Business Analysis Checklist!


Checklists are important in a way that they help keep a tap on things for you and in investing many a times emotions and short term deprival super reactions can bring about the worse in you. That being said, the importance of serendipity and embracing multi-disclipinary thinking cannot be underscored.

I create my checklist by asking myself as many questions as I can about the business and the list is and always will be a work-in-progress because what questions to ask and what not will keep getting refined over a period of time.

So here it is. My Business analysis Checklist.

Q1. Do you understand the fundamental economics of the business? (Circle of Competence)

  • You know or you think you know?
  • Can you explain the business in simple terms?
  • What drives the value of that business today and what will drive it’s value in the future?

Q2. Does that business have a distinct competitive advantage? (Network effects, patents, distribution, brand, supply chain, geographic elements, monopoly, etc.)

  • Q2A. Why does it have that?
  • Q2B. How did it achieve that?
  • Q2C. What can cause it to go bankrupt?

Q3. What are the numbers telling you? (Is it Great, Good or gruesome)

  • Q3A. Does it have a proven track record of value creation?
  • Q3B. Usually moats & floats go together, is this the case here?
  • Q3C. What are the long term returns it has generated?  Does it capture those returns itself?
  • Q3D. Basic math

How capital intensive is it?

How much debt does it employ and what is the debt capacity?

How productive are the assets on the book?

How quickly does it convert cash?

How is it’s bargaining power?

Is the business in a sinking boat?

Q4. How does the management look like?

  • Q4A. Do they have these qualities? (Integrity, Passion, Intelligence & Focussed energy)
  • Q4B. Do they have the capacity to suffer short term losses to generate long term value?
  • Q4C. What is their track record telling you?
  • Q4D. How is their capital allocation skills?

Do they destroy value by putting shareholder’s money in places which are out of their circle of competence?

Do they value paying out dividends when they cannot create superior returns or just hoard cash?

Do they acquire businesses for the purpose of empire creation?

Q5. What is the price you are paying?

  • Q5A. What is the intrinsic value of the business?

Did you calculate owner earnings with adjusting expenses that are not expenses but actually assets?

Were those expenses optional?

Do they really create value?

What was the management thought process for making those expenses?

Does the fundamental math behind that expense make sense?

Did you check for errors of omission & commission while calculating the intrinsic value?

What growth rate have you assumed? What exit multiple have you assumed?

What is the speculative value and what is the book value component in the share price?

What is the EV/Adj. EBIT telling you?

Q6. Finally, what is your opportunity cost? (The coca-cola test)

Heisenberg’s Uncertainty Principle, Turkey Illusion & Human Behaviour

New Post

Recently I read two books, Risky Savvy by Gerd Gigerenzer & A Brief History of Time by Stephen Hawkins, and when on a lazy Sunday morning my mind was wandering in the arcane & amusing world of worm holes, my tiny brain suddenly lit up to see a similarity in the two completely different disciplines! (Are they so different after all?)

So what’s the connection between The Heizenberg’s Uncertainty Principle, The Turkey Illusion and Human Behaviour? Before answering that I must define the three.

Heizenberg’s Uncertainty Principle

In his book Stephen Hawkins writes,

“Until 1926, when another German scientist, Werner Heisenberg, formulated his famous uncertainty principle. In order to predict the future position and velocity of a particle, one has to be able to measure its present position and velocity accurately. The obvious way to do this is to shine light on the particle. Some of the waves of light will be scattered by the particle and this will indicate its position. However, one will not be able to determine the position of the particle more accurately than the distance between the wave crests of light, so one needs to use light of short wavelength in order to measure the position of the particle precisely.

Screen Shot 2015-08-30 at 6.07.31 PM

Therefore, to measure the position & velocity of the object, one needs a light of high frequency, and that might pose a slight problem. A high frequency light particle will have high energy in it and will disturb the particle & change its velocity in a way, that cannot be predicted. 

Screen Shot 2015-08-30 at 5.23.40 PM

Thus Stephen Hawkins writes,“The more accurately you try to measure the position of the particle, the less accurately you can measure it’s speed and vice-versa.”

Now let’s not count chickens before they hatch! and before we start wondering about the moral of my story, let’s look at another problem, the Turkey Ilusion.

