Utilizing SWOT Analysis for Investing

December 08, 2020 · 5 minute read

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Utilizing SWOT Analysis for Investing

What is SWOT analysis? SWOT analysis is an acronym for strength, weakness, opportunity, and threats. This type of analysis considers four key aspects of a company and tries to determine its future performance. Investors take stock of current strengths and weaknesses as well as future opportunities and threats, in expectation that this will provide a well-rounded view of where the stock lies—and where it might be headed.

SWOT Analysis can be one more tool in an investor’s toolkit when choosing a stock to buy.

What is SWOT Analysis?

Many investors probably use some form of a SWOT analysis already, whether they realize it or not. Common sense could compel investors to consider the strengths and weaknesses of a company to some extent.

Using the formal SWOT analysis method gives an investor a more systematic, in-depth picture of the present and potential future of a company.

In this analysis, the strengths and weaknesses usually come from internal factors involving the operations of the company. Opportunities and threats usually come from external factors in the company’s industry or the overall economy.

SWOT Analysis: Strengths

In general, companies should be constantly trying to improve themselves and establish an advantage over their competitors. This is known as an economic “moat” and the idea is that it makes it difficult for competitors to take market share from the company, meaning they could have a high likelihood of success.

Examples of strength include things like researching new technologies or products, discovering new mineral or ore deposits (for gold mining companies), or having cornered the market for a particular sector in an area (e.g., being the first legal cannabis company in a state that recently legalized cannabis).

Analysis of strength might also come from simply looking at a company’s financial statements. Rising quarterly earnings and dividends, for example, might be considered a strength because it means the company is growing.

If such a trend were to continue, that could be reflected in higher share prices over time.

SWOT Analysis: Weaknesses

If a company doesn’t perform well in key areas that typically indicate strength, that could indicate a potential weakness. Declining earnings, cutting or suspending dividends, or a general lack of promising research and development could all be considered signs of weakness.

It’s also important to note that strengths and weaknesses can change among shifts in the overall economy. If a gold mining company discovers a large deposit of gold-rich land, it might not help them as much as expected if the price of gold also falls sharply.

SWOT Analysis: Opportunities

Opportunities represent potential areas of interest that a company might be able benefit from.

For example, if a pharmaceutical company specializes in manufacturing a certain type of drug that is expected to be in high demand soon, that could be seen as an opportunity. It’s important to note, however, that the existence of an opportunity and the reality of a company seizing it are two different things.

How can investors determine how likely a company might be to take advantage of opportunities? There’s no way to know for sure, but some good indicators might be the company’s track record for making new progress, how much competition they have, and how good their management team is.

SWOT Analysis: Threats

Threats can be seen as the opposite of opportunities. Both exist outside of the company itself, in the general sphere of influence of what the company does or its position within the general economy. A threat could be anything that might destroy opportunities for a company or add to its weaknesses.

For a company that specializes in oil and petroleum products, for example, the rising trend of electric vehicles, renewable energy tech, and shifting consumer trends toward sustainable practices could post a significant threat. This is a very real trend that poses a threat to an entire sector, and has given rise to related investments in renewable energy and both “green investing” and “socially responsible” investing.

Other examples include things like a company’s biggest product becoming obsolete (like film and digital cameras did once smartphones became widespread) or a large competitor encroaching on its business.

How To Do a SWOT Analysis: Example

To help answer the question “what is SWOT analysis,” let’s look at one of the most popular stocks today, Netflix, through a SWOT lens.

Netflix Example: Strengths

Some strengths of Netflix include brand recognition—their name has become synonymous with online video streaming. People sometimes use the term “Netflix” to mean any kind of streaming service, and anecdotally it can seem like practically everyone has a Netflix subscription.

While Netflix does have many competitors, they have somewhat of an economic moat established due to several factors:

•  They were the first big player in the streaming space
•  They produce tons of exclusive content that can’t be found anywhere else
•  They have an unbeatable reputation with both users and investors

A few decades ago, we could have included one of Netflix’s old competitors in the analysis: Blockbuster Video.

Blockbuster was once a popular store that people used to rent movies and video games from back when those things only came in the form of physical tapes and CDs.

Netflix actually offered to buy Blockbuster at one point, but the company refused. They later went out of business as people made the transition from renting VHS tapes and DVDs to using streaming services that are now built into most modern television sets.

Netflix Example: Weaknesses

One of Netflix’s weaknesses might be that the company has a relatively singular focus: streaming online entertainment content.

If a new technology were to somehow make this service obsolete, or consumers were to change behavior for some reason, it could spell doom for Netflix in the same way they themselves spelled doom for Blockbuster.

Netflix Example: Opportunities

These might include the potential for Netflix to acquire other media companies, create new movies and documentaries, or branch out into other products or services (like making their own TVs or virtual home assistants).

While it’s uncertain if Netflix will actually do anything like this, it’s logical to assume the opportunities exist. So far, the only real innovation Netflix has done has been to create their own movies and TV shows.

Netflix Example: Threats

The visible threats to Netflix would likely be their competitors, including Hulu, Amazon Prime, Disney+, and HBO Max.

Disney+ in particular has gained a large number of subscribers since it was made available. They also have a recognizable, trusted name along with plenty of exclusive content that can’t be found elsewhere (like Disney movies and the Star Wars hit series, “The Mandalorian”).

The Takeaway

It’s not uncommon for investors to consider at least one of the four areas of strengths, weaknesses, opportunities, and threats. But looking at all four from a systematic, big-picture perspective can provide insights that might have been missed otherwise. That is the essence of SWOT analysis.

While SWOT analysis won’t eliminate investment risks, it is one more way for an investor to be as informed as possible before making any financial decision.

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