A Stock Analysis Framework

I am writing this article as an all-encompassing guide which I or anyone who wants to analyze companies can refer too.

It covers every step—from initial candidate filtering to final decision-making—without skipping any details. We'll explore the core principles I have learned from various value investors, the chronological 4Ms process (Meaning, Moat, Management, and Margin of Safety), valuation techniques, risk avoidance strategies. By the end, you'll have a practical checklist to reference for every analysis.

North Star

Buy a wonderful business at a fair price. Do not compromise on business quality to chase a “cheap” price. Price only matters after the business passes your quality bar.

The 4Ms Process: A Step-by-Step Analysis Framework

The 4Ms is a chronological sequence taught by Phil Town of Rule One Investing. I have personally found it to be a solid foundation for finding value driven investments. It builds certainty layer by layer.

Meaning: Building a Deep Understanding

Phil Town’s "Meaning" principle is rooted in the idea that investing isn’t just about crunching numbers; it’s about ownership. When you buy a stock, you’re buying a piece of a real business, and Town insists you should treat it like you’re buying the whole company. If you don’t understand the business or feel a connection to it, you’re more likely to make emotional, uninformed decisions—especially when the market gets shaky. Sticking to your circle of competence (a term borrowed from Warren Buffett) means you’re playing in a sandbox where you already know the rules.

Ask the Right Questions: Town emphasizes three big ones:

• Do I understand how this company makes money? If the business model is a black box (think complex derivatives or niche biotech), it’s probably outside your circle.

• Would I be proud to own this business? This ties to your values—would you feel good telling people you own a piece of this company? For instance, if you’re passionate about sustainability, you might avoid fossil fuel companies and lean toward renewable energy firms.

• Does it excite me? Passion keeps you engaged. If you’re bored by an industry, you’re less likely to do the homework needed to invest wisely.

Moat: Identifying Durable Competitive Advantages

Imagine a castle surrounded by a wide, deep moat that keeps invaders at bay. In investing, a "moat" is like that—it's a built-in, long-lasting edge that shields a company's profits from competitors. Without a strong moat, rivals can chip away at your earnings over time, eroding margins and making the business vulnerable. The key is that moats aren't short-term gimmicks; they need to stand the test of time, lasting for decades to truly protect the company.

Types of Moats

Here are the main kinds of moats, explained with real-world examples to make them easier to picture:

• Brand: This is when a company's name or image is so iconic that customers happily pay more for it. Think of Coca-Cola's massive loyalty—people choose it over cheaper alternatives because of the brand's emotional pull and recognition.

• Pricing Power: The ability to buy materials at rock-bottom prices or charge premium rates without losing customers. For instance, Walmart uses its enormous scale to negotiate the cheapest deals from suppliers, giving it an edge in keeping costs low.

• Secrets: These include patents, unique recipes, or proprietary technology that others can't easily copy. Google's search algorithms are a classic example—they're closely guarded secrets that keep the company ahead in the tech race.

• Toll Bridge: Like owning the only bridge over a river, this moat gives monopoly-like control over something essential. Utilities or railroads often have this, where customers have no real alternatives and must pay the "toll" to use the service.

• Switching Costs: High hurdles that make it painful or expensive for customers to switch to a competitor. This includes network effects, where the value grows with more users. Microsoft's software ecosystem is a great example—once you're locked in with files, apps, and integrations, switching feels like starting over.

It's also crucial to get a full grasp of the company's overall essence. Skipping this step can lead to risky investments, so dive deep to build confidence.

Breaking It Down

To really understand the business, break it into these key areas:

• Understand the Industry: What makes this sector tick? Look at the main drivers, like barriers that keep new players out, government regulations, or whether it's cyclical (up and down with the economy) versus secular (steady long-term growth). For example, in consumer goods, examine supply chains and how consumer habits are shifting, like the move toward eco-friendly products.

• Company's Position in the Industry: Where does this business stand? Check its market share, if it's a leader in specific niches, and how it stacks up against rivals. Mentally apply Porter's Five Forces: the power of suppliers and buyers, threat of substitutes, potential new entrants, and overall competition.

• Business Model: How does the company actually generate money? Break down revenue streams (like ongoing subscriptions versus one-off sales), cost structures, and scalability. Bonus points for recurring revenue, as it creates predictable income.

• Company Culture: This is the "soft" side—core values, how happy employees are, and the drive for innovation. A strong culture fuels long-term success and helps the company adapt.

Management: Evaluating Leadership Quality

A fantastic moat is worthless if the people steering the ship are incompetent. Even the strongest business can falter under bad leadership. Focus on three essential qualities in the team, especially the CEO: integrity (being honest and ethical), intelligence (smart strategic thinking), and motivation (having real skin in the game, like owning significant shares).

Researching the CEO and Team

Don't just skim the surface—dig into these sources for a well-rounded view:

• Beyond Filings: Use Google to find biographies or any scandals; hop on YouTube for interviews to see how they communicate and think.

• Shareholder Letters: These are often in annual reports. Look for straightforward, honest writing that emphasizes long-term goals over short-term hype.