Consider a happy turkey that is fed by a man everyday. The turkey is just absolutely EUPHORIC and cannot wait until the next meal. Everyday for the last 364 days it has been on the receiving end of a wonderful meal and has no reason to suspect that the next day will be any different. But unfortunately the turkey couldn’t have predicted one thing, that the next day was Thanksgiving! Woah! how could a turkey possibly know about such a thing even existing!

Turkey illusion

In his book Risk Savvy, Gerd Gigerenzer writes that Risk is not the same as Uncertainty. In a world with perfect hindsight, one knows what can and what cannot happen and therefore assign risk weighted probabilities to such events, build a model and take calculated decisions. However, in a world where we cannot possibly know what can and what cannot happen, assigning probabilities and building models therefore can lead us to the same fate as that of our euphoric turkey.

Now let’s move on to our final leg, Human Behavior! (I’ll talk in the context of Financial markets and I leave you to have your own Sunday morning musings and apply the concepts there as well)

People build models to predict the future based on past observations. But there are 2 problems with that (You guessed it, the two stories above)

  • One,
    • You cannot possibly assign reason to what happened in the past just by building up a story you think suits your observations.
    • Human behavior is irrational and assuming that, say, a stock price or market index, did well based on certain parameters, you could be unaware of the toxic combinations of herd behavior, and the influential analysts with vested interests that made that possible

Thus What You think you know cannot be measured accurately (The Heizenberg’s principle) and on top of that, when you try to build a future based on that, you are heading towards an enemy territory which has Hidden Land Mines. Prey you don’t step on one!

  • Two,
    • When you confuse risk with uncertainty, a model that has identified the so called risks based on past events, you are probably going to fall Head over Heels (Unfortunately, not in love!). You are a Turkey living in an illusion!

Hence, neither can you measure the past accurately nor can you see the uncertainties of the future. And thus, all you can do is keep yourself safe by having a cushion to protect you, in case you fall! (What Ben Graham calls “Margin of Safety”)

Is Advertising a moat enhancement outlay?

Quasi /ˈkwɑːzi/ apparently but not really; seemingly
Superfluous /suːˈpəːflʊəs/ unnecessary,through being more than enough
Necessary Evil - something unpleasant yet unavoidable

These are the words that describe the situation that I was in, while thinking about advertising as an expense. You see why I am skeptical about advertising is because of this new age creation called Ambush Marketing.

Ambush 1

Ambush 3

Why do firms advertise?

The rational reason (and probably why they should) is this:

This would help them reach out to a large number of customers directly

  • Generate an interest
  • Convert into sales and
  • Ultimately help in building a brand

Buffett thinks about advertising as an investment, an optional outlay that helps them in acquiring a direct relationship with a large number of households and solidify their brand in the minds of the customers. But beware, he keeps a close track on the unit economics behind the idea!

These are my learnings from GEICO’s advertising!

How advertising played an important role ?

  • Helped to acquire a direct relationship with a huge number of households
  • Was an optional outlay that helped to achieve both significant growth and solidify the brand (Definitely relates to growth Capex)

Why did it work?

  • A remarkable low cost product with a great story to tell
  • Well-directed newspaper advertising
  • Favorable Calculations
    • Inquiries per ad and,
    • Closure ratio – % of inquiries converted into sales

Therefore treating this as an expense will be an Error of omission! (you will be too conservative in calculating the intrinsic value and won’t be able to see the true potential)
Here is a tweet from an interesting twitter debate where people have discussed about advertising expense being quasi in nature!

Screen Shot 2015-08-07 at 12.07.18 AM

These are the questions which Prof Bakshi left me with while explaining this concept.This is the link of the video of Tom Ruosso he is talking about!

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What are the risks in treating moat enhancement outlay as investments?
Blindly treating all advertising as an investment can be a criminal mistake, for you might end up inflating the value of the business way beyond the actual potential. You don’t want to be too aggressive and commit error of commission.
How can you mitigate those risks?

