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Constructing An Investment Thesis

Course Section 4 - Lesson 5

We have finally reached a point where we have identified a strong investment opportunity. The last step that we need to complete before we execute a trade is documenting our investment thesis.

Why Write an Investment Thesis

Before we jump in and start writing, let's first establish what this documentation step accomplishes.

Inside our investment thesis, we will commit to writing all the critical points we have learned while researching our target security. We will define our beliefs about the industry, the stock, and how it should be valued so that we know what our thought process was months or even years down the road when we review this investment.

Suppose our investment doesn't perform as well as we planned. In that case, this document will serve as the reference point that helps us evaluate whether our initial analysis was flawed.

Similarly, if our investment performs well, we can look back to this document to decide if a continued opportunity for market outperformance exists with this security going forward.

What Information Belongs in an Investment Thesis

Your investment thesis should contain the key points surrounding the company's environment and what you believe about the company and no more.  

This document is only for you and should serve as a reference point to revalidate the investment in the future. It should contain a few bullet points on the industry, the company itself, and the current valuation of the stock. Each bullet should allow you to quickly state whether or not it remains true when you revisit each of them in the future.

Finally, you should include a thesis statement summarizing all of the ideas in the document and directing the action you take.

Going through this process with Texas Roadhouse might look something like the following:

Texas Roadhouse (TXRH) Investment Thesis

Industry

  • The casual dining industry is a mature market that should grow roughly in line with GDP.

  • It is competitive, and operating margins are tight, but the best operators should generate profits.

  • The industry was hit hard by Covid-19, but as transmission rates fall in the US, industry sales should recover to pre-pandemic levels.

Company

  • Texas Roadhouse is one of the premier casual dining operators in the space.

  • Management at the company has exhibited a consistent ability to open new and profitable restaurants at a much higher rate than the industry.

  • Revenue at Texas Roadhouse should recover inline (or slightly faster, due to new restaurant openings) than the industry.

  • Once revenue recovers, management should grow sales at an annualized 7-9% rate for the foreseeable future.

  • As the company's restaurant base matures, operating margins should have the potential to expand from their current level of 8% to ~9-10%.

Valuation

  • The company currently trades at 18x EV / EBITDA. I believe the company should be valued in line with the best restaurants in the casual dining category at 20-22x EV / EBITDA.  

  • Such a valuation would equate to a stock price of between $104 to $140, with a target of $121.

Stated Thesis  

As of April 30th, 2021, the market is valuing Texas Roadhouse in line with weaker peers who have not exhibited the same level of growth potential or the same opportunity for margin expansion. I believe that the company will be among the fastest-growing, most profitable companies in the category, which will justify an expansion in the company's EV / EBITDA multiple to 20-22x. This multiple expansion equates to a target stock price of $116 - $140.

Reviewing the Thesis

Notice how each bullet in the thesis is stated as a belief based on the research conducted throughout the course. This makes it easy for us to confirm or invalidate our investment thesis when we review this document in the future.

Imagine that we get 12 months down the road. Every restaurant in the category has recovered from the pandemic except for Texas Roadhouse. That would be an unambiguous indication that something about our thesis was wrong, and we either need to reevaluate or sell our position. The same goes for every other statement that was made.  

Reviewing the thesis for every company you hold should be a regular part of your portfolio review process. By structuring a short writeup of each security you own in this way, you make it easy to revisit your ideas and ensure that your positioning remains valid.

Mark Complete