The Investment Checklist E-Book

Michael Shearn

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Sprache: Englisch

Seitenzahl: 627

Veröffentlichungsjahr: 2011

Beschreibung

A practical guide to making more informed investment decisions

Investors often buy or sell stocks too quickly. When you base your purchase decisions on isolated facts and don't take the time to thoroughly understand the businesses you are buying, stock-price swings and third-party opinion can lead to costly investment mistakes. Your decision making at this point becomes dangerous because it is dominated by emotions. The Investment Checklist has been designed to help you develop an in-depth research process, from generating and researching investment ideas to assessing the quality of a business and its management team.

The purpose of The Investment Checklist is to help you implement a principled investing strategy through a series of checklists. In it, a thorough and comprehensive research process is made simpler through the use of straightforward checklists that will allow you to identify quality investment opportunities. Each chapter contains detailed demonstrations of how and where to find the information necessary to answer fundamental questions about investment opportunities. Real-world examples of how investment managers and CEOs apply these universal principles are also included and help bring the concepts to life. These checklists will help you consider a fuller range of possibilities in your investment strategy, enhance your ability to value your investments by giving you a holistic view of the business and each of its moving parts, identify the risks you are taking, and much more.

• Offers valuable insights into one of the most important aspects of successful investing, in-depth research
• Written in an accessible style that allows aspiring investors to easily understand and apply the concepts covered
• Discusses how to think through your investment decisions more carefully

With The Investment Checklist, you'll quickly be able to ascertain how well you understand your investments by the questions you are able to answer, or not answer, without making the costly mistakes that usually hinder other investors.

Leseprobe

Contents

Preface

Acknowledgments

Chapter 1: How to Generate Investment Ideas

How Investment Opportunities Are Created

How to Filter Your Investment Ideas

Using a Spreadsheet to Track Potential and Existing Holdings

Chapter 2: Understanding the Business—The Basics

1. Do I want to spend a lot of time learning about this business?

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

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?

Chapter 3: Understanding the Business—from the Customer Perspective

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?

Chapter 4: 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 its suppliers?

Chapter 5: 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?

Chapter 6: Evaluating the Distribution of Earnings (Cash Flows)

27. Are the accounting standards that management uses conservative or liberal?

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?

Chapter 7: Assessing the Quality of Management—Background and Classification: Who Are They?

33. What type of manager is leading the company?

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

35. Is the manager 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?

Chapter 8: Assessing the Quality of Management—Competence: How Management Operates the Business

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 way?

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?

Chapter 9: 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?

Chapter 10: Evaluating Growth Opportunities

53. Does the business grow through mergers and acquisitions (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?

56. What are the future growth prospects for the business?

57. Is the management team growing the business too quickly or at a steady pace?

Chapter 11: Evaluating Mergers & Acquisitions

58. How does management make M&A decisions?

59. Have past acquisitions been successful?

Appendix A: Building a Human Intelligence Network

Evaluating Information Sources

How to Locate Human Sources

How to Contact Human Sources—and Get the Information You Want

Create a Database of Your Interviews for Future Reference

Appendix B: How to Interview the Management Team

Ask Open-Ended Questions

Be Aware of the Danger of Face-to-Face Assessments of Managers

Appendix C: Your Investment Checklist

About the Author

Index

Copyright © 2012 by Michael Shearn. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

Shearn, Michael, 1975–

The investment checklist : the art of in-depth research / Michael Shearn.

p. cm.

Includes index.

ISBN 978–0–470–89185–8 (cloth); ISBN 978–1–118–14943–0 (ebk); ISBN 978–1–118–14944–7 (ebk); ISBN 978–1–118–14945–4 (ebk)

1. Investment analysis. 2. Portfolio management. 3. Investments. I. Title.

HG4529.S47 2011

332.63’2042—dc23

2011021446

For my wonderful wife, loving parents, and beautiful daughters.

Preface

This book can help you make better investment decisions by helping you truly understand the companies you’re investing in.

If you’re like most investors, you make mistakes when you rush into an investment idea without doing the proper work to understand the value of a business. By rushing, you are essentially betting on probabilities that certain assumptions will work out, instead of basing your investment decision on real analysis.

Too often, investors buy stocks by relying on recommendations from other investors, or on hunches, or because of isolated facts they’ve heard or read about a business. When you make your purchase decisions on these factors and do not take the time to thoroughly understand the businesses you are buying, you’re more prone to make investment mistakes. Your decision-making then becomes dangerous because you don’t really know enough, and you’re relying on other people and the information (or misinformation) they provide about a particular stock. Instead, your investment purchases should be based on understanding the value of a business through in-depth research. If you truly understand the value of a business, then you will be in a position to recognize investment opportunities and can more easily make buy or sell decisions.

