Company Analysis – Business and Governance

1What company analysis asks

A company is a small unit within its industry and economy, but company-specific factors decide how it performs. Key questions:

1. What is its business? (This also defines its industry.)
2. What is its business model?
3. Does it have a competitive advantage?
4. Can it exploit opportunities and withstand threats?
5. Is management competent to choose and execute strategy?
6. Does management have a vision, and does it give visibility on short-term performance and long-term goals?
7. Is there a governance structure that makes the board and management act for shareholders?
8. Is it actually implemented?

Analysts should dig past superficial answers and support qualitative views with data.

Remember

• Start with "what is the business?"

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2Understanding the business and its model

Equity is part-ownership of a business, so first ask: what does the company do and how, who are its customers, why do they buy, and how is it served? If you cannot state what a company does in one precise line, do not go further. With over 4,000 active listed companies in India, investors should own a few they understand rather than many they do not. Buffett: wide diversification is only needed when investors do not understand what they are doing.

Each sector has its own metrics: footfalls and same-store sales for retail, NII/NIM for banks, ARPU for telecom, average room rates for hotels. Each company also has its own way of operating. Gary Hamel: competition is not between products but between business models.

Remember

• "Do I understand the business?" comes first.

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3Pricing power

Pricing power is a company's ability to set its own prices: to pass on input cost increases and to raise prices when demand is strong, protecting and growing margins.

• Industry factors: competition intensity, price elasticity of demand and degree of commoditisation.
• Company factors: natural leadership (smaller petrochemical producers price off Reliance), brand loyalty, and a low cost base (rivals with higher costs cannot follow its low prices).

Remember

• Leadership, brand and low cost give company-level pricing power.

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4Competitive advantages

Three sources of differentiation:

1. Product differentiation: better quality or features that appeal to target customers, backed by strong R&D and an innovation culture. Check it with data, not marketing claims.
2. Competitive pricing: sustainable only with a low-cost advantage; otherwise rivals copy price cuts. Easy to compare for commodities, harder elsewhere (a cheaper car may have fewer features), so judge value for money through primary research or past model performance.
3. Execution: better communication, sales strategy, branding, advertising, alliances and positioning (Flipkart, Airtel, Haldiram, Hero MotoCorp). Judge it from the track record of the company and management.

Remember

• Low prices last only with low costs.

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5SWOT analysis

Strengths and weaknesses are internal; opportunities and threats are external. When conditions change, well-placed companies prosper and vulnerable ones may fail (strong balance sheets survived COVID-19 lockdowns; weak ones struggled).

Two approaches:

1. Start with strengths and weaknesses, then find matching opportunities and threats. Suits companies setting strategy.
2. Start with opportunities and threats, then find the strengths and weaknesses that matter. Suits an external analyst, and fits the E-I-C (economy, industry, company) order.

Remember

• S and W internal; O and T external.

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6Strengths and weaknesses

Strengths: strong finances; valuable intellectual property; low customer concentration; low cost or high margins; support from a parent or government; strong execution record.

Weaknesses: weak finances; high fixed costs; thin margins that can turn negative in a slowdown; high customer concentration; major legal cases; lack of experience with a strategy or environment.

Focus on strengths and weaknesses relevant to the opportunities and threats: lack of self-driving expertise matters only if such cars are about to take off; a dip in quarterly profit is a weakness only if it costs an opportunity or a loan. Outsiders cannot see everything: companies do not disclose political clout, and creative accounting can hide trouble.

Remember

• High customer concentration is a weakness (internal), not a threat.

7Opportunities and threats

Opportunities (external):

• Inflection events: new battery technology for EVs; firms moving production out of China after COVID-19.
• New business from technology or regulation: the Companies Act 2013 created consulting work; Y2K created IT services work; ESG compliance.
• Geographic expansion when capital controls or market conditions change.
• Consolidation in bad times: Jet Airways' suspension in April 2019 let rivals gain share; recessions bring cheap acquisitions.

Threats (external risks): recession; regulatory headwinds (a ban on single-use plastics); technological disruption (AI threatening BPOs doing repetitive work); deregulation removing entry barriers (RBI's on-tap bank licences). One industry's opportunity can be another's threat. Focus on events with a reasonable probability; listing every possible black swan is not useful.

Remember

• Deregulation can be a threat to incumbents.

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8Management quality and agency risk

Ownership is separated from management: shareholders appoint the board, which oversees the CEO and team. This creates agency risk: managers may pursue their own interests or simply lack ability. Analysts should judge competence and integrity, but integrity is almost impossible to assess and should not be questioned without evidence, so focus on whether the governance structure has controls to prevent abuse.

Remember

• Agency risk comes from separating ownership and management.

