Stock analysis process
How I screen stocks and perform deep-dive analysis
I’ve written and updated these notes over time to organize my thoughts on stock analysis. Maybe someone will find them useful - past me certainly would have!
Please don’t consider this a dogmatic approach. While some points include specific numbers, they serve as rough guidelines and reminders of an ideal scenario. It’s rare (if not impossible) to find an investment that passes all the checks.
This stock analysis process is a part of my broader investment framework.
Quick Scan Filter
When I first review a stock, I try to find a reason to say ‘no’ as quickly as possible. If you can’t find a reason within a few minutes, you might have discovered a potentially interesting stock.
At this stage, I typically skim recent financials, the company’s presentation, and its investment thesis (if the idea came from another write-up). I focus on the following points:
Company profile
Know your limits and stay within them. Make sure that you understand how the company makes money. If the business model isn’t clear, stop looking at the stock—unless you’re willing to research the industry in depth.
Predictable economics: The business model should have predictable long-term economics. Ideally, the company operates in a strongly growing end market.
Special situations
Take extra care, if it’s a special situation. Make sure you understand the full picture.
What are the incentives of key decision makers (management, board, and different shareholder groups)?
Growth
Can the company grow revenues organically with 5-7%+?
Can it grow EPS and FCF/share with 7-10%+, ideally 15%+? Growth can come from buybacks, improved efficiency, or revenue growth—ideally, all of these.
Does it offer asymmetric upside or optionality (preferably not already priced in)?
Capital allocation
High, consistent, and growing ROIC ****(above 15%) and ROE (above 20%). Ideally, ROIIC (Return on Incremental Invested Capital) > ROIC, showing the business is becoming more efficient.
Avoid companies that dilute shareholders significantly. Prefer “stock cannibals” that reduce shares outstanding by 5%+ annually. But be careful about leveraged buybacks - earnings yield should be higher than the cost of borrowing.
ROIC may be less important as a measure of future compounding for companies with stable FCFs, no reinvestment opportunities, and minimal capital requirements for growth. In such cases, it primarily reflects historical returns on someone else’s investment. However, ROIC remains highly important for businesses that reinvest heavily.
Profitability
Does the business already generate profits? Avoid investments based purely on future promises (e.g., management projections or hype).
High margins—at least 50% gross margin and 10-15% net margin—are a good indication that a company has a competitive advantage.
Cash generation: consistent free cash flow generation of at least 70-80% of earnings.
Low/no debt
The company should not have a risk of bankruptcy during hard times.
A few useful metrics: Net debt / FCFF < 5, Net Debt / EBITDA < 3, Debt/Equity < 80%, Interest Coverage (EBIT/Interest) > 5.
Strong TSR (Total Shareholder Returns)
If the stock has consistently failed to create shareholder value, something is likely wrong.
Did the company outperform the index and industry in the last 10 years? Did it perform well in absolute terms (>10% CAGR, including dividends)? It shows that the company is a winner in the industry and in the market. Also, check performance since IPO.
Valuation
Don’t buy stocks purely because they look cheap. There should be a potential catalyst or clear story for revaluation.
As a quick check, compare the stock’s valuation metrics (P/E, P/B, P/FCF, EV/EBIT) to its historical averages (5–10 years) to see if it trades at a discount.
If none of the above points yield a clear “no,” you may have found a potential investment. If the only issue is valuation, you’ve identified a candidate for your watchlist. At that point, it’s time to move on to deeper analysis.
Quality Analysis
In a deeper analysis, you should examine the company’s moat, management integrity, capital intensity, expected growth, and other factors. Build upon the insights from your quick scan and dig deeper into the following categories.
The key question to answer: “Is the business simple enough that I can see what it will likely look like a decade from now? Am I confident that earnings will be higher in 10 years?”
Don’t forget: “Familiarity ≠ Competence → Pick up annual reports and learn.”
Tools: Annual reports, proxy statements, press releases, transcripts, peer/customer/supplier analysis, industry reports, customer feedback, news, etc.
Financial Stability
In general, look for stability and consistency over a 7-10 year period. Focus more on the Balance Sheet and Cash Flow Statement than on the Income Statement. Almost all points from the quick scan were about financial stability. So, we dig deeper into those, plus a few more:
Capital intensity
CAPEX, particularly maintenance CAPEX, should not consume a significant portion of operating cash flows. Ideally, CAPEX / OCF < 15% and CAPEX / Sales < 5%.
Capital-intensive companies often spend heavily on new technologies or inventions, which may primarily benefit customers rather than shareholders. Especially, if the product is a commodity, because all the companies will invest in the new tech in the same way and profit margins will not improve (e.g., airlines, and internet providers in the past; the same will probably happen with AI).
Capital intensity can be more favorable for monopolies (local or global), as the benefits tend to flow directly to the bottom line.
