Checklist questions

[Myth465]

I don't see how someone else's checklist could be of any help in one's investing.  There is no right way to invest.  The primary goal is to protect capital and thus put yourself in the best possible position to make money.  How you go about that is an individual, not a group, decision.  As a wise man once said, "now the world don't move to the beat of just one drum, what might be right for you, may not be right for some".

 

Then try looking for evidence to suggest that you're wrong. Munger has a name for this. An iron prescription, I think.

 

In my view, what you're saying is akin to the following: I don't see how someone else's checklist could be of any help in one's flying.  There is no right way to fly a plane.  The primary goal is to protect your safety and thus put yourself in the best possible position to get from Point A to B.  How you go about that is an individual, not a group, decision.  As a wise man once said, "now the world don't move to the beat of just one drum, what might be right for you, may not be right for some".

 

Of course, plenty of pilots would be dead today had they not totally relied on someone else's checklist.

 

I agree there is no "right way" to invest. That the goal is to limit downside and to maximize upside. And I agree decisions come down to the individual. But it does not follow from these premises that using someone else's checklist cannot be helpful. As an investor my returns would be half what they are had I not totally relied on someone else's checklist.

 

Boom, a Munger quote.  I am obviously wrong.  You got me. 

 

In reading what I wrote, I should not have said it's of no help.  That's clearly incorrect.  It could be of some help in ensuring that one is asking the questions they want to be asking.  Personally, I find checklists in investing to be worthless though.  Investing is not analogous to flying a plane or medical care.  Just my opinion.  You don't need to throw out another Munger quote or a Buffett quote to prove me wrong.

 

"if all you have is a hammer everything looks like a nail"

 

I agree with Kraven, investing isn't like flying or surgery.  Every company is different, do you think the same way about investing in a bank as you do an industrial manufacturer?  Do you have checklists for each industry?

 

A checklist is great for a process or procedure that's repeatable every single time.  I have used checklists extensively with things I've done professionally because the process needs to be the exact same.  Checklists work, but with investing items vary each time, they're not the same.

 

I can see the value in a very high level macro list, but the detailed stuff seems crazy.  I've seen checklists with things like "Does the CEO have a good track record of acquisition integration?"  For anyone who's been a part of a merger you know that no two acquisitions are the same.  Most acquisition success is related to the personalities of the people involved, not how strong willed the CEO is.  I've been at companies where one acquisition worked extremely well, and one a year later failed, not due to products or the market, but all personalities involved.

 

Pardon me while I digress... I wonder aloud if there is a lot of thrashing in the investment world because of the personality types who are drawn to investing?  This isn't an attack on anyone in this thread, but this thread has me thinking.  I see a lot of people talking about maintaining massive spreadsheet watch lists, or huge checklists, or reading piles of 10-Ks so they're "prepared" for an investment.  The impression I've had is that most investors are detail oriented structure type personalities.  When I think about those two things it makes perfect sense.  Many investors are the same people who make detailed packing lists before they go on vacation, or plan and structure their vacation down to the hour. 

 

I am not a detail oriented person, I'm far from it, I'm big picture at best.  I'm detail oriented about things I care about.  If I'm researching a company I will suddenly care about the details, but I can't keep a watch list for the life of me.  I like to think about the marginal return from more research.  The marginal return from looking at the financial statements vs not looking at them is huge.  The marginal return from reading the notes vs not reading them is smaller, but still sizable.  The marginal return from reading the notes from an annual report 12 years ago is almost zero.

 

I'd take this level of thinking even further, if I were to look back in time I'd say the return from reading the BAC thread on this board far exceeded reading their entire 10-K.  Yet many investors read the thread, then read every shred of paper out there on BAC.  I don't think the additional information helped them make a better investment, but it made them feel better about it.

 

I think there's a sweet spot in researching, and it's finding enough information to make a great decision, but not drowning yourself in information to feel better about a stock.  If the numbers are ok, and the company is ok it's not necessary to feel good about an investment.  The investment itself isn't the problem, it's the emotional temperament of the investor that's the problem.  I think some people assuage their doubt about an investment by over-researching the investment.  Over-research can be dangerous because it can lead to someone loving a stock instead of being dispassionate about it. 

