10 Important Questions to Consider Before Investing in a Company
This checklist can help you grow your wealth
1. Do I understand the business?
Can I explain, simply, what the business does? Do I understand how it makes money? What are its unit economics?
Why is the product or service valuable to its customers? What makes it better than the alternatives?
How elastic is customers’ demand to changes in price?
Who are the competitors? Does this company have a sustainable competitive advantage? If so, what is it, how big is it, and how long is it sustainable for?
2. Can I (approximately) estimate the key financial characteristics 10 years out?
How much bigger or smaller will the addressable market be? How will market share change?
How does the cost structure change with changes in sales over the long-term?
How will the capital-intensity of the business change?
What investment opportunities does the company have? At what rates of return on capital?
What is a reasonable range for future return on invested capital? For future free cash flow?
3. Can the balance sheet withstand severe temporary adversity?
If a severe recession starts tomorrow, will the company go bankrupt? Will it be forced to issue distressed securities and dilute the value of the company to existing shareholders?
Does the company have large debt maturities that make it reliant on the capital markets for refinancing?
What are the debt covenants on the bank loans? How much can sales drop before these would be violated?
4. Is the management honest?
When I read the proxy statement, is the compensation structure fair to both the management and the long-term shareholders?
Have I seen them make choices that hurt them personally financially in the short-term, but which are the right decisions for the long-term benefit of the shareholders?
Does the management team communicate both the good and the bad news honestly, or just selectively communicate only the good news?
5. Is the management competent?
What is their record of capital allocation? Have they done large, “strategic,” acquisitions which later destroyed capital? Have they bought back shares when the stock was cheap or did they sit on their hands then and only buy it back when everything was rosy?
How does the company’s operating performance (organic sales growth, margins, capital intensity) compare to its peers over time?
6. What fundamental developments would be responsible if this investment were to fail?
If I were 5 years in the future looking back on why the business did much worse than I had originally envisioned, what happened?
What are the biggest threats to the company?
What do the people who think this company is a bad investment say, and why? Are there short-seller reports that I can read? Negative write-ups on the Value Investor’s Club or Sumzero?
7. What evidence over time would confirm my thesis?
What data points do I want to see on a quarterly basis that make me more confident that my thesis is correct? How would I separate evidence that truly supports my thesis from positive results achieved for temporary/unsustainable reasons?
8. What evidence over time would disconfirm my thesis?
What data points do I want to see on a quarterly basis that make me believe my thesis is incorrect?
How do I separate temporary problems due to an economic cycle or other short/intermediate-term problems from evidence of structural problems?
How much negative information would it take for me to completely change my mind and exit the investment?
9. Does the valuation of the security afford a large margin of safety vs. my intrinsic value estimate?
What is a reasonable range of intrinsic values for the business? How sensitive is this range to key inputs?
What is the discount the current price affords to the base, or the most likely, estimate of intrinsic value?
How much downside is there currently to the worse case?
10. What is the opportunity cost of making this investment?
What other investments would I have to forego right now in order to invest in this company? How does their risk/reward profile compare to this one? Their expected return?
What possible future investment opportunities might I be foregoing if I make an investment in this company? Is the risk and return profile sufficiently attractive on an absolute basis in order to risk foregoing these future opportunities?
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About the author
Gary Mishuris, CFA is the Managing Partner and Chief Investment Officer of Silver Ring Value Partners, an investment firm that seeks to apply its intrinsic value approach to safely compound capital over the long-term. He also teaches the Value Investing Seminar at the F.W. Olin Graduate School of Business.
Note: An earlier version of this article was published on the Behavioral Value Investor website.
How much ownership do you want management to have in your perspective company? Ownership in the company and personal wealth % invested in the company. Buffett has 99% of his personal wealth in Berkshire.
Great piece Gary! I find that having a good fundamental checklist (such as the one in your post) is an extremely valuable asset for investors to keep themselves closer to making sound investment decisions within their portfolios. Still, it's a tool that's often overlooked by most. I guess the simplicity of the exercise makes the majority of the investing community dismiss the value brought by it...