There are also “surfers”, who ride on the wave as first inventors/implementors, but it’s very hard to spot them, and they fail as soon as they make one mistake → better avoid.
Working capital (Inventories / Receivables / Payables)
Check that inventories are not growing faster than revenues.
Compare the Cash Conversion Cycle (CCC) with peers - the lower, the better for working capital management and ROIC. Ideally, CCC should be negative, meaning the company is financed by its suppliers and generates cash just by growing.
R&D and Advertising/Marketing expenses
Do they create long-term value?
Quality of assets
The more liquid assets are, the better (cash, short-term investments, etc.)
Lower goodwill and intangible assets are generally better.
Check financial covenants and debt maturity for companies with debt.
Profitable unit economics
Evaluate the key economic drivers for the business. For example, in retail, consider the total potential number of stores, the capital required to open each store, and the return on capital each store generates at maturity.
Beware of organic growth above 15-20%—it may be unsustainable. Check that staff is not bloated, the cost structure is under control, and there are not many unrelated businesses that drag the core down.
Is growth speeding up or slowing down?
Moat, Risks, and Opportunities
Types of Wide Moats:
Network effects: The value of the product or service increases with each additional user.
Examples: Direct (Facebook), Indirect (Apple), Two-sided (Visa, Airbnb, Uber, Copart).
Switching costs: High costs or difficulties for customers to switch to competitors.
Examples: Microsoft Office, AWS, Intuit’s QuickBooks, Adobe, Otis (elevators).
Intangible assets: Unique brands, patents, licenses, or proprietary technologies that create competitive advantages.
Examples: Moody’s, Ferrari, Hermès, Coca-Cola, Disney (unique experience), Apple.
Economies of scale: Lower costs as volume increases, especially when savings are shared with customers.
Nick Sleep's principle: “Scaled economies shared, growth begets growth!”
Examples: Costco, Walmart, and Amazon.
Cost advantages: Lower costs due to unique processes, sourcing, or efficiency.
Examples: Costco, IKEA, Copart, Ryanair, Floor & Decor (FND).
Key Questions to identify a moat:
Who are the peers?
What differentiates the company from its competitors?
ROIC is a proxy of a moat
Has the company consistently achieved higher ROIC ****over time?
Does it consistently outperform peers in margins, ROIC, and other financial metrics?
Is the brand respected and is there proof in the pricing power?
Can the company raise prices without losing customers?
Is moat durable or fleeting?
Do numbers (e.g. ROIC, margins) support it?
Is the product/service needed or highly desirable?
Is it a simple proposition - useful, easy to use, aesthetically pleasing?
Innovation: user or producer?
Is the company a user of innovation (leveraging existing technology for efficiency) or a producer (investing heavily in creating new technologies → capital-intensive)?
Being a user is typically much better since you enjoy higher efficiency without spending capital on inventing it and competing with other inventors
“Does the company sell picks and shovels, or does it try to dig for gold?” In modern terms, does the company provide tools/platforms (e.g., hardware, infrastructure) or does it focus on developing high-risk innovations (e.g., AI models)?
In this regard, be careful about the huge AI CAPEX spending of some of the big techs
Is the company an innovator or a cloner?
Cloners often succeed more reliably by replicating proven ideas
Is the business model sustainable?
Does the model create a win for customers, employees, and shareholders?
Is the product/service primarily a “one-shot” deal or recurring (e.g. razor blades, which customers have to keep on buying)?
If yes, a slowdown in growth can be devastating.
Can the company sell effectively without excessive marketing spending?
Industry Attractiveness and Opportunities:
Room for growth
Are there plenty of Reinvestment opportunities for the company?
High ROIC, high ROIIC, and a large amount of capital that can be productively reinvested.
Substantial barriers to entry - monopoly/duopoly/oligopoly are perfect
Growth tailwinds
Is the end market expanding (e.g., cybersecurity, obesity treatment, data centers)?
Be cautious about hyped industries with unclear long-term economics.
Fragmented buyers with inelastic demand
Fragmented suppliers with little bargaining power
Prefer industries competing on unique product characteristics rather than price
A slow rate of change in industry structure and product offerings
Limited government interference
Management quality
Who are the key decision makers (management, board, different shareholder groups, etc.)?
CEO Tenure—the longer, the better. If there were several CEOs, check the tenure of each one (10+ years is preferable).
What are the incentives of key decision-makers?
Founder-owner-operator stock is usually good.
Substantial insider ownership is preferable since it greatly aligns interests with shareholders. Look for 5-10%+ stake for managers and the board (check 13-Fs, proxy statements).
Compensation
Analyze proxy statements and compare compensation to industry peers (NVR is a good example).
Smaller cash compensation relative to stock compensation is better.
