In order to analyze a company’s business risk, start by understanding what the company sells and how it generates cash. The best starting off point its to read the company’s 10K. The company must file this document once a year within 60 days of its fiscal year end. There is a section titled, “Description of our business” that discusses the company’s products, customers, competitors, market share, industry dynamics, suppliers, owned properties and much more.
Once you understand the company’s business, the next step is to identify the company’s competitive advantage. This is crucial to the company’s credit risk because a company with weak or unsustainable competitive advantage will likely face profit pressures in the near future. Sustainable competitive advantage could be due to the following:
- Low cost producer due to economies of scale, technology or other
- Highly differentiated product due to innovation or brand recognition
- Focus on a niche product
Sometimes, a competitive advantage can last a very long time such as some branded consumer products like Coke. Other times, the competitive advantage only last short time such as AOL due to technological and industry structure changes. The job of the credit analyst is to determine how sustainable the competitive advantage is and how long it can last.
Other favorable factors for companies include the following:
- Consistent or increasing market share
- The ability for pricing power
- Diversification by products, geography or types of customers
- Consistent sales or recurring revenues
- Long product cycles
Another framework to use for company specific risk analysis is to use SWOT analysis, which analyzes the strengths, weaknesses, opportunities and threats for a specific company.