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Chandan Dubey
Chandan Dubey
Articles (150) 

How Faithful Are You?

March 31, 2013 | About:

Checklists are an important tool for value investors. They protect us against our inherent mental shortcuts/biases and a need to “jump to conclusions.” They also make sure that we have thought about a pre-decided set of downsides and are not fitting the data to derive a particular conclusion. This last point is best explained by a story.

A Russian General was driving across a remote village during the World War II when he came across a set of circles on a large wall. At the center of each circle there was a bullet shot. He was mightily impressed and stopped his vehicle to find the shooter. He thought that a good target shooter like this one will be a great addition to his company. He accosted a villager and inquired about the person who was responsible for such a phenomenal shooting. “Oh ! He is the son of the shoemaker. But you don’t understand - he is a weird fellow” - quipped the villager. “Why so ?” - asked the General. Well, he first shoots on the wall and then draws a circle around it.
It is also important that the checklist is brief and to the point. A long-winded checklist resists thorough testing, and many significant details may be ignored at the expense of some minute and significantly less important facts. Hence, I made a very small checklist of things I want to have before I consider buying a company. The list is an amalgamation of several value investors philosophy (Warren Buffett and Martin Whitman among them):

- A business that I understand.

- A good and strong balance sheet.

- Run by able and reasonably honest management.

- A business with competitive advantage.

- Margin of safety or selling at a discount.

With such a simple set of rules one would think that I will be able to follow them. But a majority of the stocks I hold do not satisfy at least one of these qualities. Before going any further let me rate my top five holdings based on these checklist items. Each item (except Moat) may get one of five values: Exemplary, Fair, Moderate, Poor, Disastrous. Also, the margin of safety is rated according to the price I paid, and not the current price.

CompanyCircle of competenceFinancial StrengthManagementMoatMargin of safety
Roche HoldingFairModerateExemplaryWideFair
Bank of AmericaDisastrousNo IdeaFairFairNo Idea
France TelecomFairModeratePoorFairFair

Roche fails the financial strength test and this is one of the most important rules on the checklist. When I bought Roche it had an SFR 36 bn in debt as opposed to an SFR 7.3 bn in equity.

ArcelorMittal is in a commodity business with no moat. Its debt is rated junk and the amount of my understanding of Iron and Steel consumption and demand is flimsy at best.

France Telecom does not have a great management and for some reason they are expanding in Africa for their growth. I do not doubt that Africa may offer huge growth potential but the income per customer there will be even worse than the income per customer in India - which Vodafone found out the hard way.

At this point I find myself quite divided. I understand that I should be able to eliminate at least a few of my holdings by testing them against each item in my checklist - in a emotionless way. But I am unable to do so. Then I get down to the individual companies I find that I have reasons for not selling - and good reasons. So I end up taking a walk and the cycle repeats.

I will be happy to hear suggestions.

About the author:

Chandan Dubey
I invest because I want to be free by the time I reach 40 years of age i.e., 2025. My investment style is to find a small number of bets with large margins of safety. I pay a lot of attention to management and their incentive. Ideally, I like to buy owner operator businesses. I am fortunate to have a strong inclination towards studying. I aid my financial understanding by extensive reading in psychology, economic, social sciences etc.

Rating: 3.1/5 (9 votes)


Marcolanaro - 4 years ago    Report SPAM
Hello Chandan,

my question is regarding BAC, why did you buy it if it is not in your circle of competence and you have no idea on margin of safety and financial strength? Said that I would direct you to do some search on the internet and look at the reasons why BAC is the second largest holding of Bruce Berkowit's Faairholme Fund, I believe it is very interesting and that one (BAC) I would not sell it.

Happy investing!!
Cdubey - 4 years ago    Report SPAM
I bought 5 stocks when I started. Credit Suisse (sold it at a loss of Sfr 5000), HP (still holding it and will break even at $27), Best Buy (sold it at a small loss), BAC (still hold it at $12) and Roche (at a 70% profit now, still hold it) . Being one of the first my due diligence was not up to par - which is putting it mildly.

I did not sell exactly because Bruce Berkowitz, later Warren Buffett and Mohnish Pabrai went long in effect. I am coat-tailing and will probably not sell for the foreseeable future.
Rafaelscremin - 4 years ago    Report SPAM
MT (12.98) is a very good BUY

Rollling - 4 years ago    Report SPAM
Independently of it being a good investment or not I can't understand why after holding BAC fir 3 years (or so) you still have no idea if you have a margin of safety and it being completely out of your circle of competence... I believe that instead of searching for new investments you should first understand those you hold....after that just decide... (most probably what you've written isn't exactly true)... coattailing without undestanding is probably a bad idea... good investors also commit mistakes and if you miss you'll probably [size=12px][/size]notice earlier that your initial reasoning was wrong

ps: you don't need an A+ on circle of competence if you have a HUGE margin of safety but it would be wise to enlarge your circle of competence because if you do it and continue to believe the margin of safety is huge then you'll feel confortable to go all in (or whatever an all in means for you be it 20% of portfolio or 100%)
Cdubey - 4 years ago    Report SPAM
@Skyaboveyou: Ok, I have followed the bull case of Berkowitz and also have agreed with most of the management decision Moynihan has made. Furthermore, I have tried to learn more on the banking industry and from what I see BAC is still cheap.

The only problem is that with banks - you never know. The best you can say is that the management is honest and hence you are invested in them. There is so many things going on their balance sheets that it is virtually impossible for me to come up with a reasonable estimate of the downside risk. Probably adding more around $5.5 would have been better ... but well ... you live and learn.
Praveen Chawla
Praveen Chawla premium member - 4 years ago
Hi Chandan - Good checklist. I am long MT - its a highly cyclical business so timing to buy and sell is critical. I bought Mittal (before its merger with Arcelor) for around $2 and it went up to $100 - and now its back to $11. Any way lesson learnt. I think one should always buy these cyclical business on their way down (and below tangible book value) and sell on the way up when the economy is booming with the understanding that you will miss the highs and the lows by 25 to 50%.

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