Investment Checklist

  • A recurrent revenue stream
  • A business with high organic growth prospects
  • Management that has long tenure at the business
  • A competitive moat
  • High free cash flow.
  • High returns on invested capital
  • Limited competition.
  • Low capex requirement.
  • A diversified capital base
  • A strong balance sheet.
  • How does the business generate earning?
  • How does business evolved over a time- you need to determine whether revenue growth translating into profit growth over long term in foreign market.
  • How business operates
  1. Its each business segment
  2. Distribution channel
  3. Marketing strategies
  4. Manufacturing activities
  5. regulatory requirements.
  6. Management strategy and derisking business.
  7. Industry size and trends
  8. Insights into a competitive environment.
  • you need to figure out who the core customer of business is.
  • Is the customer base concentrated or diversifying?
  • Is it easy or difficult to convince customer to buy products or services?
  • Businesses that rely on high press sales tactics to sell their products or services do not have sustainable business models
  • customer retention rate?- Longer the better
  • What pain does business alleviate? What customer needs does business filling?
  • Ask what the customer would do if the business disappear tomorrow?
  • Evaluate business strength and weakness from competition.
  • Figure out how individual supply chain work?
  • Does the business have a sustainable competitive advantage and what its source?
  • Always Ask
  1. How easily can someone else copy or replace this advantage?
  2. How quickly might they do it?
  3. Moats add the most value to business that have lots of re-investment opportunity.
  4. Relation between growth,moats and intrinsic value is central to understanding when it is truly worth paying up for a business.
  • more is being popular, more is being used.eg social media, ecommerce site.
  • though it can legally protect product for 15–20 yrs but the more innovation,more technological changes in an industry, the less value patent will have as source of protection.
  • It can limit competition. Eg in pharma industry
  • There may be an additional cost associated with changing products . Eg in pharma industry
  • it includes factors such as economy of scale and advantage locations.
  • it takes advantage lower / unit cost. low price of products/services compared to competitors.
  1. Result of regulation, prime location, better distribution network
  2. The customer has a limited choice in the products or services or they can use for an extended period of time.
  • It is difficult to find business with competitive landscape because
  1. consumers are less loyal to products or brand names
  2. increased global competition has decreased entry barrier
  3. technology advances has decreased the lifecycle of competitive advantage.
  • Look for business that are increasing allocating to R&D
  • look for market that are increasing awareness of their products with unique business value.
  1. It has ability to increase price without losing customer
  2. profitable business models
  3. quality of product is more important than price.
  1. calculate the range of ROIC(return on invested capital) of various competition of the industry.
  2. Always try to locate the best business in industry by finding the business with highest operating margins, highest ROCE(return on capital expenditure) and lowest cash conversion cycle.
  3. understanding how industry evolved will help you operate the business in the context of competition, its operating environment and various other forces that shape it.
  1. Does the business have limited competition?- more competition, more customer choice and less profitability. competing by copying has risk.
  2. Does the industry change often?
  3. Risk?
  4. fierce competition?
  5. why did competitors fail? who sets the standard?
  1. what drives the industry?
  2. How do people compete with the industry
  3. large macro pictures?
  4. industry trends?
  5. available free cash flow of business and available cash conversion cycle of the industry.
  6. Industry exposure to cyclical markets?
  7. industry ability to pass on price increase?
  8. the volatility of demand from customer?
  • look at risk, inflation, balance sheet issue, debt and health
  • measure the business quality , how well the business generates ROIC(return on invested capital) and how much possibility for reinvestment.
  • Always ask what are fundamentals of the business?- fundamental drive value of business.
  • Identify the metrics of a particular industry- 1st identify what you are trying to measure?
  1. overcapacity
  2. commoditisation
  3. de regulation
  4. shifts in technolog
  5. product obsolescence
  6. patent expiry
  7. brand erosion
  8. not too many drivers
  9. R&D fail
  10. Too concentrated on particular geography
  11. Mergers and Acquisition failure
  12. Product development failure
  13. weak product pipeline.
  • To learn for potential financial application of risk, look for past evidence.
  • how inflation is affecting the business?
  1. wage inflation
  2. if business has high debt — then high interest expenses.
  3. is business be able to maintain its cash flow in real terms?- If business unable to increase the prices to offset the impact of inflation, then it will to fail to maintain its cash flow in real term.
  • High ROIC means company using its asset efficiently, high profit margin
  • It is calculated by taking income and dividing by investment used to generate the income.
  • High-Quality business- ROIC> 10%
  • Higher ROIC means more business able to earn.
  • Higher the ROIC, better wealth-generating capacity for shareholders.
  • You want to own a business that over an extended period of time can excess earning at higher ROIC.
  • Higher ROIC doesn’t generally mean better business- what counts is the ability of a business to re-invest its excess earning at higher ROIC, which creates future value.
  • ROIC is less useful in knowledge-based business like wealth management or information services or platform services
  • If a business can generate more sales for each dollar of property, plants, etc then it will be able to generate a higher ROIC.
  • Business that earn their revenue from recurring sources are easier to value when compared to those that generate revenue from one off transactions.
  • - The benefits of high operating leverage can be immense. Companies with high operating leverage can make more money from each additional sale if they don’t have to increase costs to produce more sales. The minute business picks up, fixed assets such as property, plant and equipment (PP&E), as well as existing workers, can do a whole lot more without adding additional expenses. Profit margins expand and earnings soar faster.
  • Get insight into character of management and its ability to execute. Gauge management in terms of honesty, passion, transparency and competence
  • Look for CEO who has low salary and high stock ownership.
  • Most successful businesses are built on hundreds of small decisions, instead of 1 well-formulated strategic plan.
  • First they eliminate the risk . Then grow the business.
  • They dont concentrate on meeting guidance but on earning of a business.
  • YOu should look for managers who promise only what they can realistically deliver & dont bow to the analyst demand for high predictable earning.
  • Management should be clear about all the risk and uncertainities involved and should outline how a business is progressing towards meeting its long term objective.
  • Management must value his employee, good compensation, retention rate be good and adequate training.
  • management must ensure good culture prevail in business.
  • There are 5 actions management can take with excess free cash flow
  1. Reinvest capital back in business.
  2. hold cash on balance sheet
  3. pay dividends
  4. buy back stocks
  5. make acquisitions

