At Blackink Research, we have strict rules regarding our company valuations, to ensure they are valuable, truthful and reliable. On the other hand, why would anyone buy the recommendations of unreliable analysts? In this article, we will explore our methodology, with the goal to better explain precisely the reasoning behind our valuations, our ratings and our considerations.
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While it’s not at the beginning of the report, our research on the company starts from its business model. We have to understand perfectly how the company earns revenue, otherwise we won’t be able to judge the market, estimate the future of operations and, most importantly, explain in simpler terms to the reader what the business model consists of. To understand the business model, we rely on many sources, mainly coming from the company’s financial statements, but sometimes also directly from employees or customers. These two groups of people are particularly important for our analyses, as they give us special insights that are hardly found written anywhere else. For some companies, like those from the consumer staples sector, this job is fairly easy: indeed, it’s not difficult to imagine how companies like Procter & Gamble Company or The Kraft Heinz Company make money. For some others, especially those coming from innovative or highly technical industries, it’s harder, and we are not always able to summarize their business model in simpler terms: for example, Owl Rock Capital Corporation requires strong financial knowledge in order to be understood, and the same is for Linde Plc, which requires strong industrial background knowledge. However, considering that these niche industries are mostly unknown by outsiders, this fact does not represent an issue for our goal of making financial research accessible to everyone.
After having studied the business model of the company, we read the transcripts of the last earning call: sometimes, we start to analyze a company just before their quarterly results, and in that lucky scenario we listen to the call live. Earning calls are a wonderful source of useful information, as they show the current condition of the company both from the financial, the competitive and the operational perspective. We find particularly valuable the words of Chief Financial Officers and the answers to the shareholders’ questions. More often than not, in these words are contained all the information needed to evaluate the investment opportunity. After having done so, we ask for opinions on the company’s product, services and reputation by insiders: be them customers, employees or competitors’ employees, they give us important insights which we wouldn’t be able to get anywhere else. Insider information is the most valuable out there and contributes greatly to our considerations: they allow us to understand the industry as if we were part of it, without having to be. However, it’s worth noting that we don’t get or use any information that is not already publicly available, as it would be illegal and unfair.
Finally, after having understood the business model and having formed an opinion about the company, we start the valuation process. To evaluate a company, we usually use a discounted cash flow model, which we described well in our dedicated article. The model we use is based on the last 15 years worth of financial statements’ data and has a forecast period of 10 years. However, sometimes we use different lengths depending on the availability of information and the predictability of operations: for example, we don’t have much public financial data for new companies like Cloudflare Inc. or Duolingo Inc., and we cannot limit ourselves to 10 years of forecast period for hyper-growth companies like Palantir Inc. Usually, we use as the required rate of return a fixed value over the expected risk-free rate at the end of the year, called “risk premium”. For most equities, our model uses a risk premium of 6.00%, however sometimes it is higher due to the size of the company or its financial performance.
Rating and conclusion
When we finish our model, we have the fair value. The rating is automatically calculated based on the percentage spread between our estimated fair value and the current market value. We have to keep in mind that none of our rating is an investment suggestion, and they should be interpreted this way:
- “Strong buy” or “Buy” means that there is a good risk-reward ratio at the current prices and the company is likely to outperform the market.
- “Overweight” means that we expect the company to outperform the market, but the returns won’t be so high buying at the current levels;
- “Hold” means that we wouldn’t buy but, at the same time, we wouldn’t sell either;
- “Underweight” means that we expect the company to underperform the market, therefore we wouldn’t buy at the current levels, and we’d likely take profits on our position;
- “Strong sell” or “Sell” means that there is a terrible risk-reward ratio at the current prices and the probability to lose money is far greater than that of gaining something.
We explained how these ratings are assigned in quantitative terms on this page. There are some cases in which our opinion on the company is extremely positive, but our rating is not. While this can be confusing at first, it really isn’t: as Warren Buffett once said, “a good company may not be a good investment”. Since our investment philosophy consists in buying good companies at a fair price, we can’t recommend in good faith to buy something we like but consider severely overvalued.
The rating concludes our analysis. Once reached this point, we simply write down everything we found and publish the report. You can find all our reports available for purchase at a competitive price on our store.