This column was originally published on RealMoney on April 20, 2007 at 10:02 a.m. ET. It's being republished as a bonus for TheStreet.com University readers. For more information about subscribing to RealMoney, please
The Changing Business EnvironmentWhat do you think is the most important change happening in the competitive environment at present? This query can highlight emerging issues and demonstrate how the company is adjusting to the changes. Again, you need to compare the answers of various managers against each other; an odd answer could either be ahead of the pack or out of touch. If you think the answer makes sense, it can open up new questions that further enhance your understanding of the industry and the role that the company you are interviewing plays in it. After Hurricane Katrina and other storms in 2005, ratings agencies toughened up their risk models, and catastrophe modeling companies increased their frequency and severity estimates. This created an even greater squeeze in the 2006 property reinsurance markets than what the losses of capital alone would have caused, as happened to the 2005 property reinsurance market from losses suffered in 2004. New entrants in the reinsuring property risk space found that they could write only half of the premium that their more seasoned competitors from the class of 2001 could. Further, property-centric writers found the capital required went up more for them than for their more diversified competitors. There was less effective capital in property reinsurance at the end of 2005 than at the end of 2004, even though surplus levels were higher on net. Those who recognized the change in the rules of the game caught the rally in the stock prices as the price for reinsurance went up more rapidly than most expected for the 2006 renewal season.
Mergers and AcquisitionsWithout naming names, what types of business alliances do you think could be most valuable in the future? This helps flesh out competitive strategy. Managements will be reluctant to part with details, but usually are willing to explain their approach to supplier agreements, joint ventures and so on. The answer to this question can also highlight the "missing pieces" for the current business, and how the management team is trying to source them. It can also shine a light on new products and services that management is considering. Is it cheaper at present to grow organically or through acquisitions? The right answer is almost always organic growth. Acquirers usually overpay, particularly in acquiring scale. Intelligent acquisitions are usually small and often private firms, where the sale is negotiated and not an auction. The goal is to gain new core competencies or markets that can grow profits in concert with the capital and other resources that the company can add to their new acquisition.
SummaryThe difference between my approach and the approach of most analysts is that I think about the business and its strategy rather than the next quarter or year's earnings. My methods probably won't help you make money in the short run but will help you make money in the long run as you identify intelligent management teams that understand how to compete for the long term, rather than those that can manage only next quarter's GAAP earnings. Two additional side benefits to doing it my way: First, the management teams will like talking with you. I can't tell you how many times managers have said they appreciated my businesslike approach to analyzing their companies. Second, it will translate back into an improved understanding of the business you presently work in, as you think about strategic issues there. Key Points:
- Management needs to be in touch with changes in technology, culture and regulations.
- Flesh out competitive strategy by asking about acquisitions.
- These questions take the long-term view, unlike most analysts' quarter-focused queries.