How To Do A SWOT Analysis For Stocks
Investing in the stock market can be an extremely rewarding activity, provided you base your decisions on the fundamentals. This essentially means evaluating a company on the basis of its strengths, weaknesses, and future calibre before buying its stock.
While there are many tools to assess a company, a SWOT analysis is a well-known method that can lend interesting insights into the company’s potential.
The SWOT analysis for stocks evaluates the investment viability of a company from the following angles:
- Strengths
- Weaknesses
- Opportunities
- Threats
In this blog, let’s understand more about how to do a SWOT analysis of a company to help in investment decisions.
Evaluating Strengths
While investing, you must understand the strengths of the company in which you are investing.
For many successful businesses, leveraging the strength or key focus area has helped them become big. Eventually, this has resulted in them being market leaders in their space and hence a viable investment avenue for investors.
Following are some of the critical factors that may be considered strengths while evaluating a name –
- Management, including the promoters and the employees
- Products or services (quality of the product, criticality in the value chain, research & development, patent, and the likes)
- Margins (sustenance of the margins vis-a-vis the competitors, importance of the product, substitution, etc.)
- Customer base (customer loyalty, brand loyalty, etc.)
A company with fortified upper management, viable product offerings, excellent innovation facilities, and great mass appeal is likely to thrive in the future and can be considered a viable bet. However, do keep in mind that every company, product, and market has different strengths.
For example, a tech company and an agrochemical or pharmaceutical company will have different strengths. While a pharmaceutical company may have R&D expenses or several patents as critical criteria, the tech company may have a client portfolio and order book as the strength. To analyze the strengths of a company keeping the industry and sector in mind to reach a suitable conclusion by buying its stocks
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Evaluating Weaknesses
In addition to the strengths, there may be certain areas where a company will be lacking. Some of these shortcomings can be overcome, while really critical ones can make or break its future growth prospects. These soft spots and the gravity of the weaknesses can give a fair idea of the future potential of the company.
While evaluating the weaknesses of a company is not an easy task, one thing that can shed a lot of light in this regard is the annual report. In the notes of accounts, companies tend to mention contingent or potential liabilities that may arise. This information may help you understand the weaknesses of a company.
Also, the following are some other weaknesses that should be considered –
- Product liability
- Absence of research/innovation
- Unstable management or declining promoter’s interest, including siphoning of the funds from the company resources.
- Competitive intensity
Similar to the strengths, a company’s potential weaknesses will be different. For example, while the utility sector may not face any competition, the FMCG sector may experience it at an elevated level. So again, keep in mind the intrinsic limitations of the industry before evaluating a company for its weak spots.
Evaluating Opportunities
One of the crucial and complicated factors to figure out is opportunities.
Opportunities show the potential growth pattern the company may chart out. For some companies, spotting a prospect could be easier than for others. Thus, as an investor, you should look for companies that are aggressively venturing out into upcoming areas and possess an early mover advantage.
For example, Maruti announced entering the electric vehicle segment when it was evident that India, sooner or later, would adapt to the same owing to the rising pollution level. Similarly, a lot of start-ups are finding opportunities in different segments, such as artificial intelligence.
While evaluating the opportunities front, here are a few things to look out for-
- Internal opportunities such as new geography, new product, etc.
- External opportunities such as mergers or acquisitions, a new segment, new industries, etc.
- Macroeconomic factors such as scarcity of resources, an abundance of the same, etc.
- Social trends
In the annual report of a company or even the transcript call or quarterly earnings presentation, a company may share its insights under the Management Discussion & Analysis section. This is where the company talks about its plans for the future and how it is going to leverage the growth of the economy or the sector.
An investor should gain insights from the section and accordingly form an opinion of the company’s future.
Evaluating Threats
The last of the four-point framework in the SWOT analysis of stocks is the threats. Every investor needs to look at the direct risks to their investments, and threats a company faces can tell you a lot about the risk your investments could be exposed to as well.
Threats are basically weaknesses magnified that have a direct impact on the business of the company.
For example, a high contingent liability could be a threat. Some common risks include:
- Litigation
- Government policies that may impact the business
- Competition
- Substitute and its pricing
The notes to the accounts section provide excellent insights into potential threats to the company. An investor could look at line items such as a lawsuit against the company, a ban on the product/process of the company, any pending litigation matter, a stay order, or any ban on the production/license (more applicable to pharmaceutical, agrochemical sector). Competition can also pose a threat in case the company is not fast enough with its product and pricing innovations.
Summing Up
To conclude, use the SWOT analysis of a company before basing your bets. It may seem like a cumbersome and time-consuming activity; however, it will make sure your investment decisions are based on sound fundamentals and not short-sighted gains.
Eventually, this research will bear fruits in the form of long-term gains as well as protect your capital to a large extent. So make informed decisions, carefully weigh the pros and cons and then stay invested!
Happy Investing!
Disclaimer: This blog is solely for educational purposes. The securities/investments quoted here are not recommendatory.