Know thy investment, find thine edge
These are two good books on checklists
Checklists need to be different for different types of businesses. One ought to be able to answer most of the questions for a business listed below.
Do you understand the business?
Can you write five bullet points about why you think you know more about your investment than others and your thesis for investing?
Does the business have a consistent operating history?
Is the company likely to be much bigger in 5-10 years from now?
Is there a big island around the business? Moat
Can a fool run this business?
Is the business capital heavy?
Can the company adjust prices in response to inflation or input price?
Have you read the annual reports of the main competitors?
Management integrity, energy, intelligence, rational?
Diworsification and mergers?
Management wants to be rich and famous?
Is the business on secular uptrend or is it a fad?
Stock options treated as an expense?
Increasing dividends? Interest alignment with minority.
ROE ratio ?
Growth over next five years?
Margins better than competitors?
Margin of Safety. DCF / some value based metric measure cheapness ? Not greater fool theory.
One time problem for cheap stock?
Classify the type of business, B2B, B2C, Cyclical, Commodity, Brand, IP etc.
Say no much more frequently, improve the quality and character of portfolio.
Think in terms of Process
Don’t bet the farm
Find out what can go wrong, do a pre-mortem. Think backwards, and assume the business has failed, what could have gone wrong?
Opportunity cost – Is the current investment must better than alternatives?
What are the probabilities of gain in 1 year, 5 years and confidence ?
Find out your psychological biases, hindsight bias, recency bias, over confidence etc.
Separate P&L from Cash Flow
Owner earnings? Brand investment written off?
Where is the business in economic cycle?
Is liquidity important to you?
Type 1/ Type 2 errors, False Positive, False Negative
Value in spin-offs, index adjustment, forced selling by institutions.
Magic Ratio: High Roe, Low PE
Piotroski F Score
Have superior information synthesis skills
Find your “edge”, your edge could be scuttlebutt, or teaching, or journalism, or networking, or institutional linkages or research. My edge is turning stones and researching. In the recent fortnight I have gone through 200 annual reports of small and micro caps of UK companies (post Brexit) and more optimistic than ever probably same as in 2009, about buy-and-hold investing in British small caps for my Fund. Your “edge” is defined broadly as analytical [expertise and experience] , psychological [delayed gratification, go against the crowd, peculiar perception etc.] or institutional. I am talking two things here perhaps, one is your “calling” and “madness” that you bring to the investment game, other is increasing your income.
Will you average down when the stock will fall?
Reduce portfolio turnover
Wait for the fat pitch
Work unceasingly, nobody died of hard work
Stay intellectually inquisitive and humble. Know that even after becoming the richest person in this planet with highest IQ you still know next to nothing that Universe has to offer. There are beings who can create galaxies by mere act of willing. All the wealth of this planet’s mud puddle cannot be seen from few light minutes away, our galaxy, one of 100+ billion known galaxies is 100,000 light years wide. Universe truly is infinite.