A quick initial check list when reviewing potential investment opportunities can save a great deal of time and grief. Furthermore, it’s usually our big mistakes that cost us most when it comes to overall performance.
1. Understand the capital structure
2. Follow the cash
3. Know the immediate downside – if you can’t figure this out quickly, avoid the investment all together.
4. Is the company a wealth creator or wealth destroyer
5. Will they be around in ten years – this last point seems almost too obvious to mention, yet we often don’t take this point into consideration.
1. Understand the capital structure
2. Follow the cash
3. Know the immediate downside – if you can’t figure this out quickly, avoid the investment all together.
4. Is the company a wealth creator or wealth destroyer
5. Will they be around in ten years – this last point seems almost too obvious to mention, yet we often don’t take this point into consideration.
- Understanding the capital structure or balance sheet. We are often inundated with news about the income statement, but very few individual investors look to the balance sheet. Focus on things such as cash and debt balances, composition of short-term to long-term assets and liabilities, and growth of book value. A simple quick check can help avoid many serious disasters.
- Follow the cash. Focusing on cash flow (true profitability) can magnify financial strengths and weaknesses. Any divergence from earnings to free cash flow can reveal some nasty future surprises when it comes to profitability.
- Know the downside. Again, this is a consideration must of us avoid. When we make a choice for any investment, we tend to only think about upside potential. Thinking about the potential downside can help to put our risk level into healthy perspective. It always the investor to quantify the potential impact on the entire portfolio. For example, if one is planning to take a 5% position and the potential downside is 20%, then the portfolio impact is 100 basis points (or 1%). Surely it is an inexact science, but it will force disciplined investing.
- Wealth creator or destroyer. A quick check of return on capital for previous years against a company’s cost of capital can indicate profitable, efficient results or a company which destroy shareholder wealth.
- Sustainability. Spending a few minutes seriously thinking about whether a particular business can sustain and survive through multiple economic cycles is basic but incredibly meaningful.
