In this post, I am going to explore my investment checklist. My checklist IS NOT unique. It is based on other investor’s checklists and tailored towards my own personality.
“The person that turns over the most rocks wins the game.” - Peter Lynch
The Rookie Checklist
Keep it simple - this is the overarching theme of my checklist. Several years ago, I had a +10 step checklist, but I never used it because it took too much time. It was hideously long and I realized…a checklist is only good if it’s being used and specific to me.
I don’t have time to spend all day on a single idea, and thus, I created my own checklist tailor to myself and what I care about.
My investing is very straightforward; I want to own businesses that 1) I like, 2) are growing, 3) generate a high amount of free cash flow, 4) have future optionality, and 5) are led by a great management team. I want to own my businesses forever.
Step 1: Do I understand the business and it’s market?
Yes or No?
If YES, great - proceed to next step.
If NO, great. Do I want to learn about this business and it’s market? Do I find this business interesting and something I am passionate about? It’s critical to NOT be intellectually lazy here and throw ideas away too fast.
This has cost me a lot of money over the years with companies like Crowdstrike or Twilio - I was too quick in my dismissals of these companies and not pushing myself further to understand these businesses.
I want to better define ‘understand’. When I say ‘understand’ I don’t mean that YOU need to understand/know everything about the business or to read every 10K/10Q. When I think of ‘understanding’ a business I use these parameters:
How does the business make money?
Who are the competitors? And is it winning, why? Or losing in the sector, why?
What does the business’ future look like (1-2 years)?
Is it in a growing sector?
Could I teach a 5 year old about this business and why it is important? The important thing here is not that the 5 year old understands the business, but are YOU able to break down the idea into digestible chunks that can be comprehended.
Two simple and old frameworks to use for Step 1 is a SWOT and Porter’s Five Forces.
If I am able to answer these 5 bullet points and feel comfortable enough to defend that business, this then allows me to move onto Step 2.
This is a jam:
Step 2: Moat and Future Growth/Catalysts
Moat
“What we're trying to do, is we're trying to find a business with a wide and long-lasting moat around it" and “We think in terms of that moat and the ability to keep its width and its impossibility of being crossed as the primary criterion of a great business” - W. Buffett
Now if you did Step 1 properly this section should be fairly straightforward. Business moats are difficult to define, but the main questions to ask yourself are, “Does this business have pricing power over the long-term?” and “how does this business differentiates itself against competition? Is it brand? Is it pricing model? Is it a feature set?”.
If these questions are extremely difficult to answer then you probably didn’t do enough homework in Step 1 or it may be that their moat is weak and will deteriorate over time.
Growth / Catalysts
This section is self-explanatory. AND It is incredibly important to understand how a business is planning to grow in the future…
You’ll need to be able to understand the growth story and how management executes their plan to get there…this is how you’ll make money. Aswath Damodaran does a brilliant job of describing how stories, growth, and valuation all tie together.
You’ll find winners if you are able able to understand the optionality of a business and how they are able to leverage their current strengths to continually generate top line growth and free cash flow.
Some questions to ask yourself are:
Does the business have QoQ and YoY Revenue Growth?
If not, does the business have any form of Catalyst on the near horizon (i.e Feature Release, FDA approval, M+A)?
Has there been a strategic shift in the business and/or are they telling a different story?
A recent post by Shomik Ghosh on “SaaS Companies Going From ‘Asset Light’ to ‘Asset Heavy’” is a great example of how recognize a great business and how they are creating their own growth catalysts.
In Part 2 of The Rookie Checklist we will examine how I think about Management, Valuation, and The Rookie Quick Fire Challenge.
Thanks for reading.
"Keep It Simple, Stupid" https://getyarn.io/yarn-clip/eed08f4f-d1c9-4cc0-b041-f280a5dbf0a5