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SWOT Analysis for Stocks

SWOT Analysis is a subject taught in every MBA class.

It's something that might be discussed in every company strategy meetings as well.

But what exactly is SWOT?

And how does it help investors?

For an investor, SWOT is a useful tool for fundamental analysis of a company.

What is SWOT?

Simply put, SWOT stands for Strengths, Weaknesses, Opportunities and Threats.

Strengths

This is internal and specific to the organisation. Strength implies the competitive advantage that a company has compared to its peers.

A lot of people get confused by what strength of an organisation is. Porter has beautifully described what a competitive strength is and what it is not.

What distinguishes and organisation from its competition is what is the unique service or value proposition it offers. It is not a race to be the best. It is rather a race to be unique.

If an organisation's strength is to be the best among competition, that strength won't last long. If companies try to compete with the best product, that will always be prone to new competitors.

On the other hand, if a company strives to be unique, that can be a real strength.

In the 2000s, the whole 2-wheeler market was competing to make the best bike. Everyone was trying to cater to the mass market with bikes in the below 200 cc segment.

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The segment was crowded. While a Bajaj Pulsar would work once, there would be competition from a Hero or other two-wheelers. They were all trying to outdo each other in the same segment.

Then came Eicher Motors with its 'Royal Enfield' brand. It did not want to compete with everyone else to make the best bike. It wanted to offer something unique.

It focused on the less crowded +250cc space. A market that was nascent. A market no one was focusing on.

Slowly, but steadily, it created a whole new market. It realised its strength and focused on being unique.

The result: A 90-95% market share even after being in the business and seeing competitors come and go for decades now.

The strength should be seen in numbers as well. If the company you're looking at truly has a long lasting and durable strength, it will show up in numbers.

Is the company earning above average return on capital? Is the company able to maintain its market share for a fairly long period?

Always link the strengths of an organisation with numbers when analyzing a company.

Eicher Motors' Strength in Numbers

  10 year Sales Growth
(Annualized)
10 year Profit Growth
(Annualized)
Eicher Motors 12.00% 30.20%
Bajaj Auto 10.00% 12.00%
Hero Motocorp 6.20% 3.80%
Data Source: Ace Equity

Weaknesses

Again more than theoretical definitions, a look at a company numbers will give you a better idea of a company's weaknesses.

Are gross margins for the company lower than the industry average? It means the company is not able to command a higher price to customers as compared to the industry.

Why would this happen? Either the company's product or the perception of the product is not too strong enough for customers to pay up.

Are operating margins lower than the industry average? It might indicate that the company might not be operating as efficiently as it should.

As an investor, you need to check if this is a one-off or a long-term issue. Has the company's gross margins been lower than average for years? Has operating margins been sub-par for years?

Certain numbers will clearly give you weaknesses of the companies you are looking at.

Check for return on equity (ROE) of a company. If a companies' ROE is consistently lower (12% would be a good benchmark), it signals an inherent weakness in the business or the industry the company is operating in.

If occurring over a long-term, these weaknesses are too serious for an investor to ignore. Investors might be better off focusing on other stronger players for investment.

Businesses with Inherent Weaknesses

  5 Year Average Return on Equity 10 year Average Return on Equity
Apollo Hospitals 5.60% 7.80%
Vedanta 7.50% 11.00%
Adani Enterprises 5.40% 8.40%
Hindalco 6.30% 6.70%
SAIL -0.80% 3.30%
Source: Ace Equity

Opportunities:

If you get this analysis right as an investor, you might have a potential wealth creator on your hands.

Opportunities for an organisation can be in different forms.

It can be a huge market size of the industry that the company belongs to. Always remember, a small fish in a large pond is much better than a large fish in a small pond.

A huge opportunity size can mean decades of above average growth for a company. The size of the export opportunity for the IT sector in the 1990s created multibaggers like Infosys, TCS in the Indian share market.

Focus on different kinds of potential opportunities as an investor. Also, see if the company you are looking at is capable of maximizing on this opportunity.

If you get both of these factors right, you have a potential wealth creator in front of you.

Threats

Threats are external factors that can disrupt a company's operations. It can either be new competition entering the market.

It can also be due to technology disruption that can threaten the business of the company.

We saw this with Kodak getting disrupted once technology took over the photography market.

Investors need to be careful if they are holding on or looking at businesses with obvious threats. Once disrupted, these businesses can take a long time or might never recover.

On the other hand, if the threat is a temporary one, it can be a good buying opportunity if the investor is convinced about the company's strengths.

SWOT for an investor

As an investor, it's important that he/she looks at SWOT as an important step in the analysis of a company.

Analysis of SWOT will help in identifying the key attributes that can make a company an attractive investment. It is also important to look at all four attributes together.

A comprehensive SWOT analysis gives a key insight about the company's strategy, competitive advantage, and competitive intensity in the sector.

It's a necessary tool for fundamental evaluation of the company an investor is looking at.

Recommended readings on SWOT Analysis:

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