Saturday, April 7, 2012

My investment checklist

This is the general checklist that I go through each time when I examine an investment opportunity. This is long-winded and generic. This won't be exhaustive enough to cover all the possibilities nor specific enough to cover specific aspects of individual companies. Not all the points are applicable in all cases. Many are open questions of which the answers can mean opposite things in different circumstances.

The purpose of having this in place is to avoid silly mistakes, to slow myself down and to minimise the influence of my own emotion, laziness and blindspots. This will be a living document that I'll add or delete points when I have newer insights upon reflections.

Utilising a checklist is probably a Mungerism.

  • Am I thumb-sucking?! (some elaboration here and here)

Rebuild the history and the profile of the company
  • Filings and public information
    • 5-10 years of public announcements (financial reports, proxy statements, annual reports, tax filings)
    • Differential analysis: what mgmt said in one year vs what happened in the next year; things said in different statements
    • Recent new releases
    • Industrial or government data and statistics
  • Scuttlebutt
    • Competitors, suppliers, customers and products
    • Media coverage of company and mgmt
    • Court cases?
    • Background check: mgmt, accountant, lawyer, cross-holding parties

Financial Quality
  •  Debt Health
    • Interest cover
    • Debt-to-asset and debt-to-equity ratios
    • Maturities and covenants of loans. Fixed interest or floating?
    • Off-balance sheet liabilities? (e.g. operation leasing, subsidiaries) VIEs?
    • Capital structure 
    • How open are the debt markets?
    • Dependent on credit rating (which will put constraints on minimum equity)? 
    • How is the financial health implied by the yield on the bonds and preferreds? 
  • Cash Liquidity Health
    • Quick Ratio
  • Profitability
    • Predictable long-term earning? What are its 10-year average earning and FCF?
    • ROE
    • Segment mix and margins
    • DuPont analysis: Cash conversion rate x Net Margin x Asset Turns x Gearing = Cash ROE
    • DCF if it's a runoff business or products with a defined lifetime (e.g. drugs with patents)
  • Assets
    • Mindful of the difference between liquidation value vs going-concern value
    • Book value, NTA, NCAV
    • Hidden values
      • Properties, LIFO inventories, uncapitalised "intangible"assets
      • Tax sheltering, semi-permanent accrual-vs-cash discrepancy
      • Depreciation & amortization
  • Operational efficiency and asset efficiency
    • Cash Conversion Cycle = Receivables Turns + Inventory Turns - Payable Turns
    • Capex vs Depreciation
  • Capital Allocation
    • Cash used in financing over the years
  • Optionality
    • Ability to raise capital or issue debt
  • Insider
    • Executive compensation & options, perks
    • Related parties?
    • Insider ownership

Business Quality
  • Business understandable?  Corporate structure understandable? Capital/debt structure understandable? (How thick is the annual report?)
  • Are the customers happy with the products enough to leave some cash crumbs on the table? 
  • Competitive advantages and competition landscape
    • Can I comfortably say how the industry/business will look like in 10 years?
    • Moats / Porter's 5 Forces / Barrier to exit
    • Concentrated clients or suppliers?
    • Pricing power - can the company easily raise price by 10%?
  • What is the megatrend? What's the macro business environment? 
  • Counterparty risk
    • e.g. Will customers default? Are the clients struggling? Are the clients making money?
  • Management integrity? Irrational motives?
    • Does the management show candor in its communications over the years? 
    • Institutional imperative? (some elaboration)
  • Where will growth come from? 
  • How does capital allocation look like? 
    • maintenance capex
    • dividends, acquisition, share buyback, capex expansion
    • Chance of capital raising?
  • Only one hurdle to jump? Is the difficulty the company facing temporary?
    • industry-level recession, market over-correct, one-off management mistake, war, one-off restructuring cost, out of favour 
  • Any catalysts?
  • Does the company have enough staying power while we are waiting for the value to realise?