 

The truth is that no matter how much we research and how much we know none of it makes a difference in the outcome.  If I invest in a great company and spend a year researching, then the CEO has an affair with a staffer and half the execs leave I have no control or way of knowing that, or even changing it.  There is so much unknown and unknowable unless one goes Philip Fisher and starts to interview employees and learn about the culture.  My sense from this board is that no one does that.

 

To pull this full circle I think it's important to know yourself and know your flaws.  If your flaw is that you continually miss the same information when you invest then maybe a checklist is important.  But it's not the end-all be-all. 

 

I'm fully aware that I've probably killed this thread, or will be ignored, but I've said my peace and now I'm content....carry on!

 

Great post oddballstocks.

[JBird]

Yes, I agree flying isn't like investing. The analogy was meant to illustrate the benefit of using a checklist to meet a goal. I suppose it wasn't a good one.

 

I didn't quote Munger.

[one-foot-hurdles]

Taken from Greg Speicher's ebook 10 ways to improve your investment process:

 

...Guy Spier talks about how checklists counter what he calls “cocaine brain” which is the feeling of euphoria that can cloud your judgment when you get excited about a stock. A checklist brings you back to earth and prevents stupid mistakes...

 

They are not a substitute for judgment, but they do aid our memory and help us to manage complexity. They help us to manage our emotions and misjudgments. They also help reduce the effects of complacency. Instead of thinking – “Why bother reading the proxy and footnotes? Most of the time there’s not much in them.” – you go through them because it’s on your list and part of your discipline.

[Hielko]

Do you really need a checklist to read the footnotes?

[vinod1]

 

"if all you have is a hammer everything looks like a nail"

 

I agree with Kraven, investing isn't like flying or surgery.  Every company is different, do you think the same way about investing in a bank as you do an industrial manufacturer?  Do you have checklists for each industry?

 

A checklist is great for a process or procedure that's repeatable every single time.  I have used checklists extensively with things I've done professionally because the process needs to be the exact same.  Checklists work, but with investing items vary each time, they're not the same.

 

I can see the value in a very high level macro list, but the detailed stuff seems crazy.  I've seen checklists with things like "Does the CEO have a good track record of acquisition integration?"  For anyone who's been a part of a merger you know that no two acquisitions are the same.  Most acquisition success is related to the personalities of the people involved, not how strong willed the CEO is.  I've been at companies where one acquisition worked extremely well, and one a year later failed, not due to products or the market, but all personalities involved.

 

Pardon me while I digress... I wonder aloud if there is a lot of thrashing in the investment world because of the personality types who are drawn to investing?  This isn't an attack on anyone in this thread, but this thread has me thinking.  I see a lot of people talking about maintaining massive spreadsheet watch lists, or huge checklists, or reading piles of 10-Ks so they're "prepared" for an investment.  The impression I've had is that most investors are detail oriented structure type personalities.  When I think about those two things it makes perfect sense.  Many investors are the same people who make detailed packing lists before they go on vacation, or plan and structure their vacation down to the hour. 

 

I am not a detail oriented person, I'm far from it, I'm big picture at best.  I'm detail oriented about things I care about.  If I'm researching a company I will suddenly care about the details, but I can't keep a watch list for the life of me.  I like to think about the marginal return from more research.  The marginal return from looking at the financial statements vs not looking at them is huge.  The marginal return from reading the notes vs not reading them is smaller, but still sizable.  The marginal return from reading the notes from an annual report 12 years ago is almost zero.

 

I'd take this level of thinking even further, if I were to look back in time I'd say the return from reading the BAC thread on this board far exceeded reading their entire 10-K.  Yet many investors read the thread, then read every shred of paper out there on BAC.  I don't think the additional information helped them make a better investment, but it made them feel better about it.

 

I think there's a sweet spot in researching, and it's finding enough information to make a great decision, but not drowning yourself in information to feel better about a stock.  If the numbers are ok, and the company is ok it's not necessary to feel good about an investment.  The investment itself isn't the problem, it's the emotional temperament of the investor that's the problem.  I think some people assuage their doubt about an investment by over-researching the investment.  Over-research can be dangerous because it can lead to someone loving a stock instead of being dispassionate about it. 

 

The truth is that no matter how much we research and how much we know none of it makes a difference in the outcome.  If I invest in a great company and spend a year researching, then the CEO has an affair with a staffer and half the execs leave I have no control or way of knowing that, or even changing it.  There is so much unknown and unknowable unless one goes Philip Fisher and starts to interview employees and learn about the culture.  My sense from this board is that no one does that.

