Recently I was listening to an Audiobook titled: Education of A Value Investor, by Guy Spier. In the book, he talked about the importance of having a checklist for investing and cited Monish Prabai as one investor who use a checklist to make investing decisions.
Feeling inspired, I dug up Philip A Fisher’s book: Common Stocks and Uncommon Profits and read through his check list again.
As Philip Fisher’s investing philosophy really strikes a chord with me, I decided to use his checklist to aid my investing decisions. Hence, the check list you see below contains several points from Fisher’s book. I have left out the points which I personally know that I would not use. I have also added my own points in 12 & 13 based on personal experiences and point 14, which was inspired by Charlie Munger: The Complete Investor, in which he talked about the importance of having a moat.
Here’s the checklist:
1. Does the company have products or services with sufficient market potential to make possible a sizable increase in sales for at least seven years?
“Sales cures all.” – Mark Cuban.
I totally agree with that statement. Sales is the lifeblood of any business. Sales is the biggest sign that tells us how the market is responding to the company’s product.
With this first point, Fisher is looking for a continuity in sales for a LONG long time. He is not interested in making a one-time profit by buying bargain stocks. He is looking to hold a company forever.
Why go through all the trouble to pick a company that can only unlock ‘value’ to reap a 1-time gain?
I like this first point of Fisher because I too, would like to buy and hold forever, and not worry when to sell or dump my position.
2. Does the management have a determination to continue to develop products or processes that will still further increase total sales potentials when the growth potentials of currently attractive product lines have largely been exploited?
This point may seem similar to the first one, but it’s not. What Fisher is looking for here the attitude of the management to innovate, invest in research and development, to develop more products that can complement the core products. He adds that if such products are successful, new industries unrelated to the existing business may be opened up to the company. Hence, increasing overall potential growth. (E.g – Amazon creating Amazon Web Services to help companies with website hosting. That has totally nothing to do with their core business of e-commerce.)
We do not want management to be contented with the success of just 1 product. We want them to continue pushing and innovating.
I find this especially relevant in today’s world. The rapid changes in technology sets the conditions where new businesses just spring up out of nowhere and threaten to disrupt a well-guarded moat. I have more faith in companies that are constantly seeking to find ways to improve their existing product line or find ways to break into new industries.
3. Does the company have a worthwhile profit margin?
Sales will only be of value if the profits can grow correspondingly. Strong companies tend to not have such a high variation in the profit margins regardless of good or bad years. Weaker companies, in contrast, see huge swings in their profit margins depending on the industry dynamics. Companies with consistently large profit margins are preferred.
4. What is the company doing to increase profit margins?
Again, this item here is to probe for clues to see if the company is making efforts to continue improving profits for the future. How a stock performs after you buy it is not based on the actions the company did in the past, but on its actions in the future. This quality may be hard to spot and may require some digging with management or company employees.
5. Does the company has outstanding employee relations?
The strength of a company can be seen by the quality of its workforce. And usually, a happy workforce is a more productive one. A good work culture will also help to attract and retain talent. This is extremely critical as the playing field is very competitive in the globalised economy. Employees have high expectations and have the job mobility to switch jobs whenever they see fit. A company needs all the best workers and executives it can get. ( A check on glassdoor.com will give you an insight to a company’s employee satisfaction.)
6. Does the company have depth to the management?
All human beings can only serve a company for a finite number of years. A succession plan is needed to limit key personnel risks. Also, the company should have an employee ascension program where executives are trained internally to take on management roles in the future.
7. Are there other aspects of the business, somewhat peculiar to the industry involved, which will give the investor important clues as to how outstanding the company may be in relation to its competitors?
Other than just looking at sales figures, we can look at other metrics or factors that tell us why this company outperforms its competitors. For example, in the insurance industry, we may want to compare the combined ratios of the companies in the industries over a few years. For a social media company, we may want to look at user engagement metrics like time spent on site or average number of content shared by each user. For some industries, patent protection might be an aspect to take note of.
8. Does the company have a short-range or long-range outlook regarding profits?
Look for companies that have a long-range outlook on profits. Some signs include companies who pay their partners or vendors fairly to establish good relationships, or companies that may go out of the way to care for the customer. Although such actions may seem to reduce profits in the short-term, the goodwill accrued from such acts may pay back in profits in the long-term.
9. In the foreseeable future, will the growth of the company require sufficient equity financing so that the larger number of shares then outstanding will largely cancel the existing stockholders’ benefit from this anticipated growth?
A company that’s strong enough should be able to borrow money without much trouble. For early-stage companies or companies over the debt limit, raising money by issuing equity is still an option. What one should look out for is that the company, after issuing equity, is able to generate higher earnings or cash flow. We can look at past history or track records for data on how a company performs after issuing equity. ( Do also take note of granting of share options to staff in place of monetary incentives. This could dilute the shares for the current investors or mask the costs of running the company. )
10. Does the management talk freely to investors about its affairs when things are going well but “clam up” when troubles and disappointments occurs?
A company’s management should be straightforward and authentic. When crisis hits, a good company should accept responsibility, analyse their mistakes and come up with a plan to overcome that obstacle. Even the best run companies will encounter some difficulties in the future. Management that “clam up” may not have a plan to solve the unexpected problems, and it may also hint that they do not care about the other shareholders. Avoid companies that try to hide bad news or withhold information from the public.
11. Does the company have a management of unquestionable integrity?
Ways to spot questionable integrity of a company include
– insiders paying themselves salaries way above the normal work performed
– insiders renting their own properties to the company at above-market rates ( however, sometimes insiders may do that not for personal gain, but just to free up limited working capital.)
– using brokerage services owned by relatives or friends of insiders to earn a hefty commissions from transactions
– copious issuance of stock options to insiders that does not seem like a fair reward for the work performed.
12. Is the company buying back its shares? Or are there any recent purchases of the company’s stock by investing gurus?
Company share buybacks will help to add confidence to the investment thesis and also shows that the management also thinks that their stock is undervalued. An example would be Kingsmen Creatives share buybacks in 2008 and in the recent past few months.
Stock purchase by gurus could also give you a better peace of mind. Purchases by gurus can be tracked on sites like gurufocus.com. For example, it helps to sleep better at night to find that investing gurus like Seth Klarman and Carl Icahn have bought Paypal at roughly the same price as you. Or that Tom Gayner, Monish Prabai and a few other have added to positions to Alphabet (Google).
13. Is this company in a cyclical industry?
After getting burnt on oil and gas, and commodity stocks, I have decided to steer clear of cyclical industries where the companies aren’t really in control of their own fates. Cyclical companies tend to be kicked around by macroeconomic factors that I don’t understand. So — no cyclicals for me thank you!
14. What is the economic moat of the company? How is the company growing that moat?
Identify what are the factors that prevent competitors from stealing a company’s market share. An economic moat will give a firm a competitive advantage over others in the industry. Moats can arise due to patents, technological advantages, high barriers to entry, branding or network effects.
For example, Google has a moat on search engines with its complex algorithms and tonnes of data; Facebook has a moat from network effects by users; Apple has a moat that traps the users in an eco-system where all their products work well with one another; Vicom has a moat due to vehicle inspection laws.
Next, having a moat is not enough. We want to see how a company is consistently growing its moat over time. Google is branching out into more products and services like google maps, google classroom, Nest connected homes and the like. Facebook is expanding its network effects through Instagram and WhatsApp. Amazon is locking customers in with Amazon Prime, improving the efficiency of their storage and delivery routes and expanding their territories into areas outside e-commerce with AWS. A company that keeps expanding its moat will keep growing stronger over time.
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