Glossary
Due Diligence
The research and analysis done before an investment or deal to understand the business, its risks and its valuation.
Due diligence is the homework done before committing money. In a corporate deal it is a formal investigation of a target company's books, contracts and legal exposure before an acquisition closes. For an individual investor it is the less formal but similar process of learning what a business does, how it makes money, what could go wrong and whether the price makes sense, before buying.
What it covers for a stock
A practical checklist usually touches four areas:
- The business. Products, customers, competitors, and what protects its profits.
- The numbers. Revenue growth, margins, debt and cash flow, read from the Annual report and Form 10-K rather than a summary.
- The people and incentives. Management's record, insider buying or selling on Form 4 filings, and how executives are paid, found in the Proxy statement.
- The price. What the current Valuation assumes about the future, and whether those assumptions are plausible.
Common shortcuts to avoid
- Relying on one source, such as a single article, social-media post or analyst note.
- Reading only the bull case. The "Risk factors" section of a filing is written by the company's own lawyers and is worth reading in full.
- Stopping at the story. A great company can still be a poor investment at too high a price.
- Skipping the boring parts, such as footnotes on leases, pensions and Non-GAAP earnings adjustments.
Diligence cannot remove risk, and no amount of research makes a forecast certain. What it does is make sure you know which risks you are taking.