While working on a new company, the first thing an analyst tries to figure out is the business model of the company. In simple words, the question we would ask is how does a company generate revenue? A bank makes money by acting as a financial intermediary. A fertilizer company makes money by combining raw materials and selling final products to farmers. A retailer buys finished products and makes money by selling the finished products as well as making money through working capital management.
However, if we want to go deeper into the subject the right question should change a bit. What is the company’s true value proposition to its customers? Lets apply this question to a few industries.
A Seven-Eleven store sells convenience to its customers and thus marks up its price higher. Similar for a Duane Reade Pharmacy. In contrast, a Walmart or a K-Mart is a discounter where the main value proposition to the customer is lower prices. Another example can be shown for an industrial raw material like fabric. In many cases, importing the material from foreign sources can turn out to be cheaper. However, buying it from a local vendor reduces inventory days and makes quality control much easier.
It’s a very good idea to thus understand the qualitative aspect of a business first and then understand the numbers. This is one thing which I learned from personal mistakes. Understanding the business model first allows the analyst to also understand the differences in the financial metrics. It will be easily clear why one company has a higher margin but a lower asset turnover by simply understanding whether the company went for an asset heavy model (capital expansion) versus an asset light model (renting or outsourcing).
Try this out. I can assure you that it will make you a better analyst who understands the big picture as well as the bottom up.