There are so many benefits to creating checklists, yet there are millions of people who never bother to make them.
You know what, Pilots use checklists prior to take-off to make sure everything is functioning as it should. Similarly, surgeons also use basic checklist to help minimise errors.
Same goes with investing in stocks. An investment checklist can protect you from yourself, and propel you towards investment success.
When you base your purchase decisions on isolated facts and don’t take the time to thoroughly understand the businesses you are buying, stock-price swings and third-party opinion can lead to costly investment mistakes.
This is where Investment checklist comes in handy as it makes the stock research more structured and process driven than random. The idea behind the same is to not to miss out on important parameters.
We are glad to share with you our basic Investment Checklist that has helped us identify many great investment opportunities and most importantly avoid land mines.
Here it goes:
Business checklist –
- Is the business simple and easy to understand?
- What is the nature of the business? Is it deeply cyclical (ex. Commodities), moderately cyclical (ex. Financial services) or low cyclical (ex. Pharma, FMCG, etc)
- How long has the company been listed? (we tend to avoid companies with listing history of less than 3 years)
- What is the growth outlook for the industry?
- What is the positioning of the company in the industry?
- How long has the management been in the business?
- How did it respond to previous downturns/crises?
- Do they have skin in the game i.e. whether their interests are aligned with the minority shareholders?
- Is the salary structure performance driven?
- Check the related party transactions to see if private firms of management are being given preference over the listed company
Financial Performance –
- Check financial performance for minimum 7 years and possibly 10 years
- If cyclical company, check whether the performance is reflecting cyclical low or high
- In a low cyclical company, look for growth in sales, margin profile, profitability, return ratios.
- Match operating cash flows with PAT
- Look at the trend of cash conversion cycle
- Check if the company has history of regular dilution in equity
- Give priority to consolidated results over standalone results
Valuations – Valuations is a very subjective exercise and becomes more complicated in case of low cyclical, high quality companies. Nevertheless, important points to consider are:
- In case of cyclical companies, focus more on mcap/sales, price to book value than price to earnings
- In general, avoid paying more than 30-35 earnings when buying presumably a high-quality company
Investing is more of an art than science and therefore investment checklist can vary depending on one’s investment style. Also, investing is much more than ticking all the checkpoints; however, an investment checklist helps avoid repeating mistakes and overcome biases to a certain extent.