  • Unless you have a remarkable product with a great story to tell and the unit calculations are favorable, advertising will most likely be an expense and not a moat enhancing outlay
  • You can try to calculate an approximate ratio between sales and the advertising expense and then treat the additional expense over and above the basic requirement for the sales generation as a moat enhancement outlay (Caveat! : This is a grey area and draws a lot of parallels to calculation of growth capex, can’t be sure if this is logically and statistically a correct method)
  • Another way would be for you to be able to identify a management which in honest and intelligent. One that takes conscious decisions based on statistically correct data and not engages in the superfluities of the so-called Ambush Marketing – a phenomenon synonymous to what Buffett calls “Institutional Imperative” (the word itself sounds like showing a red cloth to a bull, in-fact a lot of bulls with sharp horns).
  • This is in my opinion would take care of a lot of things
  • One can also keep a numerical margin of safety while calculating the intrinsic value of a business (only if you are convinced about the business and the management that is). This is a blog post that I really like for calculating the intrinsic value that uses a final discount to the intrinsic value calculated

I invite you to please share your valuable comments

Disclaimer: These are my personal views which I have gathered from various sources including Prof Bakshi on twitter and the various blog posts mentioned as links. These have no relation to any firm.

Intelligent Fanatics & the Physics Principle

Intelligent Fanatics

Wo are intelligent fanatics and why do they matter?

Recently Prof Bakshi shared a wonderful presentation on twitter that he delivered in Italy. You can view it here.

Prof. Bakshi identified 8 intelligent fanatics in India and boy have they created wealth! (He identified them before they actually created this huge wealth for the shareholders.)

The three attributes he associates with intelligent fanatics are:

  • Integrity
  • Energy that is focussed, and
  • Intelligence

Now there have been various arguments about this theory supported by the power of storytelling, halo effect and also about identifying patterns where there is randomness!

You can read a wonderful critic on the Mystic Wealth blog here. Professor has also written about optimism and the need to intelligently look for patterns in the comments. Almost all the comments there are a great place to get your brain juices flowing.

The Physics Principle

So getting back to my question, who are intelligent fanatics and why do they matter?

Before answering that, I’d encourage you to watch the video in this link from 18:55 to 20:09.

This is a framework of thinking from Elon Musk (who in my opinion is among the greatest of thinkers today).

He says, instead of trying to find analogies in everything, you can break down stuff to their very fundamental truths (The Physics principle) and reason from there.

Now this is something which though is very simple sounding but not widely practiced. I think even Munger has said that –  To make decisions try to break them down to the core math behind them and reason with that, while explaining his inversion trick.

That being said, Let’s apply this principle to a business. 

A business is run a by a real person and what he does or does not, Can Make or Break it!

  • Would you agree that a business being run by a person who has Integrity and thinks about his customers, who  genuinely thinks about  solving their problems, who doesn’t cheat them; is the business that has a high probability of doing well in the future? (How many wonderful businesses in the world have survived by cheating and dis-honesty?)
  • Would you agree that a business being run by a pro-active person, who is full of energy and is unwilling to lose his focus, Come What may!, is the business that can survive? (How many times have successful businesses been successful just from the very beginning, if they have then you can again argue the role of Skill vs Dumb Luck)
  • Would you agree that a business being run by a person who is Intelligent and understands what it takes to get it right, or has the capability to learn what it takes to get it right, is a business that is likely to survive in fickle times? (The Learning Machine)

If you do, then you are breaking down a business to it’s very fundamental truth (The man / men behind the show!) and you are arguing from there. 

 There is always the power of a story and the halo effect, but in my opinion, this is a question that tests the very roots of a business!

My Experiments with Capital Expenditure (Capex)

Recently I read a blog post by Jana V on how to estimate Maintenance Capital Expenditure (Capex). He writes

“The earnings that you can take out of the business every year without affecting its competitive position is called as Owner Earnings. This term was coined by Warren Buffet and the formula for calculating it is given below. The capital expenditure (capex) he refers to is maintenance capex and not growth capex. But how do we know the maintenance Capex?”

It was indeed a very good method for estimation but I wasn’t convinced if it it right to differentiate maintenance & growth capex and so I wrote this.

