Building An Investment Thesis

This month, the team at SeventyTwo have reviewed several themes and ideations from leading market makers and investment managers to provide an overview of concepts to support your own investment thesis.

Megatrends, top-down considerations

As part of the 2023 AFR Business Summit, politicians and business leaders urged investors to zoom out
from today’s data to look at five big themes for the next 30 years. Speakers, including international economist Nouriel Roubini, billionaire Andrew Forrest, Bank of America chief executive Brian Moynihan, Australian National University professor Heather Smith and Incitec Pivot boss Jeanne Johns, highlighted five megatrends that will confront the global and Australian economies over the coming decades.

  1. Decarbonisation – arguably the most prominent megatrend at the Summit and the global race for capital and capabilities.
  2. National Security – where recent geopolitical tensions have fuelled a growing focus on border security and localisation.
  3. Deglobalisation – linked to national security and the loss of low-cost supply chains that underpinned rising living standards for decades and have now been replaced by a rush towards re-shoring, where nations seek to bring production as close to home as possible.
  4. Digitisation – which will require investments in computing power, tech skills, cybersecurity and, potentially even a stronger social safety net for those workers displaced by automation and AI.
  5. Inflation – decarbonisation, deglobalisation, defence and digitisation will all require huge investment from governments that already have increased debt levels and little appetite to raise taxes – therefore rising government debt will ultimately limit the level central banks can take interest rates

Most of these trends are under way – and all of them should be top of mind as investors consider how to construct a portfolio with a long-term outlook. Macquarie’s market guru, Viktor Shvets, also nominated three buckets of companies that investors can consider as part of forming a compelling investment thesis.

Shvets’ approach to selecting companies focuses on quality sustainable growth and also highlights companies that can grow without excessively leveraging their balance sheet or discounting margins while
maintaining a minimum return on equity.

  • The first bucket of companies that Shvets identifies for consideration are those that produce commodities needed to build the new age. These include copper, nickel, lithium, and rare earths.
  • Shvets’ second bucket focuses on capital goods companies needed to build the new age. These companies will provide the equipment and machinery necessary for the development of new industries.
  • The third bucket consists of companies that will operate the new age. This includes robotics and automation, alternative energy and transport platforms, fusion of infotech and biotech, and companies improving efficiency and reducing costs.

In summary, Shvets’ approach to selecting companies for investment focuses on quality sustainable growth. Investors can consider companies that produce commodities, capital goods, and those that will operate the new age, as well as defence and security and deglobalisation stock baskets. By selecting
companies from these buckets, investors can position themselves to benefit from the megatrends that are shaping the future of the global economy.

Developing an investment thesis framework

As part of formulating an investment thesis framework, we take a constant and consistent approach to screening companies across all sectors. Furthermore, heuristic biases need to be considered. Although we
are all human, any emotional bias towards a sector can sometimes affect the decision-making process.

A framework for developing a robust investment thesis typically involves a systematic approach to analysing various factors that can impact an investment opportunity. This may include market trends, industry dynamics, company financials, competitive landscape, and potential risks and uncertainties. This framework guides SeventyTwo in formulating a clear and compelling investment recommendations that have identified key drivers of value and potential risks to growth.

SeventyTwo’s framework typically includes steps such as identifying the market opportunity, conducting industry and competitor analysis, evaluating the management team and financials of the company, assessing potential risks and uncertainties, to formulate a compelling and evidence-based thesis that outlines the key drivers of value and potential catalysts for growth. Another important consideration is valuation discipline. You can find the perfect company process wise, but if you pay too much for it, it can be the perfectly wrong investment.

Porter’s Five Forces is also a widely used framework in strategic analysis that provides insights into the structure of an industry and competitive intensity. The framework looks at five key forces that shape competition in an industry, including:

  1. Threat of new entrants: the ease or difficulty of new competitors entering the industry. High barriers to entry such as high capital requirements, complex regulations, or strong brand recognition may discourage new entrants and reduce competition.
  2. Bargaining power of suppliers: the power of suppliers to negotiate prices and terms with firms in the industry. Suppliers may have more bargaining power when there are few suppliers of critical inputs or when there are high switching costs for firms in the industry.
  3. Bargaining power of buyers: the power of buyers to negotiate prices and terms with firms in the industry. Buyers may have more bargaining power when they are large and purchase in large volumes or when they have many alternatives.
  4. Threat of substitute products or services: the extent to which alternative products or services can meet the needs of customers in the industry. The availability of substitutes can limit the pricing power of firms in the industry and increase competition.
  5. Competitive rivalry: the intensity of competition among existing firms in the industry. High rivalry can result from many firms in the industry, slow industry growth, or high fixed costs.

By analysing these forces, insights into the competitive dynamics of an industry and the potential profitability of investing in a particular company can be determined. For example, a low threat of new entrants and low competitive rivalry may suggest a more favourable industry structure, while high supplier bargaining power and high threat of substitutes may suggest a more challenging environment for companies in the industry.

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