In Part 1 of The Rookie Checklist we covered sections on Understanding the Business and Growth/Catalysts. You can read about Part 1 here.
In Part 2 of The Rookie Checklist we will examine how I think about Management, Valuation, and The Rookie Quick Fire Challenge.
Management
Oh boy…this step in the Rookie Checklist may be the most critical to your investments’ future success. A good management team can turn a bad company into a good investment, a bad management team can turn a great company into shit, and a great management team can turn a great company into a ‘shit-ton’ (technical term) of money.
There is no ‘scorecard’ or ‘formula’ for what makes a great CEO or leadership team, but I believe there are ways to at least make educated guesses on ‘if you want these people managing your money’.
Here are some things that I like to verify before investing:
Do they have any ‘skin in the game’?
Has the CEO had success in their last venture? Was the CEO unsuccessful in their last venture and why? Have they had any scandals or fraudulent activities?
Are the CEO and Chairman of the Board the same person?
What is the CEO’s reputation on Glassdoor or in the news?
Rookie Gut Check: listen to at least 2-3 of the most recent interviews of the CEO and see if 1) he/she is consistent in their message/story, 2) deflecting questions and giving vague answers, 3) do they seem trustworthy to YOU
What is the management team’s background? What is their expertise and are they a well-rounded management team (i.e. skills, backgrounds, race, gender, etc).
Also, if you really want to understand Management and the dark-arts of aligning incentives with common shareholders I recommend subscribing to Non-Gaap Mike - he is the best.
Valuation
“All models are wrong, but some are useful.” - George Box
I won’t spend too much time here. You could spend days on estimating the appropriate future growth rate of your company, or what discount rate is correct in your model and it will most likely be completely wrong.
“It is better to be approximately correct, than precisely wrong.” - Warren Buffett
I am a huge fan of Mohnish Pabrai’s style of doing ‘back of the envelope’ valuations, and then, I like to combine this with the general outline/formula described in Tobias Carlisle’s book “The Acquirer's Multiple”. This should give me a general idea of what the company’s intrinsic value is, and how much of a margin of safety I have.
The most important thing about the Valuation step is to THINK and ANALYZE why the company is trading where it is.
Always ask the questions 1) what is the company’s rough intrinsic value and 2) why is it trading there and why is the market wrong?
Just because the company is trading with a huge margin of safety doesn’t mean it’s a BUY and instead, it could be a value trap. And likewise, if a company is trading at a huge ‘premium’ or ‘multiple’ doesn’t mean you should automatically dismiss that company.
If you have made it this far - thank you.
This is what I was listening to when I was writing this section:
The last step in my Rookie Checklist is a quick-fire challenge that I put each one of my ideas through - this idea was copied directly from Brian Feroldi - he’s a fountain of amazing wisdom.
The Rookie Quick Fire Challenge
Does the company have recurring revenue? (Yes +1, No -1)
Gross Margins (<50%, 50% to 80%, >80%) (0 - 3)
FCF: (Negative / Positive / Positive and growing fast) (0 - 3)
Returns On Capital: (Low, Average, High, +1 If Rising) (0 - 3)
Network effect, product ecosystem (None / Weak / Strong) (0 - 10)
Switching costs (None / Weak / Strong) (0 - 10)
Durable Cost Advantage (Scale / Distribution / Physical Location / Vertical Integration) (0 - 10)
Intangibles: (Premium Brand, Patent, Trade Secret, License) (0 - 10)
Optionality: (None / Within Industry / New Industry) (0 - 7)
Moat Direction: (Narrowing / Stable / Widening) (0 - 5)
Cost of Acquisition (CAC): (Expensive / Normal / Word Of Mouth) (0 - 3)
Top dog And First Mover In Important, Emerging Industry And/Or Industry Disruptor: (0 - 3)
Pricing Power: (None / Some / Tons) (0 - 3)
Soul in the game/Insider Ownership: (Founder/Family/Long Tenured CEO) (0 - 3)
Mission statement? (Simple, Inspirational, Boring) (0 - 3)
5-Year Performance Vs. S&P 500 Or Since IPO (Yes +2, No -2)
Customer Concentration: (Yes +2, No -2)
Industry Disruption: (Active / Possible / None) (-3, -2, 0)
Outside Forces: (Commodity Prices, Interest Rates, Strong Economy) (-3, -2, 0)
Headquarters: (High Risk Country / Medium Risk /Low Risk) (-3, -2, 0)
Best Score Possible: 81 points
Worst Score Possible: -14 points
These questions force me to think about the business from tons of different angles, and gives me a systematic way to ‘turn over rocks’.
In my next post, I plan on taking one company through the The Rookie Checklist and showing you how it works. Stay tuned for more.
dr dog all day