This is the second-last part of this long-running series where we lay down a series of questions to ask before committing to an investment.
This comprehensive list has been adapted from Michael Sheen’s book “The Investment Checklist”.
Today’s session will look at questions relating to the evaluation of growth opportunities and also mergers and acquisitions (M&A).
You can check out the first 11 parts in the links below.
Part 1 – please click HERE.
Part 2 – please click HERE.
Part 3 – please click HERE.
Part 4 – please click HERE.
Part 5 – please click HERE.
Part 6 – please click HERE.
Part 7 – please click HERE.
Part 8 – please click HERE.
Part 9 – please click HERE.
Part 10 – please click HERE.
Part 11 – please click HERE.
53. Does the business grow through mergers and acquisitions, or does it grow organically?
It is important to identify the growth drivers of a business, and these come in two main forms – organic growth and acquisitive growth.
Organic growth refers to the business expanding its current base of customers, introducing a new product line or charging higher prices.
This type of growth is internally-driven and not the result of buying over another business or company.
M&A, on the other hand, involves the acquisition of external businesses to add to the current one.
In general, organic growth is preferred to acquisitive growth.
There are many more things that could go wrong when acquiring a new business.
Some examples include over-paying for a business that subsequently does poorly, a lack of synergies (in integration) or being unable to integrate the acquiree’s working culture with the acquirer.
A recent example is Okta’s (NASDAQ: OKTA) acquisition of Auth0.
Both companies had radically different sales teams and Okta was too optimistic about how fast it could integrate these sales teams to enable them to work together seamlessly.
54. What is the management team’s motivation to grow the business?
Investors need to assess if the management is growing the business for the right reasons.
Management may engage in what is known as “empire building”, the acquisition of numerous businesses to add new divisions to the group.
Doing so constitutes more of an ego trip for the manager rather than him or her taking care of shareholders’ best interests.
Other types of management may be incentivised to grow the business by receiving a fee for making acquisitions.
If the motivation is purely monetary, it may end up creating a situation where management becomes overly aggressive and performs shoddy due diligence.
55. Has historical growth been profitable and will it continue?
Take a peek at the company’s history and track record to determine if it had always operated efficiently and generated a profit.
If historical growth was unsteady and was filled with numerous mistakes and/or missteps, investors need to be wary of management’s capital allocation capabilities.
By studying the company’s strategies and plans for growth, investors should be able to discern if this growth can continue, or if the business may be hitting a brick wall.
56. What are the future growth prospects for the business?
This question ties back to the investor’s original investment thesis and is related to the presence of catalysts.
Are the growth prospects bright for the business, or are there many storm clouds and obstacles which may present challenges to the management?
Investors also need to assess how adaptable the business is, and whether it has evolved to remain relevant versus its competitors.
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Disclaimer: Royston Yang does not own any of the companies mentioned.
