Investment Shares
What does your investment check-list look like?
I recently came across an article in The New Yorker magazine called The Checklist written by Atul Gawande a multi talented surgeon who is also the author of a interesting book I am reading called Complications: A Surgeon’s Notes on an Imperfect Science.
The article is quite long but it boils down to that, in spite of strong evidence to the contrary, highly trained people think its below them to use check-lists as they know what to do and working through a check-list is an insult to them. From the article:
“But this time he found few takers. There were various reasons. Some physicians were offended by the suggestion that they needed check-lists Others had legitimate doubts about Pronovost’s evidence.”
This was in spite of these findings:
“Within the first three months of the project, the infection rate in Michigan’s I.C.U.s decreased by sixty-six per cent. The typical I.C.U.—including the ones at Sinai-Grace Hospital—cut its quarterly infection rate to zero. Michigan’s infection rates fell so low that its average I.C.U. outperformed ninety per cent of I.C.U.s nationwide. In the Keystone Initiative’s first eighteen months, the hospitals saved an estimated hundred and seventy-five million dollars in costs and more than fifteen hundred lives. The successes have been sustained for almost four years, all because of a stupid little check-list”
All this from a check-list with steps as simple as “wash hands with soap”
Check-lists work best in a complex environment where the performing of certain steps are critical. In flying it is taken as a given that highly trained pilots work through check-list for virtually every eventuality. An aeroplane is a complex entity, so is medical procedures and I want to argue so is investing. When evaluating a company there are so many factors that are beyond our control. We however, through empirical research, do know what increases the probability of us making profitable investment decisions. What is important is that we focus on what we can control in our research and analysis. As part of my evaluation process I work through the following check-list:
- Can I in one sentence say exactly what the company does? (Thanks Cristina)
- Operating cash flow higher than earnings per share
- Free Cash Flow/Share higher than dividends paid
- Debt to equity below 35%
- Debt less than book value
- LT debt less than 2 times working capital
- Is the debt to EBITDA ratio less than 5 (Thanks Guy)
- What are the debt covenants
- When is the debt due
- Pre-tax margins higher than 15%
- FCF Margin higher than 10%
- Current asset ratio greater than 1.5
- Quick ratio greater than 1
- Growth in EPS
- Management shareholding (> 10%)
- Altman Z Score > 3
- Substantial Dilution?
- Flow ratio (Good < 1.25, Bad > 3)
- Management incentives?
- Are the salaries too high?
- Bargaining power of suppliers?
- Is there heavy insider buying?
- Is there heavy insider selling?
- Net share buybacks?
- Is it a low risk business?
- Is there high uncertainty?
- Is it in my circle of competence?
- Is it a good business?
- Do I like the management? (Operators, capital allocators, integrity)
- Is the stock screaming cheap?
- How capital intensive is the business?
- High Profitability
- High Return on Capital
- Enormous moat
- Profitable reinvestment
- Future growth
- Net share buybacks?
- Strong cash flow
- What has management done with the cash?
- Where is Free Cash Flow invested?
- Share Buybacks
- Dividends
- Reinvested
- ROE & ROCE
- Incremental BV growth
I also have an analysis spreadsheet for companies I have come across through the Magic Screen from Joel Greenblatt. For these companies I use these additional check-list items:
- Magic formula values any outliers
- Bubble industry last 7 years
- Does the cash belong to the company
- EBIT / Assets > 20%
I have put this check-list together over a period of more than 20 years and often make changes as I gain new information and insights. I do not have a formula that if a company fails X amount of points on the check-list I do not consider it. The check-list however gives me an indication of what problem areas the company has and where I have to do further analysis.
About the Author
Tim du Toit is the editor and founder of Eurosharelab. He has more than 20 year of institutional and personal investing experience in emerging and developed markets. Tim is based in Hamburg, Germany. More of his articles can be found at www.eurosharelab.com
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