Business Characteristics

• How does the business make money?

– Fundamental demand drivers:

1) needed or desired,

2) thought by its customers to have no close substitute, and

3) not subject to price regulation

– Core customers – concentrated or diversified/recurring sales/customer retention/dependency

– Share of mind/share of wallet

– Products/services – mix/profitability/value to weight

– Segments – product/geography

– Win-win business for the entire ecosystem

– Scaleable business model

– Customer oriented

– What will it look like in 10-15 years

– Does the business add or extract value from customers?

– Franchise characteristics or commodity product(s)/business

• Does the business have a consistent operating history?

– Cyclicality – demand stability

– Resistence to and performance in 2008 and other crisis situations

– Revenues/earning power/free cash flow

– Gross margin, operating margin

– Invested capital turns/ROIC/ROE

• Does the business have favorable long-term prospects?

– Risk of disruption – technology/customer demand

• What are the key operating metrics needed to assess the business?

• What are the key significant risks the business faces?

• Is the business’s balance sheet strong or weak?

– Debt to equity – solvency

– Net debt

– Liquidity

– Float

• How does inflation affect the business?

• What is the return on invested capital for the business?

– Core operating earnings margin

– Operating tax rate – current/historical/future

– Capital efficiency – current/historical/future

– Net tangible assets

– Net working capital

– Growth without need of reinvestment

– Internal growth at high rates of return

– Opportunities to reinvest cash at high rates of return

• Does the business have pricing power?

– Offset negative effects from inflation

– Ability to pass on price increases

– Untapped pricing power

• What expenses does the business incur?

– Fixed/variable – ability to reduce costs

• Capital requirements – invested capital/float

• How much leverage?

– Operating leverage – fixed/variable costs

– Financial leverage – covenants/recourse or non-recourse/fixed or variable interest rates/interest coverage

• What important governmental, social, and political factors will present opportunities or threats?

• Are the accounting standards that management uses conservative or liberal?

• Does the business generate revenues that are recurring or from one- off transactions?

• To what degree is the business cyclical, countercyclical, or recession-resistant?

• To what degree does operating leverage impact the earnings of the business?

• How does working capital impact the cash flows of the business?

• Does the business have high or low capital- expenditure requirements?

• Can this business be decimated by low-cost competition from China or other low-cost countries?

• Earnings quality?

– Reasonable accounting standards and estimates

– Cash conversion – how does cashflow relate to revenue and earnings?


• Does management invest cash intelligently?

• Is management promotional and aggressive?

• Is management overly focused on short term guidance?

• Is management candid and realistic?

• How does management think about the business?

• Is management rational long term thinkers?

• Does management use sound metrics to measure results?

• What’s managements attitude towards debt?

• Are incentives and compensation sensible?

• Does the company use “adjusted” numbers for earnings a lot?


• Does the business grow through mergers and acquisitions, or does it grow organically?

• What is the management team’s motivation to grow the business?

• Has historical growth been profitable and will it continue?

• What are the future growth prospects for the business?

• Is the management team growing the business too quickly or at a steady pace?

• How does management make M&A decisions?

• Have past acquisitions been successful?

Capital Allocation


• Reinvestment opportunities

– How much capital is the company reinvesting into their business and what are they earning on that?

• Dividends

• Share buybacks

• M&A


• Does the business operate in a good or bad industry?

• How has the industry evolved over time?

• What is the competitive landscape, and how intense is the competition?

• What type of relationship does the business have with its suppliers?

• Are there many competitors operating in the same industry?

• How has the industry evolved over time?

• Does the business operate in a good or bad industry?

• What is the competitive landscape, and how intense is the competition?

• Strong barriers to entry?

• How has the industry evolved over time?


• Economic franchise

– Product/service that is needed or desired

– Thought by its customers to have no close substitute

– Not subject to price regulation

The existence of an economic franchise, i.e. moat, will be demonstrated by a company’s ability to regularly price its product or service aggressively and thereby to earn high rates of return on invested capital.

• Does the business enjoy any competitive advantages?

– Supply: Proprietary technology/cheap resources

– Demand: Habit/switching costs/search costs – customer captivity

– Economies of scale: Purchasing/production/marketing/distribution etc.

– Government intervention: Licenses/tariffas and quotas/authorized monopolies/direct subsidies/various kinds of regulation

     – Other: Brands, high capital costs

• Sustainability: None/narrow/wide

• Moat trend: Declining/stable/increasing


• Are you looking at normalized earnings or are you looking at boom earnings?

• What is the underlying operating business worth, i.e., what can be considered a reasonable intrinsic business value range per share?

• Will that underlying value endure until shareholders can benefit from its realization?

• What is the likelihood that the gap between price and value will narrow?

• Given the current market price, what is the potential risk and reward?

• Do I know the intrinsic value of the business today and, with a high degree of confidence, how it is likely to change over the next 5 to 10 years?

• Is the margin of safety at the current market price sufficient?

• Is this stock cheap enough (not just in relative terms)?

• Am I sure that I’m paying for the business as it is today—not for an excessively rosy expectation of where it might be in the future? Does this investment satisfy me psychologically by meeting some unmet personal need? For example, am I keen to buy it because it makes me feel smart?

• Is the business priced at a discount to its intrinsic value today and in two to three years?

• Would I be willing to invest a large part of my net worth into this business?

• Taking into account that risk cannot simply be described by a single number, what is the risk of the investment, i.e., the probability and the potential loss?

• What’s the significant risk(s) that the business faces (likelihood and impact) and that could result in a permanent loss of invested capital?

• Is the downside minimal?

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