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)