INVESTMENT PRINCIPLES & CHECKLISTS
• Good checklists are precise, efficient, easy to use even under difficult conditions, do not try to spell out
everything, and provide reminders of only the most critical and important steps; the power of checklists
is limited
o Bad checklists are vague, imprecise, too long, hard to use, impractical, and try to spell out every
single step
• Do-confirm checklist: perform jobs/tasks from memory and experience, but then stop, run the checklist
and confirm that everything was done correctly
• Read-do checklist: carry out tasks as they are checked off – more like a recipe
PROCESS
Focus on original source documents, working from in to out
• SEC fillings
o Read 10-Qs, 10-Ks, proxies and other filings in reverse chronological order
• Press releases and earnings calls/transcripts
• Other public information
o Court documents, real estate records, etc.
• Industry publications
• Third-party analysts
o Sell-side research only as a consensus-checking exercise
• Research the company’s competitors with the same process
o Research and speak to competitors, (former) employees, and people in the supply chain
• Estimate valuation before looking at market valuation
o Valuation – What would a rational, long-term, private buyer would pay in cash today for the
entire business?
â–ª Asset value
â–ª Earning power
• if EP >NAV, then franchise value
â–ª Growth value
• Requirements
o Large, well understood margin of safety
o Reinvestment opportunities for capital in the business
o Quality, ownership stake, and shareholder-orientation of management
o Ability to bear pain, both the company’s and my own
Munger’s “Four Filters”
• Understand the business
• Sustainable competitive advantages (aka, favorable long-term economics)
• Able and trustworthy management
• Price that affords a margin of safety (aka, a sensible purchase price)
Pause Points in the Process
âž” Always think in terms of Process + Patience
âž” How big is the margin of safety? How reliable is it? Why?
Pause #1
â–ª Are the business and its securities able to be understood and valued?
o Avoid loss by
Pause #2
â–ª Go back through all financial disclosure looking for information and context missed the first time
o Patterns/trends
â–ª Level and quality of disclosure
o Specifics (see next section)
Pause #3 – final checks
â–ª What can go wrong? Do a “pre-mortem”
â–ª How can capital be permanently impaired by this investment?
â–ª What are the probabilities? Are the odds heavily in my favor?
â–ª What is the time horizon?
â–ª How attractive is the opportunity? Namely, how attractive is compared to my best current
investment?
Munger’s “two-track analysis”
• First, lay out and deeply understand the rational factors that govern the situation under consideration
• Second, focus attention on psychological missteps – either your own or those of other investors
“The Most Important Things”
o Margin of safety
o Balance sheet
â–ª Capital structure and liquidity
â–ª Asset value
o Cash flow
â–ª Realistic and reliable owner’s earnings (especially a few years from now)
â–ª Can cash be reinvested at attractive compound rates?
â–ª How has management allocated capital?
Initial ideas to consider in the process
1. Separate the business from the balance sheet
• How is the business capitalized? Is it sustainable? Is it relatively efficient/optimal?
• What are the assets worth? Liquidation value and reproduction value
• Are there any “hidden” assets or liabilities?
o Excess cash, real estate, LIFO, etc.
o Pension, legal liability, litigation, operational malfeasance, funding/liquidity puts, etc.
2. Separate the business from the cash flows