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9Evaluating management competence

Questions to ask:

• Relevant qualifications? (Useful but not conclusive.)
• Years of experience, including handling past challenges?
• Track record in senior roles elsewhere? (Results also depend on conditions and colleagues.)
• Tenure and results at this company?
• A clear long-term vision and strategic direction? (Without revealing every detail to competitors.)
• Experience in executing the current strategy (for an innovation strategy, a record of leading research)?
• Does it give guidance and consistently meet or beat it?
• Timely regulatory compliance? (Failures suggest lack of control and are a red flag on integrity.)
• Enough delegation? Concentrated decision-making creates key-man risk.
• A succession plan?

Analysts should keep tracking a company's disclosures, commitments and deliveries.

Remember

• Meeting guidance consistently signals control.
• Concentrated decisions → key-man risk.

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10Evaluating corporate governance

Corporate governance is the rules and processes for running a company in the interest of all stakeholders (shareholders, lenders, employees, suppliers, customers), with special care for minority shareholders. The workbook cites Clause 49 of the listing agreement (now carried into SEBI's LODR Regulations, 2015). Regulations are a minimum; good companies do more. Points to check:

1. Board composition: ideally a majority of independent directors. SEBI requires at least 50% independent if the chairman is executive, otherwise one-third.
2. Separate chairman and MD/CEO: the workbook describes this as mandatory for the top 1,000 listed companies, with a non-promoter CEO. (SEBI made it voluntary in 2022; check current rules.)
3. Nomination committee for independent directors: ideally only independent directors.
4. Auditor independence: fees from the group should be under 10% of the auditor's income.
5. Auditor rotation: every five years in the workbook's view, so concealed issues can surface.
6. Audit committee: ideally fully independent; SEBI requires at least two-thirds independent.
7. Related party transactions: ideally all material ones pre-approved by the audit committee; SEBI requires all to be placed before it, with justification if not at arm's length.
8. Remuneration committee: ideally fully independent; SEBI requires all non-executive, with an independent chairman.
9. Independent directors' pay: full disclosure of all income from the company.

Remember

• Independent directors: 50% with an executive chairman, else one-third.
• Audit committee: at least two-thirds independent.

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11Promoter holdings and pledges

The promoter concept is largely Indian: the law simply calls a promoter someone named or identified as one, in practice the founders or controlling shareholders. Strong promoters can keep management aligned with shareholders, but can also push actions (such as related party deals) that benefit themselves at minority holders' expense. Track their holding and changes in it.

Promoters may pledge shares rather than sell them. Lenders apply a haircut to the market price. Pledging is not itself a red flag, but a high level is risky: a price fall erodes the lender's margin, forcing sales that push the price down further.

Remember

• Heavy promoter pledging magnifies price falls.

12Risks in the business

Promoters talk about the dream, rarely the risks (cheap foreign borrowing looks attractive until currency risk is counted). Entrepreneurs can bear shocks (Rupert Murdoch failed three times; Steve Jobs was ousted from Apple and later returned) but investors may not. Risks may be business, operational, execution-related, known or unknown. Keep asking "what could go wrong?" A promoter who says nothing can go wrong belongs among people who don't know that they don't know, and is best avoided.

Remember

• Good managers know and manage their risks.

13Credit rating

A credit rating assesses a borrower's ability to service debt, given by a credit rating agency at the issuer and instrument level, separately for short and long term. It matters to equity investors because shareholders are paid only after lenders: it shows financial risk and shapes return expectations. Reading past rating reports shows the agency's key concerns over time and whether management responded to that feedback.

Remember

• Rating history shows how management responds to concerns.

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14ESG framework

Concern for sustainable development and CSR has popularised ESG investing, first used by impact investors and now mainstream because it also has commercial value. Criteria:

1. Environmental: emissions and pollution (low is better).
2. Social: human rights, gender equality and similar contributions.
3. Governance: standards of corporate governance.

ESG is a screen to shortlist stocks; normal analysis follows. Claimed financial benefits: less disruption from regulation or activism; goodwill that helps hiring and sales; and good governance lowering risk and the cost of capital. SEBI requires the top 1,000 listed companies to report under the Business Responsibility and Sustainability Report (BRSR) from FY2023; over 175 companies reported voluntarily in FY22.

Remember

• BRSR: top 1,000 listed companies from FY2023.

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15Sources of company information

Annual and quarterly reports (the most reliable and consistent source); conference call transcripts; investor presentations; management interviews; company and MCA websites; credit rating reports; media and other research; the parent company's reports; competitors' websites, including international ones; discussions with suppliers, vendors, customers and competitors; and BRSR reports for ESG.

Remember

• Annual reports: most reliable source.