One of the easiest ways to improve one's investing outcomes is with a checklist. However, while this is an easy task to implement, I think it's something many investors overlook simply because there's not a lot of available information online and, in general, value investing books about checklist construction.
Many articles and books on value investing concentrate on the core principles behind the strategy, and they overlook the processes one might use to achieve superior results.
In addition, the checklist is also an intensely personal thing. Investors have to develop their own checklist based on their own experience and investment criteria.
For example, if I feel I know a lot about the mining industry, my checklist might be focused on my own criteria related to this industry in general. I might be interested to know figures such as a company's costs of production and reserves.
This would be completely relevant for other industries such as retail, but because I'm not interested in the retail industry, I wouldn't need to include it.
Nevertheless, while the detailed checklist can be a personal and unique investment tool, there are some general points to consider before looking at a potential investment. I think these points should form the basis of any investment checklist. Investors should always weigh a company up against these criteria before deciding whether or not to initiate a position.
This is the simple checklist I propose that investors can use as a starting point for their own processes.
A three-point checklist
Too much debt is the most common reason cited for business failure. Therefore, this should feature at the top of any checklist. Rather than focusing on a company's overall level of debt, I think access to financing is a better metric to consider.
Some companies are able to sustain large amounts of debt compared to asset values or earnings before interest, taxes, depreciation and amortization (Ebitda) as long as third parties are willing to continue to lend. The second access to financing stops is when problems emerge.
As such, the first point on my checklist is debt sustainability.
How sustainable is the company's debt? Is it generating enough cash to cover interest payments and are third parties willing to lend at market average rates of interest? If creditors are demanding double-digit interest rates in the current environment, that could be a sign that a company's balance sheet is in a weak state.
I think the second most crucial factor investors need to consider when analyzing any potential opportunity is the track record of management.
Analyzing management's track record of achieving goals it has set and generating value for shareholders can give us invaluable insight into how the operators of the company look after shareholders' cash.
Unfortunately, I do not think there is one metric that provides all of this data.
The only way to understand if management has a good track record is to read and study the company's past performance.
The third and final point on my simple three-point checklist concerns the company's competitive advantage.
We have to ask if a company has a competitive advantage and if this advantage is sustainable. Once again, the only way to understand the answer to this question is to analyze a company's track record of creating value and its reputation in the market (with consumers and competitors).
Understanding the advantages, how much money the business spends to maintain the advantage and its reputation among its core customer base will give us insight into the durability of the competitive advantage.
With all of the above in mind, here is my three-point checklist investors can use as a starting point for further analysis:
- If a company has debt, is it sustainable and are creditors willing to keep supporting the business?
- Does management have a track record of creating value for shareholders and supporting all stakeholders?
- Is the company's competitive advantage sustainable, and what is it doing to build the moat?
