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Due Diligence process: 9 simple steps

Due Diligence process: 9 simple steps

Thursday 11, 06 2020
Most of the steps in Due Diligence are related to stocks, but the aspects of these considerations can apply to debt instruments, real estate or other investments.

In addition, it is important to consider the risk tolerance when conducting Due diligence. There are no strategies or sizes suitable for all investors.

Step 1: Analyze capitalization (total value) of the company

An analysis of a company's market capitalization (total value) can provide an indication of how stock prices may fluctuate, how wide their ownership may be, and estimated target market size of the company. For example, large-cap companies tend to have a stable revenue source, and large and diversified investor base, which can lead to less volatility. Meanwhile, small and medium-sized companies may operate only in specific segments of the market and often experience greater fluctuations in stock prices and earnings compared to large corporations.

Step 2: Analyze trends in revenue, profit and deposit

The income statement will give information about the company's revenue, net income or profit. It is important to keep track of all trends in revenue, operating expenses, profit margins and return on equity. Profit margin is calculated by dividing the company's net income by total revenue. It is best to analyze profit margins over a few quarters or years, and compare those results with companies in the same industry.

Step 3: Analyze competitors and industry

As stated earlier, it is necessary to compare the profit margins of two or three competitors. Looking at the major competitors in each business line (if there is more than one) can help investors determine the competitiveness of the company in each market. Is the company the leader in its industry or specific target markets? Is the industry growing? Conducting Due diligence for multiple companies in the same industry can give investors insight into how the industry works and what companies have an edge over others in the competition. 

Due Diligence process: 9 simple steps

Step 4: Price multiples

There are many ratios and financial figures that investors can use to evaluate companies. There are no ideal metrics for all investments, so it's best to use a combination of ratios to help create a complete picture and lead to smarter investment decisions.

Step 5: Ownership management

Is the company still run by its founders? Or has its management board been reformed with a lot of newcomers? It is suggested to find out if the founders and executives hold a high percentage of shares and whether they have sold stocks recently. Investors are advised to consider the high ownership of top managers as a plus and low ownership as a potential red flag. Shareholders tend to be best served when company’s executives enjoy benefits from good performance of the stock.

Step 6: Balance sheet 

The consolidated balance sheet will display assets and liabilities as well as the amount of cash available. Debt levels must be tracked and compared with industry peers. Huge debt is not necessarily a bad thing as it depends on the company's business model and industry. But what is the rating for its corporate bond? Does the company generate enough cash to pay down debt and dividends? These questions must be answered carefully.

Step 7: History of stock prices

Investors should study both the short-term and long-term price movements of a stock and whether it is volatile or stable. They should also compare the profit made in history and determine the degree of correlation with the price movement. Remember that past performance does not guarantee future price movements.

Step 8: Dilution of stocks

Investors should know how many shares exist and how that number relates to the company’s competitiveness. Is the company planning to issue more shares or dilute more of its shares? If so, the stock price may be affected.

Step 9: Check short-term and long-term risks

Be sure to understand both the industry and company risks. Are there legal or regulatory issues? If a new product fails or a competitor launches a new and better product, how will this affect the company? How does raising interest rates affect the company? How about economic growth and inflation?

Once the steps outlined above are completed, investors will gain a better understanding of the company's performance and how it competes with others, and they can develop their investment strategy.

Due Diligence service in Vietnam

As shown above, the Due Diligence process may seem simple, but it is not easy, especially for investors who are looking for opportunities in a completely strange and different country to them like Vietnam, where providing accurate and transparent information is not what businesses often do. It is quite a challenge for foreign investors to conduct Due Diligence themselves here. Moreover, when it comes to Legal Due Diligence, Human Resource Due Diligence, Administrative Due Diligence, etc., things are going to be much more complicated than just looking at the financial statements. Therefore, outsourcing a company specializing in Due Diligence is the best solution for foreign investors in this case.

Currently in Vietnam, Due Diligence service has not been widely available because domestic enterprises are not really familiar with this important process. Normally, only banks conduct Due Diligence. For Due Diligence outside the bank, VietnamCredit is the only provider of this service because we understand the pressing needs of foreign partners when investing in Vietnam.

If you want to learn about a company or want to investigate a partner in Vietnam, please contact us via email [email protected] for further help.

>> Due Diligence: What you need to know

Henry Tran - VietnamCredit


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