• Trade Journal Articles: These provide insider industry views on the leaders' reputation and decisions.

• Insider Trading: Check SEC Form 4 filings. If executives are buying shares, that's a positive sign of confidence. But if they're selling more than 30% of their holdings, it could be a warning (maybe they see trouble ahead).

• Investor Relations Documents: Review proxy statements (filed as DEF 14A) to see compensation details. Ensure pay is tied to performance, like through stock options, to align interests with shareholders.

Performance Toolbox

Use these metrics to gauge how well management is performing:

• ROE (Return on Equity) and ROIC (Return on Invested Capital): Aim for at least 10% consistently. These show how efficiently the company uses its resources to generate profits.

• Debt Levels: Zero debt is the gold standard for safety. If there's long-term debt, make sure it's no more than three times annual earnings.

• Other Metrics: Watch for low share dilution (not issuing too many new shares, which waters down ownership) and smart capital allocation (like buying back shares when undervalued instead of wasteful spending).

Ultimately, you want CEOs who behave like true owners, not just employees collecting a paycheck. For example, if a CEO snaps up shares during a price dip, it signals strong belief in the company's future.

Margin of Safety: Ensuring a Fair Price

Remember: The price you pay determines your return, not just the quality of the business. A margin of safety is like a safety net—it means buying the stock at a price well below its true (intrinsic) value, giving you room for error if things go wrong. A simple way to think of it: You're getting $10 worth of value for just $5.

To find that fair price, use three separate valuation methods. Then, only buy if the current price is at or below the highest of these three (this builds in conservatism).

1. 10 Cap Rate: Seeking a 10% Yield

This is like valuing a rental property: What purchase price would give you at least a 10% annual return?

• Qualitative Checks First: Is the business straightforward and predictable? Does it have a solid moat, strong cash flow, and good ROIC? Is the CEO personally invested? Will the company be even more productive in 10 years? (You don't need exact numbers—just confidence in the upward direction.)

• Step-by-Step Calculation:

  • Operating Cash Flow: Pull this from the cash flow statement—it's the cash generated from core operations.

  • Subtract Maintenance Capex: From the same statement, take total capital expenditures (capex) and estimate 70% as "maintenance" (the upkeep needed to keep things running) if it's not broken out. Growth capex is for expansion.

  • Add Tax Provision: This comes from the income statement and adjusts for taxes already accounted for.

  • Owner Earnings = Operating Cash Flow - Maintenance Capex + Tax Provision.

  • Per Share: Divide that by the number of shares outstanding.

  • 10 Cap Buy Price = Owner Earnings Per Share × 10.

Check the 10-K notes for details on capex types to refine your estimates.

2. Sticker Price / Margin of Safety (MOS): DCF-Based

This method forecasts future earnings and discounts them back to today's value, like a crystal ball for cash flows.

• Key Inputs:

  • Diluted EPS (TTM): The earnings per share over the trailing 12 months, accounting for all potential shares.

  • Future PE Ratio: Typically twice the expected growth rate, but if that's higher than historical averages, stick to the historical high for safety.

  • 10-Year Growth Rate: Mix historical data, analyst forecasts (which often cover just 1-2 years, so extend thoughtfully), and insights from your 4Ms research (like what the CEO says about future plans). Always pick the lowest estimate and cap it at 15% to stay conservative. Check if growth is steady (linear) or speeding up/slowing down.

• The Model: Project EPS growth over 10 years, then discount those future values back to now using a required return rate (say, 10-15%). This factors in how stock prices swing based on whether earnings beat or miss expectations.

3. 8-Year Payback Time: Free Cash Flow Focus

Approach the company like you're buying a private business: How quickly can you get your investment back in cold, hard cash?

• Earnings vs. FCF: Earnings are on paper and can be manipulated; free cash flow (FCF) is the real cash left after essential spending.

• Calculation: FCF = Operating Cash Flow - Total Capex. Look at the 10-year trend in the FCF ratio. Your goal: The price should allow you to recoup your investment within 8 years or less based on average FCF.

For the final buy price, go with the highest from these three methods—that way, you're being extra cautious.

Inversions and Rebuttals: Stress-Testing Your Thesis

To avoid falling in love with your own ideas, flip your thinking on its head. This "inversion" technique helps spot weaknesses before they bite.

Inversion: List Why You Might Be Wrong

Ask yourself these tough questions:

• Do I really understand the business inside and out?

• Is the moat truly protective and built to last?

• Has any recent event damaged or breached the moat?

• Does the company have the financial strength to weather storms?

• What could prevent it from achieving the growth I've projected?

• Might this short-term event turn into a long-term problem?

Pull ideas from sources like the 10-K's risk factors section or pro/con articles on Seeking Alpha.

Rebuttals: Fight Back with Facts

For each inversion, counter with solid evidence. For example, if worried about an event, point to data from past recoveries showing the company's resilience.

Always start with inversions to sidestep confirmation bias—where you only see what supports your view. This step keeps your analysis honest and robust.