The Business Evaluation Framework that we use at Bastion Research
Welcome to this week’s edition of LEARNING OF THE WEEK! Continuing our SMART Framework series, today we we’ll examine the Third Pillar: Accounting
Investors have always appreciated stories, whether they are in private or public markets. Phrases like “a company is expected to witness hyper-growth,” “it’s a turnaround,” “commodity prices are expected to drop,” “the management is changing,” “the company has secured a huge order book,” and “it’s a highly profitable business” are common narratives we often hear. Stories sell, especially in the current market environment. And when there is a consensus that something is true, it quickly gets reflected in the market price. Storytelling is as old as humanity itself and comes naturally to us, helping us understand complex and difficult concepts.
However, there is a downside. It can lead to misconceptions. There have been numerous cases where management excels at storytelling but not so much at execution. This lures people into investments that are not as attractive as they seem. It’s not just the management; many other actors try to sell a story to investors to encourage investment in a company, even if it is not a good investment, leading to financial losses for people.
The only sure way to determine if it’s just a story with nothing on ground is through Accounting. As they say, numbers never lie! A story should always be reflected in the numbers. If it’s not, one should start asking questions: “What’s the reason for the hypergrowth?” “If it’s a highly profitable business, why have its margins decreased year after year?” “If the company has a huge order book, do they have the track record to execute such large orders?”, etc. When there is a divergence between the accepted truth and the numbers, it becomes clear that not everything is as it seems in the business. While numbers can be manipulated, there are methods than help catch those irregularities. Numbers can also reveal if a business is involved in legal cases or potential payouts. So, if stories represent simplicity, then numbers represent reality.
With that in mind, In today’s newsletter, we delve into the Third Pillar of the SMART Framework for business evaluation: Accounting. We’ll explore:
- How to analyze numbers
- How numbers can be manipulated
- Basic checks for accounting shenanigans
- Examples of good and bad accounting policies
Click the link below to watch the full video on how to assess the quantitative aspects of a business.
In earlier newsletters, we’ve discussed how we at Bastion utilize the SMART Framework to evaluate businesses as investments (Link), streamlining our analysis process. We’ve also explored the first pillar, Strong Business (Link), and the second pillar, Management (Link), with numerous examples. Be sure to check them out as well.
MEME OF THE WEEK
