equity, hedge fund and venture capital, stock pitch is always a must, because that is what you’ll do on the job, and also the best way to set yourself apart. A great stock pitch will make you memorable in the eyes of the interviewers and investors. Therefore, knowing how to write a great investment thesis is no less important if you want to break into those industries. 

1.2. Investment thesis questions rarely come up in investment banking interview

In investment banking, you won’t get “pitch me a stock” questions unless you interview for sales & trading division, or you mentioned that you have dealt with market transactions on your resume. Nevertheless, stock pitching in investment banking interviews is not a priority. You should only spend 30 minutes preparing for stock pitch questions. Focus more on concepts like DCF, free cash flow, WACC.

2. What Does an Investment Thesis Include?

A good investment thesis constitutes three parts: (1) an observation of macroeconomic & industry trends and your company’s positions within these trends, (2) a review of your company’s ability to support growth, (3) a summary where you give your conviction on the company.

In short, an investment thesis includes what you know and expect from the company, the factors supporting its potential growth, and why you are investing in it. 

2.1. An observation of macroeconomic & industry trends and your company’s positions in these trends 

In this part, you’ll research the current situation of the economy, the industry and how the macroeconomic factors will affect the potential of the chosen company. You’ll also look into where your company is located within those factors to give a convincing idea why the company is poised for growth.

The best way to do this part is to ask yourself questions. Here is how the process can be broken down

First, look into external drivers of the stocks including the economy, the stock market, and the industry in which your company operates.

• Are the economy and the industry showing potential? 
• Is the business cyclically strong in this particular time?
• Are fiscal/monetary policies supporting growth?
• What are the risks associated with the industry?

After that, focus on how your company is performing amid those external factors.  

• Is it the fastest growing business in an equally-rapid growing industry, or is it a good house in a bad neighborhood, thriving against bleak macroeconomic outlooks? 
• Is it market share rising or falling? How is it compared to its competitors?.

To answer these questions, you’ll need to pay attention to the news, the industry, and the company itself. For example, if you want to know whether current economic policies are good for stock growth or not, watch the Fed. Or if you want to see whether the company is rapidly growing, compare it to peer companies and the industry average.

Here is an example of the macroeconomic and industry observation for Lazard.

Lazard is an investment bank, so first, give insights into the investment banking industry over the past few years. Research shows that bulge bracket banks are slowly losing their power because of the financial crisis, while independent advisory firms are becoming more competitive:

Figure 1: Investment banking industry overview 

Then, find Lazard’s positions within these trends. As an independent advisor, what advantages does the company have over its bulge bracket counterparts? Where does it rank among other banks? Is there any room for potential growth?

Figure 2: Bulge brackets vs elite boutiques

Figure 3: Lazard’s ranking vs other investment banks

2.2. A review of the company’s characteristics that support growth

This part focuses on the internal drivers of the company, including its policies, performance, brand image, assets & liabilities, and management. Again, you can ask yourself more questions to see if the company’s innate can support growth:

• Does the company have stable management?
• Are the financial statements clean?
• Which aspect of the company is offering excellent growth?
• How do metrics like profit, ROE, ROA, EPS change over the year/quarter? 
• Do current company policies aim to maximize profit, or try to please investors and reach for stock gains?

For Lazard, the pitch focuses on its strength in asset management:

Figure 4: Lazard’s assets under management

Figure 5: Lazard’s organic flow growth vs its peers

Figure 6: Lazard’s AUM mix

A comparison with peer companies also adds more conviction to your analysis:

Figure 7: Lazard vs other elite boutiques

Finally, the pitch dives deep into the company’s policies and strategic planning:

Figure 8-14: Lazard’s strategic planning and policy

2.3. A summary of the reasons why the company is worth its price

This wraps up the macroeconomic and industry outlook, the company’s positions within those external factors, its own internal factors and risk/reward profile and presents why the company is worth the investment. The summary determines whether the pitch sells or not, so the more confident you are with your thesis, the better it will be.

For Lazard, after industry, company and policy analysis, the thesis concludes that the company is positioned for strong EPS growth:

Figure 15: Lazard’s verdict

Figure 16: Lazard’s EPS assumptions

3. How to Write an Investment Thesis

Writing a perfect investment thesis requires understanding of both the investors and the company. Research who you are pitching it for to find their preference, investment philosophy and strategies.  

