Most of the time when we are talking about “analyzing a company”, we’re referring to looking into the companies’ financials. Maybe business too? But the real world is more complex. Just think of shopping malls/restaurants – even if they have strong enough financials to service the debt and fuel the growth, many of them died during the pandemic COVID-19. On the other hand, companies like Amazon/Netflix benefit from this “shelter in place”
I’m not saying financials is not that important – instead, it’s the origin point of the company. However, this origin is positioned in one circle after another, where all the circle areas could impact on it. Here we call it “6 Degree of Separation”, from macro to micro view.
Before we dive into it, let’s clarify the methodology we use to assess circles’ impact to its origin, “MRT” i.e. “Materiality, R^2 (Correlation Coefficient) and Timing”. Is it material enough? Does it have anything to do with the company? In the end, when would we expect to see?
1 Global
“Global” is the broadest circle and hardly anyone can escape from it. For example, the most famous GFC (Great Financial Crisis) in 2008 was evolved into a global crisis and most of the market plunged badly. COVID-19 is another recent example that hit around the world thus all those companies.
Applying MRT: These are all “material” enough to cause impact, unlike events like regular Olympic games every 4 years. Like we said above, COVID-19 can hit some industries like F&B (Food & Beverage like restaurants) hard, which we say “strong correlation” while benefits others like online shopping the other way round – that’s “negative correlation”.
The time it takes for “global” items to impact on a company is usually relative long – compared to things below.
2 Country
“Country”-Specific rules can impact too, that’s what “country risk” is about. Probably the most well-known factor is the tax – places like BVI, Cayman Islands are tax-heaven where the U.S. has a relatively high corporate tax. Besides that, country-specific regulation must be taken into serious consideration, if the company’s business involves in it. After all, it brings nothing but all harm to enrage local authorities, right?
Applying MRT: If the company’s business is in some countries, by all means, those countries are “material”. And for example, the change to “BVI” or “Cayman” definitely “correlates” to tax-sensitive business while may not be a consideration for already “tax-free” or paying minimal-tax companies.
“Timing” can be interesting too: countries can even have very different rules including docs preparation, registration, etc.
3 & 4 Industry, Suppliers / Buyers
Almost all capital markets divided companies into different industries (also sub-industries, niche industries too), just like how universities divided students into different majors. For example, “Auto” and “Healthcare” can be, very very far apart and different. At different times of history, some industries can enjoy fast growth while others are fading away.
We can refer to Michael Porter’s 5 Forces to investigate both industry and suppliers/buyers to a certain company and derive an “MRT” answer from that.
5 Business
The word “business” is often mix-used with “company” – and that’s exactly how direct is the impact from business to the company. Simply speaking, Business is just how a company makes and spends money thus creating/adding/destroying values – and no two companies have 100% the same business with each other.
6 Financials
As mentioned in the beginning, financials are the origin, or the core/fundamental, to the company. Money flows in and out like the blood to a human being and determines its health status.
Eventually, the impact from #1 ~ #5 items above will reflect in the financials, whether in a good or bad way, like an MRT carrying people from different stations along the way to its destination.
6 degree of separation, therefore, equip us with a logical and comprehensive way of thinking. As the theme of Creditbytes and the “Timing” in “MRT” suggests, please, please, please always bear in mind the time axis, i.e. the dynamic view. After all, time changes everything, not to say any of the circles here, right?
Next time we try to “analyze a company”, don’t forget to apply!