Understand the Business You Are Investing In

When I was a kid, my father and I had this little ritual when we visited a coffee shop. It was like our own personal game. He’d catch me while I was sipping a coke and casually drop the question, “How many cups of coffee do you think this place needs to sell daily to stay in business?”

And just like that, our little game began. We’d dive into a lively discussion for the rest of our time there, breaking down everything it took to run that coffee shop. Nothing was off-limits, from rent and utilities to staff wages and the cost of those precious coffee beans. By the end of our brainstorming session, we’d do some back-of-the-envelope number crunching and figure out how many cups of coffee they needed to sell to break even. The game always concluded with what my father was really trying to get at, “Given what you know now, do you want to own this coffee shop?”

As I grew older, our game evolved. We graduated from coffee shops to restaurants, and our estimating skills became more refined. No longer content with just the price of a cup of coffee, we started considering the average spend per customer on all items, from coffee to food. We even began factoring in variables like location, risk of competition, and what kept people loyal to that particular place.

Looking back, I didn’t realise it then, but that silly game with my dad laid the groundwork for the investor I am today. Sure, it’s not always coffee—they might be selling houses, microchips, or online advertising—but the principle remains the same:

  1. How does this business make money? What products or services do they offer?
  2. What are the costs involved in providing that service or making that product?
  3. Who else is doing something similar?
  4. How easy would it be for someone to replicate what they’re doing?
  5. What keeps customers loyal?

 

Of course, there are other factors to consider, but in the end, the above is vital to answering the ultimate question: “Given what I know now, do I want to own this business?”

It might sound simplistic, but I am a tremendous fan of simplicity. You significantly increase the odds of failure if you don’t understand the basics, like how a company makes money or what it takes to keep it running.

So, the next time you’re considering buying shares in a company, maybe ask yourself:

“How many cups of coffee does this business need to sell to stay afloat?”

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