Value Investing

Investment Checklist

Recently Mohnish Pabrai started to share on a checklist that he has developed with 3 interns. They identified mistakes by great investors that resulted in a permanent loss of capital and analyzed why the mistakes occurred, including for commentary by the fund managers on these mistakes. I had developed a long checklist some time ago, covering Business, Valuation, and Management areas. Thought I’d just note down some of Mohnish’s checklist items that he talked about, in addition to some items from this FT article here and here.

  1. Business (Qualitative)
    1. Are there any big picture items (e.g. oil price, interest rates) that would negatively impact the investment thesis? Longleaf invested in GM thinking that they will do well in the truck market but failed to predict that gas prices would rise to $3, Buffett bought into Conoco Phillips in 2008 to bet on higher energy prices when oil was $100 a barrel (i.e. when oil stocks were expensive) and lost money when oil prices dropped.
    2. Is there a win/win dynamic in the business ecosystem? e.g. Pabrai made a bad investment in Pinnacle Airlines because it would only rake in money as the carriers lose a lot of money. He lost 72% with Compucredit where when the company does well it is because they are preying on lower income customers.
    3. Does the company have union issues? Pabrai lost 60% on Sears and highlighted that 324,000 employees are between the investors and the assets.
    4. Is this a good to great business? Buffett made the mistake of buying Berkshire Hathaway at a cheap price with bad economics, and struggled while bleeding.
    5. Is there a solid moat? e.g. Berkshire Mills
    6. Could the moat be shrinking / evaporating? e.g. Buffett bought Dexter Shoes thinking there was a durable competitive advantage, US Air’s moat evaporated when the market became unregulated and US Air still had the legacy cost structure.
    7. Have you read the statement of key management risks?
    8. Have you created a list of risks that will cause the investment or business to fail? e.g. for a bank it can be highly leveraged assets to equity, subject to bank run, made bad lending decisions, hurt by high unemployment and recession.
  2. Business (Quantitative)
    1. How leveraged is the company, really? Pabrai shared he has 10 questions on leverage, and he had repeatedly erred in determining how leveraged companies were.
    2. Have you gone through the key financial statements for the last 10 years? Have you checked for possible patterns in items across the statements?
    3. Have you read the footnotes in the cash flow statement?
    4. Have you checked whether cash flow and costs match the reported revenue growth?
    5. Are there large amounts of risky derivatives held by the company? e.g. Gen Re when bought by Buffett
  3. Management
    1. Does management have a large stake in the company?
  4. Valuation
    1. Are the revenues and cash flows of the business sustainable or overstated / understated due to boom or bust conditions? e.g. Wesco bought Cort Furniture in Feb 2000 but lost money because its revenues were unsustainably high due to the dot-com boom.
    2. Are there temporary tailwinds enhancing FCF? How sure are you that it is not temporary? e.g. Buffett bought Conoco Phillips at a high valuation when oil prices were temporarily high.
    3. How reliable are historical figures, e.g. sales and FCF growth, in terms of projecting them forwards?
    4. Does it have upside earnings potential? i.e. what’s the moat and is it contributing to upside earnings potential?
    5. Does it have downside protection? i.e. margin of safety
  5. Psychology
    1. Am I suffering have any personal biases?
    2. Are you suffering from commitment bias in adding to a position?
  6. Buying
    1. Are you building an inappropriately large position size simply due to the lower price, rather than sticking to your initial game plan of limiting your bet? Are you making small loser into a bigger loser?
    2. Are you simply reacting immediately to a sharp decline in an existing holding on negative news? Have you taken the time to fully review the new information to ensure that increasing the position is justified by the new development?
    3. How does this new investment correlate with existing positions? Are you diversified enough?
  7. Others
  1. Have you gone through the key financial statements for the last 10 years? Have you checked for possible patterns in items across the statements?
  2. Have you read the footnotes in the cash flow statement?


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