To Jana

I wasn’t able to discern one from other and wasn’t sure if it’s actually right to do so. I was going round and round in circles:

Maintenance Capex -> Leads to assets becoming productive->Assets start yielding and generating sales ->This causes a reference for future customers to award contracts or more people to buy seeing that others are buying too(Social Proof) – > and thus more future cash flows-> Hence this is also a Growth Capex!

So I turned to Prof. Bakshi in his twitter class and he was more than kind to me. He explained the concept to me in a way that brought about that moment of epiphany. I absolutely love the way he teaches and I have been very lucky to have learnt from him at MDI.

Before answering my question he asked me to see this video clip from 11.04 to 15.48.

Screen Shot 2015-07-21 at 11.47.28 PM

Screen Shot 2015-07-21 at 11.49.32 PM

It did change my thinking and this is what I wrote back!

Part 1

To Summarize:

It was this – Discretionary Ability

When Brown Forman invested their FCF into global expansion, that expense was not stuck in the business and was discretionary. This capex was clearly growth capex. They had the capacity to suffer and forgo near term profits to create long term value. This was adding operating leverage; and when the positive aspects start kicking in, by the increased global sales in 50 new markets, the value of the business soared!

An expense that management can spend on their discretion to generate long term value while having the Capacity To Suffer and forgo short term benefits is what actually increases the intrinsic value of the business and must not be treated as expense. This is how one should look at growth Capex.

Again you need to be only roughly right and not precisely wrong while estimating it.

I would suggest reading the more qualitative aspects from the annual report to discern the management rationale and ask questions like:

Does this outlay create more per share intrinsic value? Is the management thinking like owners? Do they have what it takes to not give into the instant gratification?

This left me with 2 things still unanswered

1. Advertising Expense as a quasi-capex

How much is discretionary and how much is non-discretionary. Can we apply the same technique to find out the “Growth Advertising Expense”, because although a large part can be discretionary, it might not necessarily lead to more value as people spend to fight with competitors a lot these days!

2. The lack of the benefit of the hindsight! (The other interesting question)

Part 2

Prof. Bakshi has already answered my question on advertising expense which I will write about in another post!

Answering What is Overpriced!

Recently I read Safal Niveshak’s wonderful blog post. His posts are full of wisdom and I would recommend it to anyone.

He writes to figure out, what is the meaning of OVERPRICED? You can read the blog post here.

After reading that, 3 things struck my mind. Now before I get on with those 3 things, I have a question and some of my thoughts on it as well.

What is P/E Ratio?

It is a mental construct of the human mind, that perennially suffers from the need to simplify things. The basic assumption while creating this construct is that when you simplify things for comprehension, the meaning of the underlying words / numbers shouldn’t change. But unfortunately, man is not a rational animal, but a rationalizing one and hence the meaning does change.


Perhaps Einsteins quote is quite relevant here, “ Make things as simple as possible, but not simpler!

Let’s do a though experiment ! Let’s forget about the “Pavlovian Association Bias” for a minute and try to deliberately assign a reason to the ever changing interpretations!

What could be the possible reason

(a) Is it Euphoria? (A random bull market)

(b) Is is Halo Effect from some one popular buying it

(c) Is it social proof ? Everybody is buying it and so i should buy it too

(d) Are the business fundamentals really great and the company has the capability of creating and sustaining its moat

(c) Is it speculation?

(d) I have absolutely no clue…

Now let me come back to the three things.

  • First is this image tweeted by Prof Bakshi, which says that, when an underlying business does well the value of the company increases.

Screen Shot 2015-07-05 at 11.02.45 PMThese are Philip Fisher’s words borrowed from Prof Bakshi’s presentation, in which he writes why one must focus on buying quality

“..turnarounds seldom turn and that the same energies and talent are much better employed in a good business purchased at a fair price than in a fair business purchased at a bargain price.”

  • Second is the mental model that tells us to Invert the problem, you can read about it here
  • And third is this post by Jana V on how he applies accounting Stephen Pennman’s way to value the business. He calculates the approximate intrinsic value. Buffett always says, ” It is better to be approximately right than precisely wrong.”

Combining these three I think we can solve our problem to figure out what is Overpriced and what is not

When coming to approximate per share intrinsic value of the business we can re-plug it to calculate an intrinsic P/E ratio, this is the part where we have inverted the problem.

