My investment framework: how I select winners

When I first started picking stocks back in 2019, I had no process at all to determine the quality of a business. Over time, I built a framework that allowed me to filter out the best and leave the rest. Having an investment framework like that helps to skew the odds of a successful investment in your favor. Over the years, it helped me pick many multibaggers. Some of these include:

• Nebius +805%
• Cloudflare +581%
• Axon +504%
• Crowdstrike +311%

Introduction

In this deep dive, I will break down the 9 steps of my investment framework that I’ve built over the years and still continue to refine. Overall, I can break down my process into two categories: the numbers and the story. The golden zone is when both reinforce each other. The numbers are focused on revenue growth, free cash flow growth, margins, balance sheet, key metrics, valuation, etc.

The story is focused on where the business could go in the future, driven by their mission, culture, industry positioning, moat, leadership team, customer happiness, expansion into adjacent markets, and so forth.

I’ll address each of them in the same order I’d like to analyze a business when I know nothing about it, which I’ve visualized below.

1 – Circle of competence

The first thing I ask myself is: "am I able to really understand this business?" If not, it directly goes into the “too hard” pile. That’s true for insurance businesses and banks, for example.

The next question I ask myself (I have a lot of internal conversations with myself) is: “Does the business interest me enough to keep tracking it?” If not, I’ll put it aside.

This is where the majority of businesses are already filtered out because my investable universe is solely focused on tech. When it does pass my circle of competence checks, I move on to the next step.

2 – Quick Glance

In this stage, I basically run a quick checklist:

• Is there consistent revenue growth → shows if there is sustainable demand
• Are margins stable or rising → signals a strong competitive position
• Are they free cash flow positive → can they scale profitably
• Is there a large and growing total addressable market → signals a long runway for growth
• Do they have a healthy balance sheet → can they weather a storm and come out on top

I treat this as a guide and not as hard knockout criteria. For example, I also invest in businesses that are not yet free cash flow positive, but where I do see a clear path to becoming free cash flow positive. There’s always some nuance to take into account.

3 – Deep dive: the numbers

This is where the real research begins, where I read quarterly reports, news articles, annual reports, research papers and use tools like TIKR and Fiscal to deep dive into the numbers. Things I look for:

• How does revenue evolve over time?
• How do they make money and what are their main expenses?
• What does free cash flow look like?
• What are the margin trends?
• Are shareholders being diluted? → the extent to which new equity is issued, resulting in a decrease of shareholders’ ownership
• Which key metrics are essential to track for this business and how do they evolve over time?
• What exactly does their balance sheet look like and is it improving over time?
• Is there anything out of the ordinary, looking at their numbers?

Once I get a clear picture of what the numbers look like, I’ll focus on really breaking down the business itself. I purposefully do it in this order, because if the numbers look bad, there is no need to dive deeper into the story (in most cases).

4 – Deep dive: the story

4.1 – Mission driven & founder led

I always look for mission driven businesses that really want to make a I always look for mission driven businesses that really want to make a difference. It creates focus and a shared goal for employees to strive for. A higher purpose so to speak.

I strongly prefer founder led businesses because they really live the mission and vision of the business. They don’t do it for the money, but for the impact. They are highly motivated to think long term instead of short term milestones.

Related to this is insider ownership: high insider ownership signals confidence in the business by insiders. Additionally, it aligns business interests and shareholder interests. I’d love to see insider ownership >8%.

There are some exceptions where I invest in businesses that are not founder led, but overall, 75% of my portfolio consists of founder led businesses.. It creates focus and a shared goal for employees to strive for. A higher purpose so to speak.

I strongly prefer founder led businesses because they really live the mission and vision of the business. They don’t do it for the money, but for the impact. They are highly motivated to think long term instead of short term milestones.

Related to this is insider ownership: high insider ownership signals confidence in the business by insiders. Additionally, it aligns business interests and shareholder interests. I’d love to see insider ownership >8%.

There are some exceptions where I invest in businesses that are not founder led, but overall, 75% of my portfolio consists of founder led businesses.

4.2 – Leadership team

There is more to a business than the CEO, so I always check the other C level executives to get an idea of who they are, what they bring to the table and if I trust them with my money. Because that’s what it is: they are the ones with leading roles in the business and an important factor that determines the execution of a business.

4.3 – Moat

Moat determines the ability of a business to maintain a competitive advantage over others in order to sustain long term profits and retain or gain market share. Research has shown that wide moat businesses outperform those with narrow moats. A great framework to determine the moat, and the one I personally use, is the one by Morningstar.

It highlights:

1. Intangible assets: brand, patents, or regulatory licenses that allow a company to charge more or operate exclusively
2. Switching costs: when customers face high costs (money, time, disruption) to switch to a competitor, making them stay
3. Network effect: a product or service becomes more valuable as more people use it, creating a self-reinforcing advantage
4. Cost advantage: the ability to offer goods or services at a lower cost than competitors, boosting margins or enabling price undercutting
5. Efficient scale: operating in a market that’s effectively limited in size, discouraging new entrants because the returns wouldn’t justify the investment

Ideally, the business has a combination of multiple interlocking competitive advantages. If it’s a narrower moat business, which usually is the case when a business is early in its lifecycle, I’ll be looking for signs of a widening moat.

