The term investment thesis refers to a reasoned argument for a particular investment strategy, backed up by research and analysis. Investment theses are commonly prepared by (and for) individual investors and businesses. These carefully crafted documents may originate from analysts or other financial professionals for presentation to their clients.
Key Takeaways
- An investment thesis is a written document that recommends a new investment, based on research and analysis of its potential for profit.
- Individual investors can use this technique to investigate and select investments that meet their goals.
- Financial professionals use the investment thesis to pitch their ideas.
Understanding the Investment Thesis
An investment thesis serves as a comprehensive guide that outlines the rationale for a potential investment. It is often created by financial experts to offer insights into investment opportunities and to present investment ideas. Sometimes, investors themselves will draft these theses, as seen with venture capitalists and private equity firms.
This tool enhances strategic decision-making. Investors and enterprises use investment theses to determine whether or not to pursue investments, such as purchasing stock or acquiring other companies. Additionally, it evaluates past decisions and their success rates. Documenting these ideas can significantly influence the direction and ultimate success of an investment.
For example, suppose an investor buys a stock based on the thesis that it is undervalued, planning to hold it for three years, expecting its price to reflect its true worth by then. If the market crashes a year later, the investor may refer to the initial thesis and rely on its convictions, choosing to hold the stock.
However, unforeseen events, such as the financial crisis of 2007-2008 or the Brexit referendum in 2016, can drastically affect the validity of an investment thesis.
If you believe in the strength of your investment thesis, maintaining commitment through market fluctuations is a sound strategy.
Special Considerations
Investment theses are generally formally documented but lack universal standards for content. Some need quick action and can’t be lengthy compositions. Particularly relevant for significant trends like a global macro perspective, an investment thesis might come with detailed documentation and promotional materials for prospective investment partners.
Today’s portfolio management has evolved into a science akin to engineering or medicine, with continual advancements in theory, technology, and market structures that enhance investment strategies. The investment thesis benefits from qualitative and quantitative methods now standard in modern finance.
Transforming an abstract idea into a well-founded proposal requires methodical research. This process refines a concept into a game plan, guiding investment decisions.
What’s Included in an Investment Thesis?
While there’s no rigid industry standard, certain components are typically included in an investment thesis. Remember, it’s a research-based proposal meant to guide the viability of a particular investment.
Most investment theses commonly comprise the following details:
- The investment in question
- The investment goal(s)
- Viability of the investment, including relevant trends
- Potential downsides and risks associated with the investment
- Costs, potential returns, and possible losses
Additional critical questions could be:
- Does the investment align with the intended goal(s)?
- What could go wrong?
- What do the financial statements reveal?
- What is the growth potential of this investment?
Written documentation helps investors make more informed decisions. A company’s management team, for instance, may use it to evaluate acquisition opportunities, ensuring the target’s vision aligns with their own or identifying market growth potential.
Complexity of investment theses varies based on the investor and the investment nature. A corporation’s thesis for acquiring a rival might be more intricate than an individual investor planning their investment portfolio.
Examples of an Investment Thesis
Portfolio managers and investment companies often publish their investment theses. Here are two illustrative examples:
Morgan Stanley
Morgan Stanley is a leading global financial services firm, offering investment management, investment banking, securities, and wealth management services. Their investment process includes five steps: idea generation, quality assessment, valuation, risk management, and portfolio construction.
During the quality assessment, they seek to answer:
- Is the company a disruptor or insulated from disruptive change?
- Does the company exhibit financial strength with high returns on invested capital, high margins, strong cash conversion, low capital intensity, and low leverage?
- Are there environmental or social externalities not borne by the company, or governance and accounting risks that could alter the investment thesis?
Connetic Ventures
Connetic Adventures is a venture capital firm investing in early-stage companies. Using data to inform their investment thesis, they focus on three pillars: diversification, value, and follow-on, each with its pros and cons.
Why Is an Investment Thesis Important?
An investment thesis enables investors or companies to make better, more informed investment decisions. It also serves as a historical guide to evaluate the consequences of their investment choices. It outlines the investment, goals, associated costs, prospects for returns, and potential risks.
Who Should Have an Investment Thesis?
Investment theses are important for any investor. Individual investors can use them to make informed stock purchases and strategy decisions, whether pursuing a buy-and-hold strategy or a short-term approach. Companies use them to assess the viability of acquisitions or growth strategies.
How Do You Create an Investment Thesis?
Documenting your investment thesis helps solidify your proposal. Ensure your thesis is clear and concise, supported by thorough research and accurate data. Include your goals, potential gains, and mitigate possible risks. It’s essential to ask critical questions about goal alignment and potential challenges.
The Bottom Line
Having a well-structured plan is crucial, especially for investing, given the financial stakes. An investment thesis equips you with a roadmap for informed decisions. Documenting your process and addressing pertinent questions regarding your objectives, costs, and potential results can mean the difference between earning returns and incurring losses. A solid thesis powerfully supports the viability of your investment.
Related Terms: portfolio management, stock market, financial analysis, investment strategy, risk management.
References
- Harvard Business School. “Writing a Credible Investment Thesis”.
- Lanturn. “What is an Investment Thesis and 3 Tips to Make One”.
- Morgan Stanley. “Global Opportunity”.
- Medium. “The Data That Built Our Fund’s Investment Thesis”.