If this is high, that means that the business is worth that much and if it is fundamentally very good and you believe that the moat is only going to grow then I wouldn’t mind paying an expensive looking price. Because price is what you pay and value is what you get.

I leave you with this quote from Charlie Munger, “..if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you’ll end up with a fine result.”

Nestlé: My wind-shied is Hazy!

Disclaimer: I don’t recommend a buy or a sell, neither do i have any position. These are my thoughts and have no relationship to any firm.


By my calculations Nestle India’s statistics look like this

Avg. Cash flow ROIC
Avg. ROE
Asset Turnover
Op. Working Capital
~Neg. 180cr
Cash Conversion Cycle
~13 days
Net Income margin

Now don’t these numbers look mind boggling. But is this a business I would like to own? Let’s see.

So Nestle basically has 4 segments:

a) Milk products & Nutrition ( Brands like Nestle a+ slim milk, Dahi, Ceralac, Lactogen etc.): Contributes ~45% to sales

b)Prepared Dishes & cooking aid (Brands like Maggi) : Contributes ~31% to sales

c) Chocolates (Kitkat, Munch, Polo, Alpino etc.): Contributes ~14% to sales

d) Beverages (Nescafe)

Now you may say that Nestle has a virtual monopoly / duopoly in brands like Maggi, Cerelac, Lactogen, Everyday & Nescafe. But on a closer look i have a few different observations to make. 

I’d like to talk about other segments before coming to Maggi.

First, the milk products category (except Cerelac & Lactogen) seems to be bleeding from competition.

Ask yourself “Why would someone buy only a Nesltle a+ slim milk carton and not one from Amul or Mother Dairy or Danone or xyz?” I don’t have an answer to that question.

I myself buy cartons of milk on a regular basis and have mostly ended up with a different one on a number of occasions. (Maybe, this is a fundamental attribution error on my part but can you tell me if this is not a commoditized product? Or if you argue about their distribution reach, do you know how many local players are out there?)

Cerelac on the other hand is an absolutely genius brand. The switching costs of end consumers is absolutely infinite in my mind. No one would want to experiment with infant food, unless they are an expert at baby nutrition; which i doubt a mango person is.But everything else, milk, dahi, or their newly launched Lassi. I don’t think they have anything special about them.

Beverages category (for the mass market) is pretty much a duopoly between Nescafe & BRU. People who prefer Bru; plain simply prefer BRU & those who prefer Nescafe; plain simply prefer nescafe. 10 years or 20 years later, people will still be drinking coffee and the Nescafe becomes a no-brainer while buying coffee for daily use (Using a mental model of system 1 thinking, people don’t think twice about buying Nescafe)

Chocolates as a category might be growing very fast and KitKat & Munch have been there for a while and even though kids and grown-ups do prefer these in this price range, but give someone (with a sweet tooth) a cadbury’s dairy milk or a perk or a kit-kat or a munch, i doubt they will make too much fuss over it. Even after Nestle has re-shuffled it’s portfolio by introducing their premium brand Alpino,  they may be generating more margins, but there is nothing extraordinary about the experience a dreamy business like see’s candy gives.

Finally let’s discuss Maggi. 

I want you to pause for a second and zoom out. What is Maggi? Is it an instant noodle? Is it a snack? Is it a habit? What is it?

Now people might differ on opinions, but here’s mine. 

I think Maggi is something which is more of an instant food rather than a narrow frame view of an instant noodle, (whose taste I will not deny that I’ve developed growing up)

Now when you think about it this way, a whole new stream of thoughts start hitting you. If you are hungry what would you eat that is available quickly and is tasty & preferably healthy?

Before i answer that, think about this: Do you see a health revolution around you like me? From coke zeros, to olive oils, to fitness wearable bands to fibre biscuits to greek yoghurts? 

Fortunately or Unfortunately I may be biased because I am a very health conscious person but I do see this happening. And 10-20 years down the line I do see this as a trend and not a fad.

So coming back to my question, if i am hungry and i have Rs 10-12 in my pocket, what would i eat? I would eat fibre biscuits or greek yoghurt or a protein bar or something even healthier which is yet to find its way into the world. 

