My Investment Checklist
The importance of using checklists has been widely discussed among investors, with the most notable being Warren Buffett, Charlie Munger and Mohnish Pabrai, who all tout the use of checklists as tools to use in order to avoid error and human misjudgment.
The concept was immortalized in Atul Gawande’s fantastic book The Checklist Manifesto, which outlines the ways in which human beings – especially in the medical profession – can reduce complexity and avoid critical error with the aid of a simple checklist.
To that point, I wanted to share some of my investment checklist below, which I use before, during and after researching a business, and find that it helps crystallize my thinking during the due diligence phase, and helps me to dig deeper into any holes within my research process.
We all know the phrase: “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.” I can’t think of a more perfect quote to describe some of the stages that investors go through, and using a checklist over the years has forced me to dig deeper into things that I want to be true but don’t know for sure, as well as mitigate risks I haven’t been weighing heavily enough.
As mentioned before in previous posts and letters, Greystone seeks to find misunderstood businesses (from a GAAP numbers or temporary problems standpoint) with underappreciated growth, that dominate a niche product or service category, with simple business models, a growing competitive advantage, aligned management teams with experience, at a value price. I always start with these criteria in mind, which is item number one. It’s then incredibly important for me to address why I feel the shares are discounted or trading at value prices, and why the opportunity might exist. If I’m able to move past these two [large] hurdles of my initial criteria and identifying why I may be getting a bargain, I can then move on to things like the business model/unit economics, the balance sheet, the management team, the industry, qualitative checks and attempting to normalize earnings or free cash flow.
My checklist is below, and any comments, additions or criticisms are welcome.
Misunderstood business with growth or characteristics that aren’t being appreciated by the market?
What niche product or service are they providing? Are they the market leader?
Good business or cheap security?
Will the business be around in 10 years? Easy to understand the model?
Customer value prop, demand, industry, competitors?
Track record and why are they able to compete favorably and grow?
Is there a competitive advantage that is in place that is likely to widen over time?
What could the moat be down the road? Anything stopping competition from coming in?
Is there opportunity to reinvest free cash flow into the business?
Is management capable of executing and incentivized to do so? Have they been honest?
Compensation/ownership aligned with shareholders?
Are they doing what they said they are going to do?
Am I paying a fair price, good price, great price?
Am I paying less than what it’s worth?
Identify WHY I’m interested
Why does the opportunity exist? Why is now the time to invest?
Read the filings, articles and industry news
Read competitor filings and transcripts
Clearly articulate the qualitative thesis based on the above four principles
Returns on equity and returns on tangible capital?
With or without leverage?
Look at compensation history
Look at share ownership
Look at compensation structure and what is rewarded
Answer this question – based on this format, is the management team going to treat this like their own money and/or their only asset?
Link pay to operating performance – we are paying ‘abc’ for ‘xyz’ performance – has it been good or bad?
What type of manager do we have – owner/operator, hired hand?
Large amount of equity ownership? If not, why? Will the CEO own more as time goes on?
Compensation structure is fair or taking advantage of shareholders?
Is this business the CEO’s opportunity to create wealth for himself, or already well-off?
Map out prior career experience using the proxy and internet articles
How did the manager rise to the top?
What is the primary experience? Marketing, financial engineering, operations, product development etc.?
Investing alongside both a good operator and capital allocator?
Capital allocation framework
Dividends – no high NPV projects in which to invest, cash should be returned
Buybacks – should always be done with respect to intrinsic business value
M&A – successful M&A requires a disciplined process that is iterated and measured
Investing in growth – Any reinvestment opportunities? What is the return profile? What is the ROI or framework? Part of core business or not?
Paying down debt – returning cash flows to equity holders
Qualitative Evaluation and Channel Checks
Talked to customers, employers, suppliers, management?
The outputs of capital allocation and competitive advantage may be quantitative, but the inputs required qualitative evaluation
Qualitative insight is less efficiently priced
Understand the value prop and potential competitive advantages
Unpack the unit economics
Am I buying for less than the business is worth, conservatively estimated?
Discount to normalized free cash flow or earnings power?
Underappreciated growth being overlooked by the market?
Opportunity for sales growth, margin expansion and multiple expansion?
Profitable growth or value destroyer? ROIC?
Multi-year holding period, not special situation?
Return profile in excess of 15% per year looking 3-5 years out?
Free cash flow yields in excess of 10%?
Listen to the arguments AGAINST buying the company. Counter those arguments successfully with FACT not opinion or drop the deal. Don’t stretch. We don’t do gray. Six inch bars!
Why are the shorts, or the bears and the analysts wrong? Why are Seeking Alpha comments wrong?
The company is on sale because the market is smarter than you, and you’re about to lose your money. Why is that not true?
Talk to someone about why it is a good or bad idea. Have someone point out the negatives.
Write out all the risk factors, and potential downsides, and assign a probability to each. If you can’t come up with any, you have a big problem
What will make or break this business? Why will it succeed just because you think it will?
The events that caused the company to go on sale are short-term, and not MOAT-eroding
Be aware of structural changes in the industry, changes in regulatory regimes, disruptive technology
Go sit quietly and think. Why would it matter if this company disappears?
Are you being impatient?
Have you not bought anything in awhile?
Too much cash on hand?
Do you think this is going to be easy? If so, you’re making a mistake
One more time – what is the biggest risk to the investment and have you found a way to mitigate it? If not, WHY are you still investing?