Don’t be daunted by the idea of in-depth research. This book makes the research manageable (more about that in a minute). Also, I’m sure you do research all the time before you spend your hard-earned money: For example, think about any major purchase you’ve made in your life—whether it’s a house, or a car, or an expensive piece of jewelry or electronics. Before you spent all that money on whatever it was, you probably spent some time researching to make sure your money would be well spent. If you were buying a house, you (or your realtor) researched the price of other houses in that neighborhood and other amenities that would make that house desirable (e.g., the school system, ease of commuting, neighborhood parks or pools or tennis courts or shopping, etc.). The more you know about your purchase, the more easily you will be able to recognize a good deal. The same is true when buying or selling a stock. The more you understand the dynamics of a business and the people operating it, the better the odds that you will be able to recognize a good deal on a business.

Many professional investors believe that in-depth research is a waste of time. To them, great investment decisions boil down to a few simple factors, such as an extremely low stock price. I used to subscribe to this theory myself, but over time, I discovered I was wrong. As I came to appreciate that the value of a business cannot be condensed into a few simple factors, I searched for books that would teach me how to value a business and invest intelligently in stocks. I was looking for a practical book instead of one that focused on broad concepts. In spite of the fact that there are hundreds of books written on the subject of investing, I honestly couldn’t find one that truly helped me.

My instinct after failing to find a good investing framework was to over-research potential investments. I often ended up reading everything I could get my hands on about a potential investment. As a result, I subjected myself to information overload and was unable to recognize good information. I also kept repeating investment mistakes, such as paying too much for a business or partnering with the wrong management team.

So I set out to establish a systematic process to force me to think through my investment ideas more carefully and help me avoid repeating the same investment mistakes. Over the past 10 years, I began to use checklists of questions I needed to answer to make informed investment decisions—questions that would guide me in learning about a business’s competitive position, customer positioning, and management strength. To come up with the questions, I studied the past mistakes I had made investing, and I read many books about the common mistakes made by investors and executives. I interviewed private equity managers, venture capitalists, entrepreneurs, chief executive officers (CEOs), hedge fund managers, mutual fund managers, and private investors to help me prepare a more comprehensive list of questions. During the stock market decline in 2008 and 2009, I made significant improvements to the checklists as the decline exposed weaknesses in my investment process.

As I used the checklists, I discovered that if I could answer the majority of the questions on the checklist, I could more easily value the business by minimizing the number of assumptions I was making about a business’s future prospects. If I was unable to answer a question on the checklist (such as “are its managers honest?”), then I could identify the potential risks I was taking in an investment and the areas that I needed to spend more time researching.

My ultimate goal was to understand how well I understood an investment by the questions I was able to answer—and those I was unable to answer, which is often even more important. With some companies, I found that the more I read about them, the more questions I had about how the company operated—and I realized this was an indicator that I didn’t really understand that business! For example, I spent a lot of time researching mortgage insurers in 2007 before the credit crisis began. Yet the more time I spent, the more questions I had. I never had enough information to be able to calculate a reasonable range of valuations for the businesses. I felt I was answering too many of the questions with assumptions rather than backing these assumptions with evidence. I therefore determined I was not in a position to value those businesses and I didn’t invest in them. That red flag saved me a lot of money!

The result of all my research is this book, which describes the checklists I’ve used in my own investing over the past 10 years.

How This Book Can Help You

The Investment Checklist is for anyone who’s investing in stocks, at any level—if you’re just starting out and thinking about what you want to invest in, or if you already have a portfolio (of any size) that you want to manage better and watch your money grow (after all, no-one wants to watch their investments lose money, shrink, or disappear altogether!). That said, this book isn’t for stock traders (aka day traders) or people who invest only for short-term gains.

Instead, this book is for anyone who wants to learn how to value a business and invest for the long term: I wrote it to help you learn what you need to know about specific companies you’re considering investing in, and to help you evaluate whether or not those companies are worth investing in.

Before you read any further, consider these questions about you and your approach to investing (and be honest): You’re not sharing these answers with anyone else!:

Do you check stock prices frequently?Do falling stock prices make your stomach churn?Do you react quickly to positive or negative news announcements about the companies whose stock you own?Do you ever feel you’re under time pressure to make buy or sell decisions?Do you have high portfolio turnover? Are you buying and selling shares often?Do you feel you need to defend your investments when others challenge you?

