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The ‘common sense approach’ to picking a winning stock

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Written by: Justin Urquhart Stewart
30/11/2015
Betting slips and playing the odds are all unhelpful analogies when trying to evaluate companies for you to invest your hard earned money in.

However, I understand the cynicism, as trying to find good businesses to invest in is never an easy task and often seems to bear more resemblance to gambling odds than anything else.  Adopting a shotgun approach of spraying a market with pellets isn’t investing, it’s lazy guessing.

Merely playing the odds is, in my view, a cop-out.  We can all apply some common sense to try to separate out the ‘wheat from the chaff’. Here are my key areas to look at:

Firstly, look carefully at the proposition, its potential and protection. This may sound obvious, but it is easy to get swept up in a fashion fad of enthusiasm without really understanding the business. In the technology boom days, silly ideas were attracting investment just because they had the term ‘internet’ in them. In reality, few people understood the businesses and their models because this whole area was new.

Don’t let your ego or pride overcome common sense so that you are parting with money for something you don’t understand. This can also apply to traditional investment areas such as mining and oil exploration. In these cases, we can probably all understand the business concept, but we won’t have the technical knowledge to appreciate whether the valuable asset is actually there or not.

As for the potential, this is a question of scalability. It may be all well and good to have built the first ‘nano-widget’, but is anyone actually going to buy it or use it in sufficient scale to actually make it worthwhile?

Just a word on protection. I have come across some sad examples where great developments have been lost to competitors because of the abilities of others to replicate them. Patent protection can help, but doesn’t necessarily stop close imitators. Take Apple and its “i” range. Many of the products have been replicated at a cheaper price than Apple’s, but they have beaten these ‘parvenus’ away through greater marketing and brand strength.

I don’t believe in star managers, and I don’t believe in star entrepreneurs. The best ones may have the reputation as the ‘face’ of the entrepreneur, but there is always a talented team behind them producing the stunning success. So it is the team I want to see. It’s not just their technical experience, but their commitment and talent that will give a company its strength. I want clear answers to: What happens when there isn’t enough money to pay everyone next month? How much of your own investment is in the enterprise? These are painful, negative questions to ask, but I get to see their ability to handle the bad news.

I want to see their rewards and where these come in the life of the business, or whether they are off as soon as the first payout comes through.  If I am being asked to make a medium term investment with my money, I expect the leaders of the business to be there alongside, so we are all waiting for our reward, reflecting the risk we have taken together.

We all love the story of the beginning and where ‘it’ all came from – but as investors we also all need to think about our exit. How are we going to be able to exit from what could easily still be a private company? Everyone needs to know well in advance what the options are and when they could occur.

You may think it strange that I put the numbers last. It’s not that they are unimportant, far from it, but if all of the above meets with my approval, then I would expect the numbers to back up the story, rather than just be the story. Let the financial numbers fit the business and its plan, and not have the business and its plan be shoehorned into the balance sheet.

There are many different points that you can look at when evaluating a business opportunity. However, there is one more point that I see as being crucial – who else is in this with us? Is it a group of like-minded investors, under the auspices of a credible equity platform such as VentureFounders, or am I dwarfed by a large private equity firm? If so, then my voice and influence is going to be a mere whisper and those larger investors will have greater leverage to protect their position, potentially at the expense of or dilution of mine.

So there are many methods of evaluation, but to me it is people, product and potential that I want to see. If I can understand these, then there is a greater chance of finding a valuable and viable business opportunity to invest in.

Justin Urquhart Stewart is head of corporate development at 7IM and VentureFounders senior adviser

 

 

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