Basic, lesson 1 of 4
Building a long thesis
A thesis is two or three claims about the business, each one tied to a number you can watch. If you cannot say what data would prove a claim wrong, it is not a thesis yet.
9 min, 2 checks
1Where ideas come from
Good ideas usually start with change the market has not fully absorbed. Analysts look for it in a few places.
- A margin or growth inflection: costs that spiked are falling, or a new product starts to matter.
- A change in who runs it or owns it: new management, an activist, a spin off.
- A shift in industry structure: a competitor exits, pricing turns rational, a regulation changes.
- A misunderstood segment: a small, fast growing piece hidden inside a slow whole.
- Price moves that do not match the news: a stock down 30% on a problem that looks temporary.
2Thesis points you can track
Each thesis point should name a driver, a number, and the data that will show it. Interviewers lose interest at 'great management' and lean in at 'aftermarket revenue rises from 30% to 40% of sales over two years, which I can track in the segment disclosure every quarter'.
Check 1
Which is the strongest thesis point for a long?
3Make the gap big enough to matter
A view that differs from consensus by a sliver does not move a stock. Run your thesis through to earnings per share and compare it with the street. Operating leverage is often where a modest revenue view becomes a large earnings gap.
Worked example
Harlow Pumps (a made-up industrial)
- 1Revenue this year: $2.0bn. Consensus expects 4% growth to $2.08bn at a 15% operating margin: EBIT $312m.
- 2Interest $12m, tax 25%, 100m shares. Consensus EPS: ($312m - $12m) x 0.75 / 100m = $2.25.
- 3Your view: 8% growth to $2.16bn, driven by higher margin aftermarket parts.
- 4At a flat 15% margin, EBIT would be $324m and EPS $2.34, only 4% above consensus.
- 5But the extra $80m of revenue is aftermarket at a 35% incremental margin: $28m more EBIT, so $340m.
- 6Your EPS: ($340m - $12m) x 0.75 / 100m = $2.46.
Your $2.46 is about 9% above the street's $2.25. That is a gap worth pitching. The 4% version is not.
Check 2
Using the Harlow numbers, suppose the incremental margin on the extra $80m is 50% instead of 35%. What is your EPS, in dollars?
Terms in this lesson: Operating income.
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