4.4 – Optionality

Optionality is the ability of a company to create new revenue streams. A great example is Amazon, which started selling books and now has a multi billion dollar cloud division, e commerce and a streaming service.

I always look for businesses that can expand into new markets, which gives them a long runway for sustainable organic growth, meaning they don’t need acquisitions to grow.

4.5 – Customer happiness

This is, in my opinion, an often overlooked part of investing. Ultimately, it is the customer who determines the success of your business. Having a deep connection with your customers and providing them with value is what really matters.

For software businesses, I always check reviews on sites like G2 and Gartner to get a general idea of how customers view their products. If available, I also check for net promoter scores, which can be found on Comparably.

4.6 – Culture

A successful business is the sum of the effort every individual employee puts in. That’s why I can’t overstate the importance of culture. I always check reviews on Glassdoor and Fishbowl (for tech businesses) to see what employees are saying about the company’s culture and how they rate the CEO.

It’s a serious red flag if the CEO and or overall reviews of the business are below 3 out of 5 stars. I prefer to see it well above 4 out of 5.

It’s also useful to listen to earnings calls to get a general idea of the tone of voice of the management team, how they address issues, and how they speak about the business and the employees.

4.7 – Sector positioning

Once I get a good grip on what makes the business tick, I focus on the context in which they operate. That’s where sector positioning comes in. I check their main competitors, what they have to offer and to what extent they overlap.

This is where the total addressable market (TAM) is an important factor to consider as well. How big is the pie and how many want a piece of it? I always take the reported TAM with a grain of salt because it often is a very rough estimation, but it gives a general idea of the potential that lies ahead.

4.8 – Customer concentration

I’d like to know if the business is depending on a few large customers or if revenue is spread across many customers. I don’t like customer concentration because losing a major client directly affects revenue and free cash flow and can ultimately be detrimental to the future of a business if it’s too reliant on one or two major clients.

5 – Risks

With every business, there are risks to consider. They can be at the business level (execution, founder leaving, fraud, you name it) or sector risk (disruption, an external shock like Covid, government enforcing specific laws, etc.).

It’s in this stage where I consider all the things that could possibly go wrong and how likely that is. It helps to do this in a later stage in my process, because at that point, I can oversee all the moving parts in and around the business.

I generally think about risks in terms of probability versus impact. The most important ones are risks with high probability and high impact. Estimating these risks isn’t hard science but more like a mental framework which helps me prioritize.

6 – Bull & bear case

The bull case and bear case help me to think in scenarios. The bull case describes “what if everything goes right,” whereas the bear case focuses on “what if everything goes wrong.” I find it very helpful to look at a business from different angles. It’s easy to get lured into hype or excitement and this step helps to look at the broader picture.

7 – Valuation

The final part of the equation is the price tag. As Benjamin Graham stated: “a great company is not a great investment if you pay too much for the stock”. It really depends on which stage of the lifecycle a business is in and which valuation method is best suited to value it.

For businesses I invest in, early stage, high growth, the price to gross profit, price to free cash flow and price to revenue ratios are some of the most useful ones, combined with a (reverse) discounted cash flow analysis or sum of parts approach.

It can also help to check how the business historically traded on these ratios vs peers. Valuing a business is not easy though and it takes time to master. Especially with DCF models, it’s garbage in, garbage out. That’s why I often use these with a grain of salt.

In practice, I use a combination of the above mentioned methods and look per individual case which methods are best to use. It also helps to use the bull and bear cases to determine if the stock is priced for perfection or priced as if it’ll go out of business (and everything in between).

8 – Thesis

The thesis brings it all together and is a summary of why I believe the business (and stock) will do well over time. It takes into account all the puzzle pieces described above into one comprehensive overview.

I also like to include what should happen to the business that would make me decide to sell it. Thinking about this will mentally prepare me in case my investment thesis goes sideways for whatever reason.

9 – Invest & track

We’re nearly at the end of my process, because the final part is to press the “buy” button (or not). When I do press that button, it’s time to continuously track how the business performs and whether it is in line with my thesis. I do so by tracking news that’s published along the way and listening to quarterly earnings calls.

I like the idea of “buy and hold” but I rather frame it as “buy and verify”, because that’s what it really is. Ideally, the business performs in line with my thesis, or better yet, outpaces what I thought would be possible. If it’s not, I won’t hesitate to pull the plug and move on to better opportunities.

Another reason for me to sell out of a position is when I believe there are better opportunities out there with a better risk reward that still fit all my criteria.

Final thoughts

Having an investment framework like this really helps me select the best businesses out there. It also forces me to do proper research and really know what I own. It’s a very important part of building conviction early on, which also allows me to double down on opportunities with confidence and stick with it through periods of volatility.

Having a framework like this doesn’t guarantee success though. It is still possible to buy shares of a business that turn out to be a bad investment, but having a process like this does skew the odds of a successful investment in my favor.

Thanks for reading and I hope you found this helpful! Feel free to ask me anything about my framework or related questions.

As always, none of this is financial advice. Always do your own due diligence before making an investment decision that fits your own risk tolerance and time horizon.

Written by

Share

Copied