The Investment Checklist

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Chapter 1 – How to generate investment ideas

  1. On stockscreens, many of best investments showed PE ratio of > 50 due to GAAP issues such as restructuring costs. After adjusting, PE is really only 5. If exclusively used stockscreens, would have missed them. (pg 8)
  2. Keep an eye on new-low lists (pg 8)
  3. Paul Sonkin of Hummingbird Value Fund uses stockscreens and new low lists but believe investors mis-use them 99%. 90% of companies on the screen are there for a good reason, and stay there for a long time. Proper way to use should be to run on a weekly basis and look for new companies that appear. This is to separate those that deserves to be there.  (pg 8)
  4. Use value line (pg 9)
  5. Buy a few shares to force yourself to follow the business. To guarantee you will not forget the business (pg 12)
  6. Don’t ignore your existing investment portfolio (pg 12)
  7. The one thing you can’t fix after making an investment is the price you pay, so it is critical to remain disciplined on price. Your future rate of return will be determined by the price you pay for the business. (pg 18)
  8. When you are paying 1 or 2 times EV/EBITDA, not much needs to go right. If business survives,  you win. As long as the business does not end, you do not need to make alot of assumptions. (pg 19)
  9. Use spreadsheet to track potential and existing holdings. This is to let the novelty of a new idea wear out. Add the business identified as unique or superior management on the list regardless of current valuation. It is the secret sauce to investing intelligently. Allows you to act decisively when opportunity available. (pg 19)

Chapter 2 – Understanding the business – The Basics

  1. To determine whether international expansion is profitable, if the financial reports do not break geographical profitability down, compare historical financial statements before expansion to foreign markets and the recent statements. (pg 33)
  2. Resources that can be used to understand difficulties of doing business in specific foreign markets: World Bank publishes Doing Business Report, Business Monitor International’s Country Risk Reports (pg 33)
Chapter 3 – Understanding the business – from the customer perspective
 
  1.  Retaining customers more profitable than churning them. A loyal customer generates predictable sales. Customer retention rate most common metric for tracking customer longevity. A way to determine retention rate, look at  number of customers enrolled in loyalty programs, year to year. They are usually repeat customers. (pg 44)
  2. Resources to check customer satisfaction rankings: American Customer Satisfaction Index – University of Michigan National Quality Research Centre (ACSI). Covers > 200 companies from 50 industries (pg 47)

Chapter 4 – Evaluating the strengths and weaknesses of a business and industry

  1. “Moats add the most value to businesses that have lots of reinvestment opportunities within their moats” – Pat Dorsey, former Director of Research, Morningstar, The little book that builds wealth. (pg 54)
  2. Eg. Microsoft gives investor reasonable degree of confidence that ROC of core business will persist but add little value due to maturity of business. Cash sits on balance sheet or invested outside moat, eg. Bing. Compare this with other companies which invest within its own moat and add tremendous intrinsic value (pg 54)
  3. Some private-label makers affect products more than others. 2010 Nielsen showed PL market share range from high of 40% of dairy to < 1% for alcoholic beverages. (pg 59)
  4. High switching costs deters customers from switching products. Eg. Bloomberg embed users with alot of training. Thus, even with lower cost models, users will not likely take competitors up. ** Look at Blackboard (classroom software tool) (pg 62)
  5. Most investment gains are made during the development phase, not after. Eg. Apple committing to iTunes even when revenue  decreased. When iPod took off, so did revenues. (pg 67)
  6. 1 way to determine pricing power is to take operating profit for its consumer division and divide by customer transactions. (pg 72)
  7. Investing in the right industry is important. Large part of potential rate of return attributable to industry rather than company. Eg. Pharma ROIC range is 13-21%. Best business not too far away from worst. Contrast this to major oil companies, range from 3-15% (pg 74)
  8. Look for companies that have few/limited competitors. Look at the 10-K which will list the competitors. (pg 80)
  9. Financial metrics to monitor if industry becoming more competitive. This may show that future earning will drop.. Total costs / number of customers or transactions. Track to see if it is increasing/decreasing for competitors in industry. (pg 84)

Chapter 5 – Measuring the operating and financial health of the business

  1. Check out A.M. Best’s Underwriting Guide on major risks that a business encounters (pg 109)
  2. Check on precedents of past evidence on potential financial implications of a certain risk. Eg. Heartland Payment Systems’ security breach similar to TJ maxx and Marshalls whose systems were hacked and settled with issuing banks for 70 cents per card for the credit cards. (pg 109)

Chapter 6 – Evaluating the distribution of earnings (cash flows)

  1. Compare income tax provision and current taxes for at least 5 to 10 years. Check that tax-return incomes are close to accounting income (pg 138)
  2. Accounts receivables growth exceeding sales growth by large margin is a warning sign. (pg 140)
  3. Earnings of business with high operating leverage can change quickly, making it difficult to forecast earnings. Thus, should pay lower price for this business with high operating leverage and give sufficient margin of safety to account for large earnings fluctuation. (pg 162)
  4. To check if there may be more reinvestment in PPE, check net assets to gross assets ratio. Closer means less likely for re-investment (pg 170)

Chapter 7 – Background and classification: Who are they?

  1. Gather historical and current articels of each manager. Trail of evidence of accomplishment. Can use DJ Factiva, LexisNexis, FT, WSJ, NYT. Interview sources, Wall Street Transcript or Charlie Rose Show. Some of the best information are trade journals and papers where company is HQed (pg 175)
  2. of S&P 500, only 28 have CEOs who held office > 15 years, typical CEO holds for 6.6 years
  3. Of 28 long term CEOs, 25 of them had total shareholder returns during their tenure that beat the S&P 500 index. (pg 180)

Chapter 8 – assessing the quality of management – competence

  1. To check on options diulution, create table that includes number of stock options issued in given year compared to number of shares bought back. (pg 253)

Chapter 9 – Assessing the quality of management – postitive and negative traits

  1. Read conference call transcripts (pg 269)

Chapter 10 – evaluating growth opportunities

  1. Be careful to distringush rising commodity prices from secular growth trends. Eg. Rise in oil revenue growth may be due to price increase in oil rather than amount of products sold (pg 287)
  2. R&D usually start out in wrong direction. Spending more money upfront usually mean more wasted money. Breaktrhoughs tend to happen with resrouces are scarce. Estimated 93% of ultimately successful innovations start out in wrong direction (pg 290)
  3. Calculate percentage of sales that come from new innovation (pg 290)

Chapter 11 – evaluating mergers & acquisitions

  1. Situations where acquirer more likely to overpay for acquisition:
  2. A lot of competitiors bidding
  3. Management team of business may fear that a competitior is making new inroads into its core business or creating new market for its customers
  4. The larger and more embitious the deal, the greater  risk of management overpaying
  5. Acquisitions made when markets are down are usually at lower prices (pg 316)

Chapter 12 – building a human intelligence network

  1. Write a letter rather than email to stand out and reference to article read (pg 328)

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