Investors are often told to think like an “owner” when considering an investment in shares of a publically traded company. That’s easier said than done, particularly since the fast paced nature of the stock market can sometimes push investors into a gambling mindset. Creating rules around investing is one way to help force the “owner” mentality and a great one to incorporate into the arsenal is the SWOT analysis.
SWOT is an acronym that stands for Strengths, Weaknesses, Opportunities, and Threats. The four create a box based on two criteria: Internal versus External and Good versus Bad. Thus, there are good attributes specific to the company (Strengths) versus unappealing specifics about the company (Weaknesses) and good things external to the company (Opportunities) and bad things external to the company (Threats). This won’t tell you specifically if you should buy or sell a stock, but it will give you a deeper understanding of the decision you are making.
A SWOT analysis can be in-depth or fairly simple, depending on the person performing it and the needs of the situation. For example, it’s probably best to start with a simple bullet-point list under each item. If the negatives clearly outweigh the positives, there’s probably no need to go further. The simple approach was all that was needed.
Digging a bit deeper, however, can help clarify one’s thinking. Using McDonald’s (MCD – Free McDonald’s Stock Report) as an example, you might place recession resistant under Strengths. This might be true, but it doesn’t hurt to think about why you believe this to be so. Two solid reasons to highlight this fact are that the low price of the company’s food items means that higher-end customers can trade down to its offerings and the low price point maintains the ability of lower-end customers’ to eat at McDonald’s even during financially stressful times. You could also add that new, “healthier” food items make McDonald’s more palatable to some customers (mothers, for example) who may have been a dissenting vote even when on a tight budget.
That last item could also find itself, in a slightly different fashion, on the Opportunities list: New, “healthier” food items, like salads and oatmeal, make McDonald’s more palatable to some customers who may have been a dissenting, and deciding, vote in restaurant selection. However, this would more likely be a line item than an explanation on the Opportunities list—which shows that there is interplay between the items in many ways. The explanation on the Opportunities list for this item might read: To combat the view that its food is unhealthy, which may be cause to avoid McDonald’s for some people, the restaurant has introduced a collection of healthy options including a variety of entree salads for lunch and dinner, oatmeal for breakfast, a fruit and nut salad for desert, and apple slices and milk to augment happy meals.
The view that its food is unhealthy, meanwhile, would be an appropriate Weakness: Food often viewed as unhealthy. The explanation for this might include something like: Hamburgers and fried products (chicken nuggets, French fries, and fish) are viewed negatively in a society that is increasingly focused on health consciousness. Which, interestingly enough, is an example of an external Threat that McDonald’s faces. The reasoning behind this, if one wanted to write it out, might be: With obesity and its health impact (diabetes, heart disease, etc.) being highlighted both in the media and politically, restaurants are being pushed to enhance the healthfulness of their food offerings and being vilified for having unhealthy offerings.
It should be fairly apparent that it’s easy to make a SWOT analysis into a lengthy document, but that isn’t really its purpose. The goal is to quickly cut through to core issues. So a simple SWOT analysis consisting of a list will often be more than enough to make a decision. However, taking a deeper dive on the items may be important when looking to differentiate between investment options. For example, pitting a company like Krispy Crème (KKD) against McDonald’s on the health issue would quickly show that Krispy Crème would be hard pressed to deal with an issue that McDonald’s has already begun to successfully address—advantage McDonald’s.
Without going into the details, here is a potential quick SWOT on McDonald’s:
Ubiquitous (viewed as the go-to fast food restaurant)
Solid, low-cost business model based on years of experience
Massive buying power
Food offerings often viewed as unhealthy (burgers and fries)
Large size of business makes growth more difficult to achieve
Commodity costs can quickly erode profit margins
Translating business model to foreign markets could be difficult (eating habits can vary greatly by country)
Large foreign operation (68% of 2011 sales) exposes the company to foreign exchange risk
New healthier food items may make food more desirable to health conscious customers (“silencing the no votes”)
Expansion in foreign markets
Remodeling of older restaurants
Increasing size of middle class in emerging markets
Entry into new and highly popular product categories (coffee)
Increased societal focus on health could reduce demand at fast food restaurants
Government regulation of food industry with regard to health issues
Foreign exchange fluctuations
Commodity price fluctuations
Competitors allowing McDonald’s to take lead (and risk) on product design, mimicking successes (salads being introduced at Burger King (BKW))
This SWOT analysis is fairly surface and could be refined with additional details. However, it provides an example of what you might do to get a better understanding of a company and its business. The effort is relatively minimal when compared against the cost of buying shares of a company—particularly if those shares fall materially in value because you didn’t think of a particular issue until it was too late.
Like Value Line’s proprietary Timeliness and Safety Ranks, a SWOT analysis is a tool that can help you to limit the list of potential investments. However, having this simple tool in your tool box can really help enhance your understanding of what you own—and what you decide not to own.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.