3.1. Understand fund’s strategies

This applies to both pitching in an interview and pitching as a part of your job. Funds and investors want stocks that are sustainable for their investment strategies. Try to understand their assets under management, investment philosophy, and holdings before pitching anything. Strategies are diverse, so diversify yourself too:

• If you are pitching for a fixed-income fund, present them a bond that offers high yield at low risk
• For a short-seller, the best pitch is an overvalued company waiting to be sold short
• For growth equity, your best bet is a company in rapid expansion 
• For a venture capital, bring them a start-up that promises reliable transition from cash-burning phase to stable cash flow

To research company’s information, you can visit the fund’s website or other blogs that follow hedge fund’s 13Fs closely like InsiderMonkey, ValueWalk. SEC filings can also be used to search for funds with over $100 million in assets under management.

3.2. Choose an idea with careful research

To do this, select an industry you are comfortable with, then find a promising company within that industry. The process can be time-consuming, picking one promising stock from hundreds of possible, but when you find that one company you are looking for, it will be worth all the effort. And remember, there is no right or wrong choice for a stock pitch. What matters are your analysis and conviction.

Knowing what you are pitching is a must, but it is also recommended to choose a less covered company that portfolio managers might actually consider. Don’t pitch them to universal stocks like Apple, Microsoft or Alphabet. Try to set yourself apart by giving them unique insights and investment recommendations.

When researching companies, focus on the three main drivers of a stock: business quality, catalysts and valuation.

• A company with good business quality possesses stable earning growth compared to its competitors. It could be high return on capital, high margins or strong management. If you are pitching for a start-up, it must show a reliable path from cash-burning stage to positive cash flow.
• Catalysts are events that affect the price of a stock. They can be internal events like earnings announcements, product launch, acquisition and insider transactions. For example, if Apple plans to release a new iPhone, Apple’s share may rise as investors believe new products will generate higher income. Catalysts can also be external like monetary policies or global events. External catalysts tend to affect the entire market. They can either help the market reach new highs, or cause panic selling, like the 2013 “taper tantrum”.
• Valuation is important since investors want to buy stocks selling at a discount compared to others. Two commonly used valuation methods are relative valuation and absolute valuation. Relative valuation compares a company with other public companies through multiples like P/E and EV/EBITDA. It is important to find the right comparable companies with similar industry, size, growth rate, margin and revenue. Absolute valuation helps to determine the intrinsic value of the company based on its future cash flow using the discounted cash flow analysis. Firms prefer companies with lower intrinsic value compared to market value.

3.3. A step by step guide to writing an investment thesis

To write a stock pitch, follow three steps: (1) conduct initial research on the industry and select one special company within that industry, (2) analyze the company’s internal factors to show its potential growth, (3) summarize the research and give investment recommendations. These steps align with the structure of the investment thesis. 

Step 1: Conduct initial research

This part aligns with the first part of the investment thesis. First, choose an industry you want to focus on. It can be something you have experience with, you are really passionate about, or you are extremely confident in its future prospect. 

After that, conduct market research to get industry data and identify trends. Look at market reports, industry insights and information to see what’s going on in the industry.

Next, screen out one exceptional company from that industry. You should find one that possesses stable management, high growth and undervalued compared to other companies. Also, try to find one that is less known because funds and interviewers always appreciate unique ideas.

Step 2: Analyze the company’s growth factor

This part aligns with both the first and second part of the investment thesis. Now you’ll research your company’s financial statements, read news, and leverage on connections to gain insights on its performance. 

Key points to look at include policies (is the management board’s direction good for its future?), metrics (are profit, EBIT, ROE, ROA, EPS on track for growth), and operation (how diversified is the company in its operation? Which aspect is showing potential?). Then present your analysis and projections with your research. Focus on the drivers mentioned above.

You can make comparisons with the industry and other companies to make your analysis more convincing. Bring the advantages your company has over its peers, and show why it is the most promising in the market.

Step 3: Summarize your research and give your conviction

This step aligns with the final part of the investment thesis. From everything you have researched and analyzed, present why the company is worth the investment. For this, confidence is everything. The more conviction you have, the better your idea will sell. And remember, there is no right or wrong answer in an investment thesis. Your analysis is what truly matters.

Link your analysis to make your thesis more convincing. For example, when pitching for Harley-Davidson, a motorcycle company, after analysing how Harley-Davidson’s sales will keep falling due to the high price tag while not being able to attract new buyers, despite an ever growing motorcycle market, you can confidently recommend for a short.

That’s just a simple case, but you get the idea. By connecting the dots and presenting your argument with confidence, you can sell any pitch to anyone.

4. Investment Thesis Example

Figure 17-18: Starbucks’ investment thesis

Figure 19: Sony’s investment thesis