Find CEO who are both good at operating the business and at allocating capital.

  • By making Buybacks when the stock is undervalued , management can materially add value to the business.
  • Passion is important for long term success in business. Passionate leaders make little time for other activities or hobbies & have few outward signs of wealth. They are normally focused on the business at hand.
  • The best management team are clear and consistent in their communication with customers, employees, suppliers and shareholders. They communicate things as they are and dont attempt to manipulate the information.
  • CEO letter to shareholders should cover
  1. What is important at their business?
  2. what is driving their decisions?
  3. the issues they have encountered
  4. The metrics that are important to monitor the health of business
  • Once you feel you have a good understanding of business , read transcript from the most recent as well as historical concalls. One can attain clear insights into how management thinks and act by reading these concall transcript.
  • Leader has to demonstrate both transparency and humility & ability to instil confidence in people.
  • Always ask -
  1. Is the management easy to listen to?
  2. Do you learn from manager?
  3. Does the manager use double speak?
  • Business that are growing profitably create a lot of values.
  • When you are purchasing growing companies , you are paying for future growth as well as current cash flow and profitability.
  • You must place growth in context of existing revenue of a business i.e. how much revenue does growth consist of?
  • Always look for growth of core business & be thoughtful of growth by launching new initiatives and making acquisitions.
  • To evaluate whether historical growth has been profitable, compare gross and operating income margins to unit growth over 3–5 yrs. As no of units sold increases, do gross and operating profit margins increase or remain the same.
  • What makes business attractive is not the rate it can grow in any single year but the no of years it can grow at any rate.
  • You need to determine how long growth can be sustained-to start , you must ask if business model can be replicated broadly
  • To forecast growth, you need to figure if there is trend that is fueling demand or if the business invests in innovation to develop new production services.
  • Be wary of long term growth and short term cyclical changes.
  • Calculate % of sales spent on R&D expenses
  • Always calculate % of sales coming from new innovation
  • When business is targeting a new customer base- it means business is starting to slow.
  • Another way to recognise if business is slowing is- when there is change in core business or dividend payout ratio is very high.
  • A high rate of growth doesnt guarantee profitability , if management follows undisciplined growth strategy.
  • A business that use their own cash to grow has more sustainable growth compared to those that finance growth by issuing debt or equity.
  • The lower the no of days in cash conversion cycle, the faster a business can re-deploy its internal free cash flow into growth b/c less capital is tied up in inventory or capital equipment.

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