Safety and Opportunity Cost
  • Do I have enough downside protection and margin of safety?
  • How does the business score under these metrics:
    • Cheapness - Quality - Growth - Capital Allocation
  • Pre-mortem: what can go wrong? 
  • Why is the other side selling? Why is it cheap? 
    • Remember the market is usually right. Where is my edge here?
    • Short interest? What are their theses? Short money is smart money. 
  • Not the right pitch? Wait for next pitch?
    • Is it a mediocre idea?
    • Would I buy the entire company? 
    • Do I compromise my margin of safety or the quality/depth of my research because of lack of patience?
    • Is it a too-hard basket case?
    • Should I keep cash instead? Time is on my side.
    • Should I wait for more evidence or better price?
  • How does it compare to my previous best idea, cigarbutt or quality business?
  • Can I say my primary reason to invest is because the business itself is undervalued?
  • Does any measurement or figure look too good to be true? 
    • How does it compare to industry average?
    • Fraud??
  • Recheck every assumption and every figure.  

Portfolio Construction
  • Correlation with my existing portfolio
  • Consider other securities for different risk/reward balance: preferred's, bonds, options
  • Position sizing as per Kelly's Criterion. (some elaboration)
  • Tax consideration - consider how the value will be realised. 
  • Can my portfolio and my personal cashflow survive a once every one hundred years event?
  • Is the general market overvalued? (Shilling PE10, Tobin Q-ratio, S&P500 Market Cap vs GNP)

Self Checks
  • Have I studied the industry and its competitors?  
  • Is my abstract reason backed up by concrete evidence? Or is it just an hypothesis without supporting empirical data?
  • Do I have tunnel vision? Do I look for evidence only for confirmation instead of invalidation? Can I tolerate non-coherent evidence?
  • Am I incorporating new information in a Bayesian way?  
  • Am I rushing, losing patience, stressed, over excited? Or is my mood swung by the market direction?
  • Am I anchoring?
  • Overconfidence? There is no way to eliminate all the risks. There are always unknown unknowns. Don't overexpose in one position
  • How would I feel if the stock loses 50%?  How would I feel if the stock gains 50% but I haven't bought any shares?
  • Am I a price taker (red flag!), or a price setter? Should I ignore Mr Market?
  • Is there any superficial reasoning? I am the easiest person to fool. 

  • Re-examine the original thesis and fundamentals.
  • Price/Value should be the primary reason. All other reasons (e.g. pruning, taxation) are secondary.
  • 3 year rule - If visibility is poor, wait for up to 3 years
  • Should I take profit in cyclicals?

[Last Update: May 2013]


  1. Great list. I steal it from you right away.

  2. Excellent!! This is very helpful

  3. Hi,Its an well organised thought process for Investment,
    Very Helpful
    Priyank Kothari.

  4. This list represents why most people never do proper investment research. Researching just one investment thoroughly is a full-time job, never mind it is fraught with questions that can only be answered with opinions, not agreed facts. And that is if you are an expert.

    If you can do it, great. Most people have full-time jobs and families to worry about and could not answer these questions about just one investment within a **year**, let alone the time before the information is stale.

    1. Hi,

      You are absolutely right.

      To beat the market, we have to be, by definition, above average. The kind of dedication and talent required is no less than that required to be, say, an above-average violinist, althelete or chess master.

      The way I see it, the corollary of this is, it makes sense to run a concentrated portfolio, investing with intensity. Taking this to the extreme, it means to have 100% in one position. i.e. Be an owner of your own business. And there are plenty of successful businessmen and shop owners around. Their dedications and understanding of their domains are equally high.

    2. Another thing is -- I can only speak for myself though -- the drive is more than just money. The sense of accomplishment is a big part of it. One really needs to find the joy in the process in order to stick to the process. In this regard, it's not that different from solving a cross-word puzzle, a sudoku or the Riemann Hypothesis.

    3. Hi Interesting list. You have a point but John's reply is entirely valid. It would be interesting to know, to contextualise the list, how many stocks each year and in total John is investing in and the percentage of John's net worth the total and the individual stocks represent.

      A large part of my net worth is invested in my (successful) business so I put in the hours (a lot of hours) whether that number hours put into investing would yield the same success I am yet to have the chance to find out but this list will be very useful when I do get that chance!


  5. I am very happy to read this. This is the kind of manual that needs to be given and not the random misinformation that's at the other blogs. Appreciate your sharing this best doc.

  6. Excellent, just excellent! Thank you for being so generous and sharing this. I've saved it and tucked it in a safe place as I know I'll be referring to this in depth, and not just a few times.