Analyzing A Live Investment Opportunity

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Estimated read time: 6 minutes 06 seconds

1. Analyzing A Live Investment Opportunity

2. EfficeSHIT Market Hypothesis - Good vs Great Investors

Good morning and happy Monday - let's get smarter

Analyzing A Live Investment Opportunity

A startup we work with in our software + service business recently had a few different new business lines / opportunities they wanted to pursue

They have never had a process to evaluate which opportunities are worth pursuing versus which are not pursuing

While this is relatively simple, it ultimately a lesson in capital deployment and opportunity cost that I think applies across various aspects of life

Taking a new job, taking a new investment, it’s all a very similar process

An investment opportunity recently came across my desk and I started to think through how I was evaluating whether it was worth pursuing or not

Here was my process:

Facts

1. Opportunity to invest in a super bowl event at a bar with a hospitality group

2. The funds would be used to pay for the performer, promoters, security, and few other small items

Evaluating the opportunity

Timing - deploy the capital within a few days and can generate a return within 2 weeks -> very quick return time

Amount - no deployment minimum, so don’t have to invest an excess amount to reach a minimum

Competition - Are we offering a premium entertainment or a premium offering so that we can charge a premium? If not, are we a lower cost than the other opportunities and can we win on volume of sales vs rather than being a premium priced offering?

Revenues

Ticket sales - Our return is solely based on the ticket sales, with no $ from food or alcohol at the bar

Break even point - In order to break even, we need to sell about 60-65% of the tickets

Bottle sales - We receive 20% of bottle sales at the VIP tables. Is this demographic likely to spend on bottles for this event?

Promoters - Our returns are heavily tied to the ability of the promoters to sell these tickets successfully prior to the event and then ticket sales at the door

How will we advertise?

Are these promoters able to get us to the breakeven sales amount prior to the event so everything at the door is a return on investment?

Is there enough margin of error that if we need to spend $10-$15k last minute on advertising we can still generate a return?

Chance of success and generating a return

Great venue around the super bowl in terms of popular bar and target demographic

High quality artists performing at the venue will generate interest

What am I not thinking about that could cause this event to fail?

Are there more popular artists at nearby locations?

If our artist has to cancel at the last minute, what happens?

What are the biggest assumptions to success and how can I stress test the financial model?

1. Increase promoter fees

2. Weather impact the venue?

3. Increase marketing $

4. Increase security budget

5. Lower table spend

6. Lower ticket sales volume

Now I never want to think about this all in my head

The best way to evaluate these opportunities is to build out a financial model and stress test the assumptions

By stress testing the assumptions, I am setting a base case of the expected outcome and then I am lowering the revenue drivers and increasing the expense drivers significantly to see what the returns look like

Even if you aren’t financial savvy, the ability to build our a basic P&L with assumptions and see what it looks like will go a long way

You can see what are the key revenue and expense assumptions are of the business model

For example:

If you have an investment opportunity where you are re-selling used cars and you make 10% margin on each of those, you’ll very quickly see in the financial model that this business will struggle to be profitable unless there are a large volume of transactions

Here is the P&L projection below

My goal is to factor in all of the exact “known knowns” that I have

As close in terms of numbers as I can get or find data on for my assumptions and then leave some margin of safety in for “unknown unknowns”

Assumptions

Projections

Now -> I can use this analysis and the amount I am going to deploy to see what my returns would look like

2 important investment metrics are IRR (internal rate of return) and MOIC (multiple of invested capital)

IRR - Time sensitive return calculation

MOIC - what is the value of the $ put in and the value of the $ after (if I put in $10k and get out $50k my MOIC is 5x)

Since I will get a return in a few weeks versus a few years, the time value of money is irrelevant here as there is no impact

The return will come very fast which is appealing

But in return for a fast return, there is a capped upside as there is only so many tickets available, tables available, and time (1 weekend)

I would highly encourage you when it comes to evaluating an investment opportunity, new job opportunity, lay it out in terms of the offering, the timing of cash flows, the upside % chance of success from equity

And think through the economics and the qualitative factors (fit, opportunity, etc)

What I ended up not like and ultimately passing on as the biggest drivers were unknown unknowns. We were tied to the promoters success which we didn't know and didn't have control over

I felt that the margin of safety was not wide enough to cover that

EfficSHIT Market Hypothesis - Good vs Great Investors

If you have taken entry level finance or economics classes, they talk a lot about the efficient market hypothesis

The efficient market hypothesis states that all factors that are readily available / known are already factored into the price of the stock

The issue is that like all things, there are exceptions or dislocations in the market where the market isn’t factoring certain things in

The analysis I walked through above looked at a lot of the micro versus the macro

It looked at a specific business model, the specific micro factors (location, venue) that can impact the investment

This opportunity is almost in a vacuum with such a quick turnaround

The issue with real life is that a lot of the best investors like also have to factor in the macro factors, that is what separates the good from the great

Since the start of 2023, crypto, and stocks overall have performed very well

So does this mean that all things interest rate related, recession related, have already been priced in and we have moved past that?

New bull market?

I’d argue that there is a major factor that hasn’t been priced in

Corporate profits recession in Q4

As we get later into 2023, more and more companies will start reporting their Q4 earnings

What if corporate profits are slowing much more than expected, and companies will have less money to spend on growth in 2023?

What if those same companies will lower their earnings estimates into 2023 lower based on their Q4?

How many people are aware of slowing corporate profits?

The ideal scenario in order to make outsized returns in investing is being contrarian and being right

If investors and people get sucked into being irresponsibly long crypto and shit stocks, then this provides an outsized opportunity to take the other side, and if you’re right, outsized returns

I constantly try and scan opportunities and think about the other side

What are they talking about?

What are they seeing and thinking?

What don’t they know?

The average US GDP growth, aka economic growth, is typically between 2-3%

If companies are making less profits, are spending less on employees, new equipment, etc, then what happens to GDP growth? GDP growth slows as these companies profits slow

Is US GDP growth going to zero possible?

Does anyone have it factored in?

My belief is corporate profits will be WORSE than expected and US GDP which will WORSE than expected over the coming months

Those factors aren’t priced in

If those factors aren't priced in, and we are seeing a bull run over the past month, it just makes the pain of the eventual come down that much worse

Most people will have FOMO of this recent rally, but not really it's built on a house of cards that may not have everything priced in

- Dev

DISCLAIMER: None of this is financial advice. This newsletter is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. Please be careful and do your own research.