Checklist

“I’m a great believer in solving hard problems by using a checklist. You need to get all the likely and unlikely answers before you; otherwise it’s easy to miss something important.”
—Charlie Munger, Wesco Annual Meeting 2007

“When investing, we view ourselves as business analysts—not as market analysts, not as macroeconomic analysts, and not even as security analysts.”

—Warren Buffett, Letter to Shareholders, 1987

A Checklist for Business Analysis & Investing

Questions to consider when analyzing businesses as potential future investments. This list of questions will be regularly updated.

Remember, all brilliant things I might put in this checklist belong to other great thinkers. None are my own. I have picked them solely for the purpose of adding value in my own research and analysis of different businesses for potential investment.

Explain how the Business Generates its Return on Invested Capital

  •  Product/Service
    • How does the business make money? 
    • Is the product a low value to weight or high value to weight?
    • What are the fundamentals of the business?
    • Can the business offset the negative effects from inflation?
      • Can pass on price increases to its customers (pricing power)
      • Has the ability to reduce its costs
      • Has low capital- expenditure requirements and minimal levels of debt on its balance sheet
  • Core Customer 
    • Who is the core customer(s) – concentrated or diversified?
    • What is the customer retention rate for the business?
    • Is it easy or difficult to convince customers to buy the products or services?
    • What pain does the business alleviate for the customer?
    • What are the signs a business is customer oriented?
    • To what degree is the customer dependent on the products or services from the business? If the business disappeared tomorrow, what impact would this have on the customer base?
    • Does the business possess the ability to raise prices without losing customers?
  • General
    • How would you evaluate this business if you were to become its CEO?
    • In what foreign markets does the business operate, and what are the risks of operating in these countries?
    • Is this company providing a win-win for its entire ecosystem?
    • How could this business be affected by changes in other parts of the value chain that lie beyond the company’s control? For example, are its revenues perilously dependent on the credit markets or the price of a particular commodity?
    • How has the business evolved over time?
    • What are the operating metrics of the business that you need to monitor?
    • What are the key risks the business faces?
    • How does inflation affect the business?
    • What type of relationship does the business have with its suppliers?
  • Operating Leverage
    • To what degree does operating leverage impact the earnings of the business?
    • The following businesses typically have high operating leverage:
      • Businesses that have a high labor component
      • Businesses with high capital expenditure requirements
      • Manufacturers with high material and production costs
      • Businesses that are required to invest a lot of money in inventory
  • Financial Leverage
    • Is the business’s balance sheet strong or weak, i.e., limited debt on its balance sheet?
    • What is the debt to equity ratio?
    • What is the interest coverage (earnings and cash)?
    • Is there any loan covenants?
    • Is there a significant refinancing risk – short vs. long-term debt
  • Earning Power and Free Cash Flow
    • 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?
    • When analyzing a company, stop and confirm that you’ve asked yourself whether the revenues might be overstated or understated due to boom or bust conditions.
  • Return on Invested Capital
    • Have you calculated ROIC over time and observed a trend?
    • Examine composition of ROIC through a DuPont analysis—does this suggest a consumer or production advantage?
    • Have you compared the company’s results to those of its peers?
    • Have you calculated ROIIC for one year and rolling three- and five-year periods?
  • Competitive Advantage
    • Does the business have a sustainable competitive advantage and what is its source?
      • Supply 
        • Superior Production Technology
        • Priviliged Access to Crucial Input (Cheap Resources)
      • Demand
        • Habit
        • Switching Costs
        • Search Costs
      • Economies of Scale
        • Research and Development
        • Purchasing
        • Marketing
        • Distribution
        • Production
      • Government Intervention
        • Licenses
        • Tariffas and Quotas
        • Authorized Monopolies
        • Direct Subsidies
        • Various Kinds of Regulation
  • Industry Characteristics
    • 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?
  • Capital Allocation
    • For each dollar reinvested, has at least one dollar in market value been created?
    • What is the dividend policy?
    • Does the entity repurchase shares? If yes, at rational price levels?
    • How does management make M&A decisions?
    • Have past acquisitions been successful?
    • Have you analyzed how companies have spent money in the past, separating operating uses from return of capital to claimholders?
    • How has the company funded its investments?
    • Identify the prime use of capital. Do you know if management thinks about that use of capital properly?
    • Have there been shifts in the pattern of spending?
    • If there is new management, has spending changed?
    • Who makes which capital allocation decision?
    • How does the company conduct its budgeting process?
  • Growth
    • Does growth add any value, i.e., ROIC exceeding its cost of capital?
    • 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?

Favorable Long-Term Prospects

  • Does the business have favorable long-term prospects? If yes, why?

Honest and Able Management

  • How are senior managers compensated, and how did they gain their ownership interest?
  • What type of manager is leading the company?
  • What are the effects on the business of bringing in outside management?
  • How did the manager rise to lead the business?
  • Have the managers been buying or selling the stock?
  • Does the CEO manage the business to benefit all stakeholders?
  • Do the CEO and CFO issue guidance regarding earnings?
  • Is the business managed in a centralized or decentralized way?
  • Does management value its employees?
  • Does the management team know how to hire well?
  • Does the management team focus on cutting unnecessary costs?
  • Are the CEO and CFO disciplined in making capital allocation decisions?
  • Do the CEO and CFO buy back stock opportunistically?
  • Does the CEO love the money or the business?
  • Can you identify a moment of integrity for the manager?
  • Are managers clear and consistent in their communications and actions with stakeholders?
  • Does management think independently and remain unswayed by what others in their industry are doing?
  • Is the CEO self-promoting?
  • How is the company’s incentive compensation structured?
  • How much stock does senior management own?
  • Is total shareholder return calculated on a relative basis?
  • Have you examined the company’s incentive score?
  • Are the measures in place to encourage management to think for the long term?
  • Are any of the key members of the company’s management team going through a difficult personal experience that might radically affect their ability to act for the benefit of their shareholders?
  • Also, has this management team previously done anything self-serving that appears dumb?
  • Is it run by able and honest managers?

Market Price vs. Intrinsic Value

Intrinsic Business Value Range
  • Intrinsic Business Value per Share
    • 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?
  • Margin of Safety
    • 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?
  • Risk, then Return
    • 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?

BMBC

Misjudgement

  • Action Bias
  • Availability Bias
  • Confirmation Bias
  • Hindsight Bias
  • First-Conclusion Bias
  • Social Proof
  • Liking/Loving Tendency
  • Familiarity Heuristic
  • Forecast Illusion
  • Illusion of Skill
  • Loss Aversion
  • Mental Accounting
  • News Bias
  • Overconfidence Bias
  • Recency Bias
  • Second-Level Thinking
  • Survivorship Bias

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