In the US, an average 32 ounce pack of greek yoghurt (~900 grams) costs less than $2. Why would i then assume that healthy things will remain expensive or that people won’t go for healthier options.

The health part must not be confused with the way Maggi defines healthy( by adding micro-nutrients), there are other aspects of health than that. In-fact if you read Nestle’s annual report of 2014, on page no. 9 of the pdf they say No food is good or bad. This to me has eerie similarities to someone selling tobacco products.

Now the numbers look brilliant, their working capital seems to be taking care of their financing, & it is indeed a debt free company. But I can’t see the picture as dreamy 10-20 years down the line as the numbers make it look like. My windshield is hazy!

How scaling up a commoditized business can be a grave mistake

Part of the reason why e-com businesses might want to shift to app-only channels, is to reduce their losses from erratic consumer behavior in an industry which now, in my opinion,  can be termed in one word: commoditized.

Take a minute to reflect, how an industry which was the exact opposite of commoditized, i.e one offering completely differentiated products, has become commoditized on this new distribution channel. Players are fighting on price while the product offerings are not much different. Fashion for example, here, has become a price taker instead of a price maker.

Whenever you are in such a commoditized business, you end up not-capturing any value that you are creating for the end customer by offering so low prices.

Scaling up such a business and thinking that by having a larger market share at the end of the price wars, could very well be a fallacy. If you think that you can then control the prices by some how creating a monopoly (which in first place was created by burning all the cash), then think about one thing; you are trying to change the very same erratic behavior you have fueled  in the minds of customers to buy from you and not from others over so many years.

Usually a monopoly works great, in my mind both for capitalists and end beneficiaries, but here the ask is to constantly manipulate the behavior of people, which has been described by a myriad of thinkers to be erratic and irrational.

The genius of UBER’s promotion scheme. Creating 2 win-win scenarios

Usually a company trying to promote its product or service spends quite a lot in trying to establish it’s presence, capture market share and develop a brand. This money is spent towards all kind of advertising and the extent of productivity is only the reach of the media used times the actual conversion rate.

Now think out of the box and look at what UBER has done. Each new user get’s a referral code which can be given to friends. Friends who install that app and use this promo code get a free ride of Rs 600/-. Now if they use this ride, not only do they get 600 off, you get extra credit of 600 in your uber account. Looks like a win-win.

So far so good.

Now comes the most important part, THE DETAILS. You think UBER paid that 600 as an advertising and promotional expense, but wait for a minute.

UBER is trying to capture the market which has a future potential of millions and millions of customers. Naturally at the start of the operation, the supply of any product or service is not high, but demand in India is rising by the minute (justified by the average one lakh rupees which a Uber driver makes) and UBER has no problem in getting customers as it has a global brand recognition also (Sure there have been some really bad instances but the company has taken corrective measures for it)

This imbalance of the initial demand and supply leads to shortage of cab drivers and so comes into play their Surge scheme. In this scheme a peak hour demand will have to pay 1.5x – 4x (could be more) the usual fare. So when i travelled from Powai to Chowpatty, although the normal fare is close to 450, i ended with a bill of 870. With my promotion i paid only 270, but UBER charges 20% cut of the driver’s revenue. So, had there been no surge they would have made Rs 90, but now they made Rs 174 and their driver a.k.a their employee made Rs 696 instead of 360. This is another win-win.

Company get’s back a share of their own promotional expense and a good share of it is not going waste to an ad agency, but it is going to their employees which creates a highly motivational scenario as an employer. All of this while enticing people with the words like “Free Rides” which are psychologically proven to be very impactful.

Even after the promotional scheme ends, UBER employing a nimble asset light business model would have no problem that comes along with high operating leverage, the white elephant expense; so to say. They could simply not use the surge mechanism, the end customers will not have a shortage of supply as the number of drivers would have increased, the fare would be back to normal, UBER’s revenue would not change much because they might have low income per ride but the volume of rides would have increased, courtesy of their genius promotional scheme.

Thus promotion linked with revenue sharing in asset Light business models (especially the ones working on content aggregation, co-branding etc.) could work wonders if there is a way to capitalize on the initial demand – supply imbalance with the help of dynamic pricing.