What Is an Investment Thesis?

In Motley Fool's MarketFoolery podcast on Dec. 30, host Chris Hill and Motley Fool One analyst Jason Moser received a question from a listener that basically said, "What exactly is an investment thesis? How do you go about creating one?" Attempting to simplify a concept that isn't always cut and dry, Moser summed it up as either a long-term trend that's playing out or a short-term event that may occur. His most helpful responses, however, came in the form of examples. On that note, here are two more examples -- both based on my two largest holdings in my real money portfolio: Apple (NASDAQ: AAPL  ) and Tesla (NASDAQ: TSLA  ) .

But first, here is another interpretation of what an investment thesis is and how to create one -- straight from my 10th grade English class.

Ms. Jones' thesis
I'll never forget the way Ms. Jones (I've used a different name for privacy) taught me to develop a thesis in the first paragraph of an essay. She described it as the bottom tip of an upside-down triangle.

"Begin your opening paragraph broadly," she would say. "Perhaps an interesting quote or intriguing fact that relates to your topic at a 10,000-foot view. Then narrow your writing until it hits a specific point -- one powerful sentence that tells your reader the central idea your communicating."

Little did she know I'd use the advice for investing. I've found her approach to have many parallels to the way I develop a thesis for a stock. After I've done my research on a stock, both macro and micro, and I'm ready to make a decision about whether or not I want to invest in the stock, I apply her approach. It usually goes something like this:

  1. Starting broadly, I ask: What are the big macro trends impacting this company and its industry?
  2. How is this company poised within this trend?
  3. What makes this company enduring (or not)?
  4. Based on these developments and situations, what is the specific reason I believe this company is (or is not) worth its current price (the answer is my thesis).

Without further ado, here are two examples of theses (with a bit of background) developed using a similar approach as the one outlined above.

An investment thesis for Apple
The smartphone market is still growing rapidly. Worldwide smartphone shipments grew 38.8% in the third quarter from the year-ago quarter, according to IDC. Apple's iPhone segment (its highest revenue and most profitable business segment) should benefit from this trend. As growth inevitably slows, Apple has built an army of lifelong customers who should prove to be a solid source of sustainable revenue over the long haul. Thanks to a very valuable brand, Apple's products boast incredible customer retention from these customers. Importantly, these customers pay premium prices for Apple's product; this has turned the company into a cash cow. Finally, Apple has consistently proven it has a strategy to jump from one new category to another, elegantly able to profitably cannibalize its innovations of the past.

My thesis: Even though Apple's customers are as loyal as ever and its most important segments are still growing, Apple is priced for low single-digit growth. And healthy cash flow combined with a diligent plan to return cash to shareholders mitigates downside risk.

An investment thesis for Tesla
In 2013 Tesla exploded onto the scene, executing far beyond the market's expectations. Before 2013, investors weren't sure whether there was meaningful demand for fully electric cars. Going into 2014, Tesla has proven there is a market. Despite a price tag that begins just under $70,000, Tesla has guided for 21,100 deliveries in 2013 -- only beginning an expansion to Europe in Q3. Of course the company sells every car it makes and continues to be supply-limited, all on an advertising budget of zero. With big plans for an affordable fully electric car to launch sometime in the next few years, the company is hedging its big bet by rapidly building a network of charging infrastructure to support long-distance travel.

My thesis: As the sole player in long-range fully electric vehicles with a significant head start over its potential competitors, Tesla is poised to be a major benefactor in the adoption of electric vehicles over the coming years. If demand for its luxury Model S sedan is indicative of the zeal the mass market may have have for an affordable fully electric Tesla vehicle, Tesla will soon become a major player in the automotive market.

Using theses
How do investors use investment theses? Here's what I've found to work: Simply reevaluate your investment thesis every time there is any new meaningful information related to your stock. I've found having an investment thesis keeps me calm even in the midst of irrational volatility; it keeps me focused on the underlying business. As long as my thesis is still intact, everything else is simply noise.

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  • Report this Comment On January 05, 2014, at 2:17 PM, SimpleWorks wrote:

    My investment thesis on Apple is simple, it comes down to growth or no growth. With no growth Apple will trade at a discount to the market, with growth Apple will simply trade at a market multiple and we will see a return to growth when Apple reports this month. I expect double digit top and bottom line growth this year. Top line catalysts are: DoCoMo accelerates growth in Japan and the China Mobile deal will double Apple's market share in China. Bottom line catalysts are: rising margins with a reduced share count. New products and new product categories will just be icing on the cake. Cheers!

  • Report this Comment On January 06, 2014, at 1:12 PM, dlwatib wrote:

    Judging by your article, an investment thesis boils down to prospects for growth. But in fact that is only half the equation. One could easily make the case that Tesla, for example, is poised for growth and yet is not a good investment because that growth has already been priced into it's shares.

    And no, dividend stocks will never make you rich. They may preserve your capital better than growth stocks, and they may provide you with an adequate income if you hold enough of them, but they will never make you rich. For compounding of returns you want growth stocks that you don't have to pay transaction costs on to reinvest proceeds, it's done for you automatically by the company management.

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