If you answered “yes” to any of the above questions, this book can help you make better investment decisions, by helping you research more effectively so you’ll truly understand how a business operates and is managed. As I developed my checklists, the benefits of creating a concise and easy-to-use framework became apparent. In short, the exercise of going through The Investment Checklist lowers your risk by increasing your knowledge of a business. Here’s how the checklists in this book can help you:

The checklist will help you filter out the noise and instead focus on information that is most important and relevant. There is an unending stream of information available; don’t get bogged down in information overload, as I did when I first started investing. This book tells you what information you really need and where to find it.The majority of the questions can be answered by information that is relatively easy to find. You can find most of the information to answer the checklist questions in publicly available Securities and Exchange Commission (SEC) documents or articles written about management and the business.The questions should help you understand the business as if you’re the business owner and help move you away from thinking of stocks as pieces of paper. The checklist questions force you to think about the fundamentals of the business rather than just its stock price. Worrying about things such as fluctuations in the stock market (which are outside your control anyway!) is a waste of time. Instead, you will be able to identify the main factors that drive the value of the business, most of the risks the business can encounter, and the things that can go wrong.The checklist will help you take a long-term view of your investments. Most people tend to remember recent events more easily. The checklist requires that you answer questions using a long time span, which helps protect you from overvaluing more recent pieces of information. Researching a business over a long period of time allows us to sort through things rationally and puts us in a position to better interpret information.The checklist is useful for compiling information that goes against your investment thesis. It is human nature to overweight information that supports your investment thesis and underweight information that is contrary to your investment thesis. The checklist questions help you ensure you’re accepting (or at least recognizing) divergent facts about the business.The checklist will help you improve sell decisions. Knowing when to sell an investment is one of the most difficult decisions you have to make. Most sell decisions are based on judgment, feel, or instinct. The checklist helps you learn when to sell by helping you identify when the fundamentals of a business, such as the quality of the business or management team, begin to change.

How This Book Is Organized

The three most common investing mistakes relate to the price you pay, the management team you essentially join when you invest in a company, and your failure to understand the future economics of the business you’re considering investing in. The questions in this book can help you minimize these mistakes by helping you gain a deeper understanding of how a business operates:

Chapter 1 outlines a search strategy that will improve your odds of finding investment ideas that are worth researching further.Chapter 2 helps you understand the basics of a business: What it does, how it earns money, how it evolved over time, and in what geographic locations it earns its money.Chapter 3 demonstrates the importance of understanding the business from the customer’s perspective rather than your own. These insights will help you learn how important a business is to the customers it serves.Chapter 4 helps you evaluate the strengths and weaknesses of a business. These are the questions that will help you evaluate whether or not a business has a sustainable competitive advantage, the competitive landscape, and the industry it operates in.Chapter 5 helps you understand the operational and financial health of a business. You’ll look at key risks facing the business, how inflation affects it, and whether its balance sheet is weak or strong.Chapter 6 looks at the distribution of earnings (cash flow) of a business. You’ll learn how to assess whether the company’s accounting practices are conservative or liberal (so you can avoid a company like, for example, the now-defunct Enron), the type of revenue it generates, whether the company makes money consistently or in cycles, and whether or not it’s resistant to recessions.Chapter 7 is the first of three chapters that show you how to understand the quality of the management team. You’ll look at what type of manager they are, how they rose to lead the business, how they are compensated, and other background information.Chapter 8 helps you gain insight into the competence of a company’s senior management. You’ll look at how they handle daily operations as well as long-term strategy, how they treat employees, and how they think about costs.Chapter 9 helps you assess the management of a company by looking at their positive—and negative—traits: How they think, whether they’re self-promoting, and other critical factors. Remember, when you buy stock in a company, you’re essentially going into business with the managers who run that company, so you want to know as much about them as you can!Chapter 10 demonstrates how you can evaluate the future growth opportunities of a business. You’ll look at whether it’s growing organically or by merging with or acquiring other companies, whether historical growth has been profitable, and how quickly it’s growing and whether management is growing in a disciplined way.Finally, Chapter 11 looks specifically at mergers and acquisitions, to determine whether those completed in the past have been successful and how management makes the decision to merge with or acquire another company.

