How to Investigate a Company Before Investing

The first thing is to figure out the other party's income.

Due diligence means you need to do cross-sectional comparisons and make discreet inquiries—not just take whatever they say at face value. They may be inflating their income, or they may be deflating it.

How do they inflate it? For example, a restaurant might bring in a bunch of relatives posing as customers, showing up every day to create the appearance of strong traffic. You think the business is booming, so you acquire it—only to discover there are actually no real customers. That's the risk of believing inflated numbers as an investor and overestimating profitability.

Just as they can inflate, they can also deflate. Consider a water bottling business: the bottle costs 20 cents, the water costs 20 cents, and distribution costs another 20 cents, so they sell each bottle for 1 yuan and keep a 40-cent profit. But if they purchase bottles from their brother-in-law's company at 60 cents per bottle, their net profit drops to zero. As an investor, you'd end up with nothing. What should have been net profit—and thus dividends for shareholders—becomes profit for the brother-in-law's company instead.

So why care about their income? Are you trying to get involved in operations? No. What matters is your equity return as an investor—your ROE. In simple terms, for every $100 you invest, how much net profit can you expect? That's what's worth tracking. And this needs to be benchmarked against industry averages; you can't compare a soy sauce brand with a Labubu toy company just because both fall under consumer goods.

Beyond that, you also need to understand your tangible assets, your debt situation, and whether your cash on hand can cover your liabilities. Say you invest in an internet cafe where they claim to have bought high-spec PCs at $50,000 each as fixed assets. Upon appraisal, you discover those used machines are worth less than $500 apiece—turns out they were procured through a related-party deal with the brother-in-law's computer company. Or consider a company that has taken on loans from other firms that went unreported; if you invest blindly, as a shareholder you'll end up eating the loss.

All of the above constitutes static due diligence—assessing things as they stand right now, at a glance. But beyond static research, investors typically also need to conduct dynamic due diligence.

In other words, you need to forecast the future.

A restaurant that's packed today with long lines outside doesn't guarantee it'll still be busy tomorrow. Look at food tenants in shopping malls—few survive three years. So you need to understand what their core competitiveness is. And even if a company does have a strong moat, if it's riding a sinking ship in a declining industry, its future earnings are likely to shrink. These are all factors an investor must examine.

Investors don't just hop aboard for free or enjoy upside without taking risk. This process requires extensive static research and forward-looking analysis. If you haven't done your homework or your judgment is wrong, rushing into an investment can easily lead to losses.

The framework above works well for companies that have already reached a stable growth phase. But what if you're looking at an angel-stage startup with no data whatsoever—where all you can see is a founder's PPT, or maybe no PPT at all, just a rough sketch on a piece of paper saying, "I have a dream..." In that case, you can only evaluate the founder themselves. What have they done before? What have they actually accomplished?

If a background actor says they want to start a film production company, no one will invest because how would you know they're not just trying to scam their way into a high-paying job? But if a former TV station director quits a lucrative position to launch a production company, investors will pay attention. At least you have reason to believe they can access industry resources and solve the many problems that arise during startup life. Running a company isn't smooth sailing—issues will inevitably surface. How would a background actor be able to handle them? More importantly, they have little personal skin in the game. If they're a background actor today and fail tomorrow, they can simply go back to being one. As an investor, you'd be the only one taking the hit. But if they're a former director, failure means significant personal loss, damage to their reputation, and harm to their goodwill. Investors will only commit alongside someone who has real downside risk. If the founder has nothing to lose, investors won't touch it.

Even if all of the above checks out, an investor still won't touch a deal if the industry is wrong.

Investors choose to back Apple rather than Zhang Xuefeng's company because fans and customers are two different things. Investors will fund Apple first because they are Apple customers, and only secondarily because they're Tim Cook fans. They won't fund Zhang Xuefeng's company because his audience consists primarily of fans first and customers second. Customers follow the company and the product; fans follow the personality. A business built on fandom alone isn't sustainable.

An investor needs to know exactly what they're buying. If all your users are fans who'll follow you anywhere, aren't you just buying a shell?

The premise of a partnership is mutual need: I have talent, you have connections; I have drive, you have experience. If you don't know how to run a business, I can teach you. With an investor steering the ship, you'll avoid many pitfalls and won't end up like your peers who failed midway. That's the foundation of cooperation—each side needs the other. If only one party needs the deal, or if there's no mechanism to hold anyone accountable, the business won't work.

Most industry investors originally started as founders in that same industry. They bring full-spectrum experience, deep networks, and strong sector foresight.

Take the Song Dynasty tradition of "snatching grooms beneath the examination boards." A senior chancellor in that era essentially had everything—but with age, he no longer had the energy to operate hands-on, so he transitioned into a behind-the-scenes investor role. The accumulated details of his lifetime of experience became his due diligence.