Stock compensation tied to stock options (not RSUs or PSUs) is preferable, as options become worthless if the stock price doesn’t grow.
It would be better if all bonuses and performance-based stock compensations were tied to ROIC/economic profit, as these directly align with shareholder value.
Check that management is not trying to inflate their stock price just to get the highest possible stock-based bonuses.
Check the size of stock-based compensation relative to Net Income - should not be excessive.
Are managers honest?
How well do they communicate in annual/quarterly statements, press releases, earnings calls, as well as shareholder letters?
Do they deliver on their promises?
Are they good operators?
Are numbers consistent and improving (ROIC, margins, FCF growth)?
Are they better than competitors on most factors?
Are they good capital allocators?
Which framework does management use? What were the returns on past capital allocation decisions?
If ROIIC is high, reinvestment is usually the best form of capital allocation. Check CAPEX, Working capital, R&D, and the reinvestment rate (invested capital in relation to earnings). Reinvestment should drive organic revenue and earnings growth.
Earnings Growth = ROIC * Reinvestment rate
M&A: Avoid companies engaged in excessive “diworsification” through poor acquisitions. Check, if they have a proven history of M&A success.
Buybacks are a good form of capital return if reinvestment at high rates is not possible. Ideally, they should occur only when intrinsic value exceeds the current market price.
Debt repayment: Good, if debt levels are becoming concerning.
Dividends: Last resort (due to tax disadvantages), but can provide some stability.
Valuation
The main question to answer after the valuation: “How confident am I that we can earn a minimum of 12% annually on this investment over the long term?” You can have another number, but my hurdle is ~12%.
A few sub-questions:
What is the upside/intrinsic value? How confident I am that it is correct and that it will stay (or improve)?
Is there some asymmetric upside/optionality, which is not priced in?
What if risks materialize? Is the downside minimal?
Is business priced with a discount? Why does the opportunity exist?
There are a pair of tools/mental models, which I normally use here.
Three engines of growth
Some time ago, I stumbled upon this great post from John Huber about the three engines of growth and I liked this simple mental model for valuation.
Every stock compounds as the product of 3 simple factors:
Earnings Growth → estimate earnings in 10 years (keep in mind, that very few businesses grow by even 10%, according to McKinsey's study)
Change in P/E Multiple → estimate P/E in 10 years (assume the current market multiple or less for most companies)
Change in Shares Outstanding + dividends → Estimate shares outstanding and dividends paid over 10 years
Example:
Earnings will grow 7%
P/E will change from 10 to 15 → $\sqrt[10]{15/10}=1.04$
Share count will decrease by 8% annually
10y return on stock = 1.07 * 1.04 * 1.08 ~= 1.12 → 20% CAGR
Or easier (but less precise) = 7% + 4% + 8% ~= 19% CAGR
Then compare this CAGR to your desired rate of return
Key Takeaways:
Value matters: low P/E will influence both the P/E engine (P/E itself can move higher) and buyback engine (more shares can be bought back with the same amount of FCF)
Modest growth, below-average valuation, and consistently good capital allocation will lead to a great result (even when each part itself is not that great)
If you find a stock with no growth but a 20% FCF yield, and that yield is returned to you through buybacks and dividends, you don’t need the market to ever revalue the stock - your returns will still be 20%, even without growth or multiple expansion. Such a stock can even outperform a company with 20% organic growth, as it benefits from the additional tailwind of a low P/E ratio.
I am extremely cautious with companies, which have PE ratios higher than 20. If their growth stumbles at some point or some predictions are proven to be incorrect, then P/E multiple compression can destroy two other engines.
Other tools
DCF model
I personally don’t like the direct DCF model. It involves a lot of assumptions, and even a small change in one of them can dramatically change the outcome. I rarely use it anymore.
Reverse DCF model
Charlie Munger often said to invert the problem to make it easier. The same principle applies here - just revert a DCF model and figure out what the market assumes, given the current price. Then assess whether these market expectations are above or below your own.
Relative valuation
Compare current P/E, P/FCF, P/B, EV/EBIT (whatever is more relevant) to the historical values
Compare these ratios to the peers
Conclusion
In the end, the analysis boils down to these two key questions:
Is the business simple enough that I can see what it will likely look like a decade from now? Am I confident that earnings will be higher in 10 years?
How confident am I that we can earn a minimum of 12% annually on this investment over the long term?
Normally, this process leads me to two different types of investments:
Fairly valued quality companies with high and growing ROIC, widening moat, and smart capital allocation, which can compound over the long term (hard to find).
Cheaper special situations with a clear thesis/catalyst, where changes lead to either a shift in capital allocation favoring shareholders (e.g., increased buybacks or dividends) or an improvement in ROIC.
Disclaimer:
This article is for educational purposes only. This is not an investment advice. I may buy or sell these securities at any time. Please see the full disclaimer here.