What Is an Investment Thesis?
A well-reasoned case in favor of a certain investment strategy that is supported by research and analysis is what is meant by the phrase "investment thesis." Investment theses are often drafted by individual investors as well as corporations, and they are also created for them. Analysts and other professionals in the financial industry may be responsible for preparing these official written papers for the purpose of presenting them to their customers.
Understanding the Investment Thesis
As previously stated, an investment thesis is a written document that gives details about a possible investment. It is a research- and analysis-based proposal often produced by an investing or financial expert to give insight into investments and pitch investment opportunities. Investors, including venture capitalists and private equity companies, may create their own investment thesis.
This thesis may serve as a strategic decision-making tool. A thesis may guide investors and corporations in making financial decisions, such as stock purchases or acquisitions. Alternatively, it may be used to reflect on why a certain choice was taken in the first place—and if it was the correct one. Putting things in writing may greatly influence the path of a possible investment.1
Assume an investor buys a stock because they believe it is undervalued. The thesis indicates that the investor intends to retain the stock for three years, during which time the price will grow to represent its real value. At this moment, the stock will be sold for a profit. A year later, the stock market falls, taking the investor's selection with it. The investor remembers the investing thesis, trusts the validity of its findings, and continues to hold shares.
That is a great technique until an occurrence that is completely unanticipated and unrelated to the investing concept happens. Examples include the 2007-2008 financial crisis and the 2016 Brexit referendum, which resulted in the UK leaving the European Union. These were very unexpected developments, and they might have an impact on someone's investing thesis.
Special Considerations
An investment thesis is often explicitly recorded, although there are no common rules for its substance. Some need quick action and are not complex compositions. A well-documented investment thesis on a major trend, such as a global macro view, may contain promotional materials for prospective investors.
Portfolio management is becoming a scientific field, similar to engineering and medicine. As in other sectors, advances in underlying theory, technology, and market mechanisms are constantly translating into improvements in goods and professional practices. The investing thesis has been enhanced by the use of well acknowledged qualitative and quantitative approaches.
What's Included in an Investment Thesis?
Although there's no industry standard, there are usually some common components to this document. Remember, an investment thesis is generally a proposal that is based on research and analysis. As such, it is meant to be a guide about the viability of a particular investment.
Most investment theses include (but aren't limited to) the following information:
- The investment in question
- The investment goal(s)
- Viability of the investment, including any trends that support the investment
- Potential downsides and risks that may be associated with the investment
- Costs and potential returns as well as any losses that may result2
Some theses also try to answer some key questions, including:
- Does the investment align with the intended goal(s)?
- What could go wrong?
- What do the financial statements say?
- What is the growth potential of this investment?
Putting everything in paper allows investors to make better informed selections. For example, a company's management team may utilize a thesis to determine whether or not to pursue an acquisition of a competitor. The thesis might assess whether the target's vision matches that of the buyer or discover market growth prospects.
Keep in mind that the complexity of an investment thesis is determined by both the kind of investor and the nature of the investment. As a result, the investment thesis for a business attempting to purchase a competitor may be more detailed and involved than that of an individual investor seeking to build an investment portfolio.
Examples of an Investment Thesis
Portfolio managers and investment companies often post information about their investment theses on their websites. The following are just two examples.
Morgan Stanley
Morgan Stanley (MS) is one of the world's leading financial services firms. It offers investment management services, investment banking, securities, and wealth management services. According to the company, it has five steps that make up its investment process, including idea generation, quality assessment, valuation, risk management, and portfolio construction.3
When it comes to developing its investment thesis, the company tries to answer three questions as part of its quality assessment step:
- "Is the company a disruptor or is it insulated from disruptive change?
- Does the company demonstrate 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 may alter the investment thesis?"3
Connetic Ventures
Connetic Adventures is a venture finance business specializing on early-stage enterprises. The organization analyzes data to create its investing thesis, which is built on three pillars. According to Connetic's blog, their venture capital investment approach was based on three pillars or concepts. These included diversity, value, and follow-up—each with a positive and negative.