 

To pull this full circle I think it's important to know yourself and know your flaws.  If your flaw is that you continually miss the same information when you invest then maybe a checklist is important.  But it's not the end-all be-all. 

 

I'm fully aware that I've probably killed this thread, or will be ignored, but I've said my peace and now I'm content....carry on!

 

Fantastic post oddballstocks.

 

I only wish you have written this a few years back. I had come to pretty much similar conclusion but not before wasting some effort.

 

Thanks

 

Vinod

[indythinker85]

What do you think of this list IMHO its too long but some good points http://www.valuewalk.com/2014/01/company-valuation-checklist/

[racemize]

Here's the requested checklist:  (IMO, this does not serve the purpose of what I'm going for, but I typed it out anyway)

 

A) How to Generate Investment Ideas

1) Do I want to spend a lot of time learning about the business?

2) How would you evaluate this business if you were to become its CEO?

 

B) Understanding the Business - Basics

3) Can you describe how the business operates, in your own words?

4) How does the business make money?

5) How has the business evolved over time?

6) In what foreign markets does the business operate, and what are the risks of operating in these countries?

 

C) Understanding the Business - Customer

7) Who is the core customer of the business?

8) Is the customer base concentrated or diversified?

9) Is it easy or difficult to convince customers to buy the products or services?

10) What is the customer retention rate for the business?

11) What are the signs a business is customer oriented?

12) What pain does the business alleviate for the customer?

13) To what degree is the customer dependent on the products or services from the business?

14) If the business disappeared tomorrow, what impact would this have on the customer base?

 

D) Evaluating the Strengths and Weaknesses of a Business and Industry

15) Does the business have a sustainable competitive advantage and what is its source?

16) Does the business possess the ability to raise prices without losing customers?

17) Does the business operate in a good or bad industry?

18) How has the industry evolved over time?

19) What is the competitive landscape, and how intense is the competition?

20) What type of relationship does the business have with suppliers?

 

E) Measuring the Operating and Financial Health of the Business

21) What are the fundamentals of the business?

22) What are the operating metrics of the business that you need to monitor?

23) What are the key risks the business faces?

24) How does inflation affect the business?

25) Is the business’s balance sheet strong or weak?

26) What is the return on invested capital for the business?

 

F) Evaluating the Distribution of Earnings (Cash Flows)

27) Are the accounting standards that management uses conservative?

28) Does the business generate revenues that are recurring or from one-off transactions?

29) To what degree is the business cyclical, countercyclical, or recession-resistant?

30) To what degree does operating leverage impact the earnings of the business?

31) How does working capital impact the cash flows of the business?

32) Does the business have high or low capital expenditure requirements?

 

G) Assessing the Quality of Management - Background and Classification

33) What type of manager is leading the company? (Owner Operator?)

34) What are the effects on the business of bringing in outside management?

35) Is the CEO a Lion or a Hyena?

36) How did the manager rise to lead the business?

37) How are senior managers compensated, and how did they gain their ownership interest?

38) Have the managers been buying or selling the stock?

 

H) Assessing the Quality of Management-Competence

39) Does the CEO manage the business to benefit all stakeholders?

40) Does the management team improve its operations day-to-day or does it use a strategic plan to conduct its business?

41) Do the CEO and CFO issue guidance regarding earnings?

42) Is the business managed in a centralized or decentralized manner?

43) Does management value its employees?

44) Does the management team know how to hire well?

45) Does the management team focus on cutting unnecessary costs?

46) Are the CEO and CFO disciplined in making capital allocation decisions?

47) Do the CEO and CFO buy back stock opportunistically?

 

I) Assessing the Quality of Management - Positive and Negative Traits

48) Does the CEO love the money or the business?

49) Can you identify a moment of integrity for the manager?

50) Are managers clear and consistent in their communications and actions with stakeholders?

51) Does management think independently and remain unswayed by what others in their industry are doing?

52) Is the CEO self-promoting?

 

J) Evaluating Growth Opportunities

53) Does the business grow through M&A or does it grow organically?

54) What is the management team’s motivation to grow the business?

55) Has historical growth been profitable and will it continue to be so?

56) What are the future growth prospects of the business?

57) Is the management team growing the business too quickly?

 

K) Evaluating M&A

58) How does management make M&A decisions?

59) Have past acquisitions been successful?