Why I write deep dives.

and how I try to manage confirmation bias.

Confirmation Bias: people’s tendency to process information by looking for, or interpreting, information that is consistent with their existing beliefs.

“Preconceptions and priors: When you start on the valuation of a company, you almost never start with a blank slate. Instead, your valuation is shaped by your prior views of the company in question.” - Damodaran

Disclaimer: Fairway Research deep dives are not investment advice. Do your own due diligence.

I recently published a deep dive on SDI Group plc. Having spent over 70 hours researching and writing about the mini-conglomerate, I concluded that it is slightly overvalued for me. I say for me because I have a different risk tolerance than you. Given the information I presented in the 7,000 word¹ write-up, and combined with your due diligence, you might have come to a different conclusion. Or you might not care about the valuation at all. That is your investing style and I respect that. Investing is different for everyone. There is no one-size-fits-all approach. But why publish deep dives in the first place?

I enjoy the research process

I simply enjoy learning about new businesses and valuing them. I feel with my 12 years of experience in M&A and professional valuations I bring an informed opinion to my readers. In my head, I try to approach each deep dive as a business writer/researcher or journalist would. I will admit that the creative process around business research excites me. It has something to do with bringing structure to financial information.

Knowledge compounds

Marcus Aurelius' favorite poet, Heraclitus, once said, “No man ever steps in the same river twice, for it is not the same river and he is not the same man.”

Similarly - “No investor ever looks at the same company twice, for it is not the same company and he is not the same investor.” Knowledge compounds. Companies grow, enter new markets, launch new products, and hire different management teams.

Studying different businesses gives you benchmarks. For example, once I’ve researched Aritzia and know that they spend $3 million on opening a new store and have revenue of $1,000 per Sq. ft., the next time I look at an apparel retail business, I will have a yardstick to compare which will enable me to ask better questions. I also feel early on in one’s investing journey, studying mediocre businesses, is often as important as studying good businesses.

My Deep-Dive Process

For a business to be deep dive worthy, it needs to pass certain surface-level criteria. First, the company needs to be simple to understand (or with reasonable effort). Second, it should have stable or growing financials, with a return on invested capital higher than 15%. Third, it should have reasonable debt levels. It should also trade at a reasonable EBITDA multiple. If it trades at 80x EBITDA, I’m not touching it. Lastly, the most subjective one, I need to find it interesting.

Often that is also how I structure the deep-dive reports. I assume the reader is starting from a blank slate. First, I write about the business discussing its products, services, acquisitions, etc. I then discuss, in detail, the financial history of the business, management’s background, compensation structure, and capital allocation. Those 3-4 sections are often 80-90% of the deep dive content. But only after having written all these sections, and having spent a considerable amount of time reviewing documents, do I open a new tab in Excel and rename it as “DCF”. This is how I try to manage my own confirmation bias.

A DCF modeled without having gone through the process of understanding the business and financials is just numbers on a sheet. Remember the often over-quoted ‘Garbage in, garbage out’ analogy about DCFs? By the time I reach my DCF valuation, I am often beyond the point of not publishing the deep dive. 80-90% of it is already written up. What is the incentive for me to not publish? If my DCF says it is overvalued, then so be it. The company simply enters my ‘informed watchlist’, i.e., businesses I know well, but I’m not prepared to take a long position in as of now. I’ll still present a sensitivity table to help my readers evaluate a range of outcomes and come to their conclusions.

After I’ve written a deep dive, I simply share it with people who might be interested in what I write. I feel a sense of satisfaction in presenting my consolidated insights about the company in one place. I feel there should be one for every interesting company. Often readers write back with thoughts, counterpoints, queries about market shares, valuation assumptions, etc. Usually, it is a healthy and respectful discussion around the business.

I have no action bias

I am not compelled to publish ‘actionable’ deep dives. Patrick O'Shaughnessy publishes a brilliant podcast called ‘Business Breakdowns’. It is about great businesses, but often you can’t buy their stock because they are private. I’m trying to be a bit like Patrick.

To conclude, you will learn something from each of my deep dives but your portfolio might not look very different afterward. Maybe in the future the company will become undervalued. Maybe a comparable company will become cheap enough. Or a similar company in a different geography will come along with a more reasonable valuation. Possibilities are always there and we will be better prepared when they come along. One can argue that my approach yields a low return on time investment. Well, I’m in no hurry to get anywhere.

1. The length of the write-up is not indicative of the quality of the analysis.