How to Create an Investment Thesis

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Introduction

An investment thesis is a written document that helps the user with guidelines on which companies to invest in. The use of an investment thesis can help the user filter and screen companies so that they can identify the most optimal investments for a given set of preferences and particular targets. Building an investment thesis will help investors to stick to a chosen strategy and provide evidence-based returns when used in the long term. This article will walk you through a step-by-step guide on devising your own investment thesis to ensure you adhere to your strategy of choice.

Market Capitalisation

Whether you are a venture capital investor or a beginner investor simply looking for a risk-averse investment that will provide steady returns, you will incorporate a company’s market capitalisation into your investment decision. Investment banks providing venture capital will target small companies whom they believe have long-term growth potential. As a result, screening out companies with a market capitalisation of above 150 million would drastically help to cut down the number of investment opportunities to these investment banks and will allow them to identify suitable investments quicker and with fewer costs. In contrast, a risk-averse investor seeking maintenance of capital accompanied by a steady source of income would be likely to screen for large-cap companies with a better capacity to maintain regular dividends. Therefore, market capitalisation is an important factor for any investor and should be the first element incorporated into any investment thesis.

Market

The second element which should be incorporated into an investment thesis is the area in which the user wishes to invest. This decision should incorporate macro-economic considerations as well as other factors such as political frictions which may affect investments as well as the user’s familiarity with the companies in the selected area. A user may choose to focus their investments in the US or include European and emerging markets for added geographical diversification. Either way, choosing your area of investment and screening out the remaining companies will drastically increase the speed at which you will be able to make your investment decisions.

Investment Style

The next element to incorporate into your investment thesis is the factors that you will be focusing on in your investment decisions. Depending on a person’s preferences with regards to investment horizon and attitude towards risk, they may choose to focus on value companies, growth companies, momentum companies, or companies that provide a passive income in the form of dividends. Once that decision has been made it should be incorporated into the investment thesis to ensure that this strategy is maintained.

Requirements

Once the factors for your investments have been identified the next step in devising your investment thesis is setting out specific requirements or metrics to be met before making an investment. These desired requirements will vary for each specific user depending on their own preferences but will be affected by the factors chosen in the previous step. For example, an investor focusing on value companies may choose to only select companies with a book value per share greater than its share price and a current P/E ratio greater than its forward P/E. Similarly, an investor focusing on growth companies may only decide to look at companies with sales and revenue growth of above 20%. These requirements will make it easier to stick to a set strategy and will filter out any inappropriate investments.

Ranking

Once your requirements have been screened, you will be left with a much smaller scope of companies that will be suited for investment. While all these companies fit the requirements for investment it may be beneficial to rank the remaining companies in areas of key interest. For example, say you were left with 100 companies after the previous screening processes but only wished to include 20 companies in your portfolio, and an efficient way of selecting these 20 companies would be to pick a metric such as ROA or ROE and ranking the companies in ascending order. Such a ranking would help to identify and invest in the most efficient companies at generating profits from their shareholder’s investments.

Monthly Contribution

After identifying the companies, you wish to invest in, one of the last factors to incorporate into your investment thesis is the monthly contribution towards your portfolio. Additionally, it must also be identified whether this monthly contribution is to be spread evenly across the total number of companies selected in the portfolio or whether the money should be added in such a way that the investments are equal between sectors or geographical locations.

Rebalance

The last step in completing a successful investment thesis is choosing a rebalancing period. This rebalancing period can range from every month to once a year and should reflect the overarching strategy of the portfolio. For example, if you are aiming to build a long-term portfolio it would make sense to have a longer gap between rebalancing and will require less stress and effort. Rebalancing your portfolio is necessary to ensure you are consistently invested in the top companies in your area of interest.

Sample Investing Thesis

This year, I will be implementing The Stable Dividend strategy. I will be investing $5000 in US large-cap stocks. These stocks must have a dividend yield greater than 2.5% and a payout ratio of less than 50%. I will then pick the top 20 stocks based on those with the highest debt-to-equity and ROIC. I will rebalance the portfolio monthly and invest an additional $500 each month. This strategy has averaged a return of 11.75% over the past 20 years.

The Takeaway

These are 7 steps to be taken in constructing your very own investment thesis. Not only will the use of an investment thesis take the hassle out of investment decisions, both before and during trades, but is also an evidence-based method of achieving abnormal positive returns on the stock market. These steps have been incorporated into each and every strategy available on Aikido Finance’s website, from value-focused to dividend-focused, with portfolio rebalancing services available soon to make the investment process for investors that much easier. 

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