The seven-stage funnel from industry to exit
The seven-stage funnel: (1) industry — TAM, structure, profit-pool shape, competitive intensity, regulatory contour; (2) company — what the business actually does and where it sits in the value chain; (3) financials — quality of revenue, margin walk, working-capital intensity, cash conversion; (4) valuation — DCF, comps, and what is priced in vs what is not; (5) risk register — what would have to be true for the bear case to land; (6) position-sizing — convert the asymmetry into a fraction of capital; (7) exit plan — name the conditions that close the trade.
Each stage's output and when to backtrack
| Stage | Output | When to backtrack |
|---|---|---|
| Industry scan | One-paragraph framing of structure, profit-pool shape, and the rate-of-change driver you are watching | If the industry frame keeps shifting after stage 3, you do not yet understand the business well enough |
| Company-specific lens | Unit-economics walk: per-customer / per-store / per-rig economics, gross-margin contribution, retention | If the unit math does not foot to consolidated revenue and gross margin within 10%, restart the segment build |
| Financial-statement reading | FCF normalization, working-capital trend, earnings-quality flags, MD&A read | If FCF and net income diverge persistently without a working-capital story, treat earnings as suspect |
| Valuation walk | Bull / base / bear price targets with explicit driver assumptions | If the bear case is not a specific failure of a stage-2 assumption, the bear is not yet falsifiable |
| Risk register | Five-to-eight named risks with severity and likelihood | If you cannot name what would make you wrong, you do not yet have a thesis |
| Position-sizing | Fraction of capital tied to reward / risk asymmetry, NOT to conviction | If sizing is driven by enthusiasm rather than the asymmetry math, restart at stage 5 |
| Exit plan | Thesis-completion exits AND thesis-broken exits, named in advance | If you cannot name a price or a fact that closes the trade, you are improvising, not investing |
Working the full case on Brimwood Lumber
Worked example — Brimwood Lumber (fictional regional building-products operator). Industry: housing-starts-driven, fragmented, with a structural lumber-cost pass-through lag of one to two quarters. Company: 14 yards in the southeast, 62% revenue from contractor accounts with stickier pricing, 38% from spot retail with more volatile margin. Financials: GAAP operating margin 7.4%, working-capital-adjusted FCF margin 5.1%, working-capital intensity rising the last three quarters as raw-cost spikes outpace pass-through. Valuation: base $54 (DCF with 6.2% WACC, terminal 2.5%), bull $73 (faster pass-through), bear $32 (housing-starts roll over before pass-through completes). Risk register: pass-through speed, two-customer concentration in contractor segment, single-yard concentration in two metros, integration risk on pending tuck-in deal. Sizing: 1.5x reward / risk asymmetry, 14-month window — starter position 1.2% of capital, full position 2.5% pending pass-through visibility. Exit: scale out into $54-58, full exit if next-quarter receivables-vs-revenue gap exceeds 4 percentage points without a contracting-mix explanation.
Why each of the seven stages is load-bearing
Reading the bull-to-bear asymmetry on Brimwood
Common ways the integration chain fails
Common integration failures: (a) treating the seven stages as a checklist rather than a logic chain — each stage is supposed to feed evidence into the next, not just get ticked off; (b) discovering a stage-6 sizing problem and patching it by inflating the bull case rather than restarting from the industry frame; (c) running the workflow in parallel rather than in sequence, which causes later stages to be built on assumptions that earlier stages have not yet supported.
Where to deepen each stage of the workflow
- Working-capital walk and FCF normalization:
fin-8infinancials-101— for the SBC-adjusted FCF mechanics referenced in stage 3 here. - Earnings-quality flags read in the MD&A:
fin-7andfin-11infinancials-101— for the receivables-vs-revenue divergence and the explanation-by-omission pattern. - WACC build and re-levering:
corpval-1throughcorpval-5incorpval-wacc-301— for the cost-of-capital walk used in the DCF here, including the size-premium adjustment for a sub-$500M name like Brimwood. - Comps cross-check on the DCF:
comps-201— for the EV/EBITDA and EV/Sales sanity-check you should run alongside the DCF before committing to the base-case target. - Bull / base / bear sizing math:
ptk-4inpractitioner-toolkit-201— for the asymmetry framework applied here. - Industry-structure framing:
micro-3andmicro-4inmicroeconomics-101— for the profit-pool and competitive-intensity lens used at stage 1.
Sit with the ideas.
You have completed the industry scan, the company unit-economics walk, the FCF normalization, the WACC build, the risk register, and the position-sizing math on Brimwood Lumber. The base-case implies $54 against a current price of $41 with a 14-month catalyst window. Three of your six diligence items remain open, including the largest single uncertainty — whether Brimwood can pass through a recent raw-cost spike. The portfolio manager asks for your recommendation. Which response is the practitioner-grade answer?