Each chapter offers countless examples of businesses I’ve researched, considered investing in, actually invested in, or decided not to invest in. These examples tell you in detail how my checklist helped me make investment decisions, and they’ll show you how you can make better investment decisions for your own portfolio. In addition, each chapter ends with “Key Points to Keep in Mind,” so you can zero in on the critical factors in each set of questions.

Now, let’s get started by learning how to generate investment ideas!

Acknowledgments

This book would not have been written without the encouragement and help of Judd Kahn and Bill Falloon who championed this book from the earliest proposal. No one deserves more thanks than my partner Ann Webb. Her willingness to make everything she touches a success is forever appreciated. Ruth Mills simplified the book-writing process for me and I can’t imagine finishing this book without her. Dr. Sandy Leeds was a true devil’s advocate. Those who have Sandy in their corner, both students and friends, are very fortunate. My friend Jeff “Falcon” Sokol helped ground the book and at the earliest stages attempted to convince me not to endeavor in this project. As such, all critics need to talk to Jeff about improving his powers of persuasion. I want to thank my mentor and intellectual coach John “Chico” Newman who always provides practical advice.

I would also like to thank the following for their contributions to the book: Bob Aylward, Ciccio Azzolini, Ron Baron, Peter Bevelin, Dr. Paul Bobrowski, Jean-Philippe Bouchard, Dr. John Delaney, Pat Dorsey, Matt Dreith, Ryan Floyd, Meg Freeborn, Ben Gaddis, Francesco Gagliardi, Dave and Sherry Gold, Bob Graham, Todd Green, David Hampton, Norman Hecht, Casey Hoffman, K.K., Paul Larson, Brad Leonard, Steve Lister, Chris Lozano, John Mackey, Denise Mayorga, Bob Miles, Vincent Nordhaus, Francois Rochon, Robert Silberman, Paul Sonkin, Jim Sud, Seng Hock Tan, Lee Valkenaar, and Matthew Weiss.

On a personal note, a heartfelt thank you to the most important people in my life. My parents have never wavered in their support of my ventures. Their patience allowed me to find my own path. Most of all I thank my wife for her steadfast love, support, and guidance. And I want to give a special dedication to my beautiful girls who have forever changed my life in the most wonderful way.

CHAPTER 1

How to Generate Investment Ideas

There are many ways you can generate investment ideas, some qualitative, some quantitative. Quantitative methods include looking at specific financial or operating metrics, whereas qualitative methods rely on more subjective characteristics, such as management strength, corporate culture, or competitive advantages. Whether you are running a complicated stock screen or simply getting ideas from other investors, all methods have their own advantages, limitations, and risks. Ultimately, the best method of generating ideas for you is the one that gives you the largest number of opportunities.

This chapter explores why stocks become undervalued, how to generate investment ideas, how to filter these ideas, and how to keep track of them. These steps are critical to creating a pool of stock ideas.

How Investment Opportunities Are Created

You can’t manufacture investment opportunities. Instead, you need to be patient, and you have to be ready for the right opportunities. It is important to understand that good investment ideas are rare, and consistent success in the stock market is elusive. Those investors who believe that they can make money year after year in the stock market are setting themselves up for disappointment. Most investors are far too optimistic: They often think they’ve found great ideas when they haven’t.

In contrast, investors with the best long-term track records have made most of their money with just a handful of investment ideas. For example, Warren Buffett states that his investment success is due to fewer than 20 ideas, such as the Washington Post newspaper, Coca-Cola, and GEICO. In short, you need to mentally prepare yourself in advance with the idea that you will not have many outstanding investments in your lifetime. Most investments you make will produce mediocre results, but a few can provide outstanding results.

The best investment opportunities usually come in big waves, such as when entire markets decline. There have been several recent examples: the Asian financial crisis of 1997 to 1998, the Internet bubble ending in 2000, and the recession starting in 2007. There were many buying opportunities in 2008 when the S&P 500 dropped 36 percent. This was caused by forced selling. The market sell-off was exacerbated by the indiscriminate selling of stocks by money managers who were forced to sell stocks to fund client redemptions. Even if these money managers knew these stocks were undervalued, they had no choice but to sell. This forced selling created artificially low prices—which created a rare opportunity for investors.

Other kinds of forced selling include situations when stocks are thrown out of an index because they no longer meet the minimum standards to remain in an index. Many investment managers who exclusively invest in stocks found in a particular index (such as the S&P 500) are forced to sell when the stock moves out of the index. Spin-offs (where a business divests a subsidiary) create a similar situation when the business that is spun off does not fit the investing criteria of an investment manager. Forced selling decreases prices—which creates opportunities.