Valuation Checklist Bias
What is your bias regarding the company and industry?
How do you feel about the company? (i.e., what are the first thoughts that cross your mind?)
Before starting the valuation, do you think this company is undervalued? If so, why?
How are you managing your bias? (which typically is optimistic)
Why are you considering buying this stock?
Is someone you admire buying the stock? What are the biases that could impair their rational thinking?
Is there any non-rational reason that is embedded in your thinking?
How are you adequately managing through your biases?
Are you open to considering an opposite view about the company?
Valuation Checklist Circle of competence
Valuation Checklist: The Industry/moat
Do you understand the industry? Why?
What is the consensus view of the industry?
What is the size of the industry?
Is the industry necessary for society?
Is the industry good for society?
What is the growth rate of the industry?
What is the cycle of product change?
Do competitors behave rationally in this industry?
What is the distribution of market share in the industry? Has market share been stable for companies in the industry? What is the market share of the company in the sector?
What is the nature of the industry?
What is the current and prospective regulatory climate?
What is the supply/demand dynamic of the industry?
Is the industry capital intensive? If so, do industry participants have differentiated goods?
Do industry prices reflect direct operating costs rather than capital employed? (excess production capacity?)
Is there excess production capacity in the industry? If so, is this a temporary condition? If so, why?
Can companies replicate their model as they go from geography to geography? Do the companies need local economy of scale?
Do you have a cultural/business understanding of the market the company is in?
Why will the industry sector face tailwinds in the future?
Over the next 10 years, will this market likely materially expand or shrink?
Could the industry be impacted by major technological change?
What unique insight do you have about the industry?
Valuation Checklist: The company/moat
What is company’s position in the industry?
How does the business make money?
What is the company’s business model?
How capital intensive is the business? What is the sales/capital ratio?
Can the business be easily duplicated?
What are they key value drivers? What could change with these drivers?
Does the company have pricing power?
How will do the business do if:
a) inflation goes up?
b) under a deflationary environment?
Is this a compounding business? (What is the ROIC vs. cost of capital over the last 10 years for this business?)
Over a business cycle, do earnings that are retained by the business earn an incremental ROIC that is substantially above the cost of capital?
What is the year-over-year trend in incremental ROIC? Has is been deteriorating as the firm grows?
How much longer can the firm keep growing with ROIC above the cost of capital?
Could regulatory/legal issues materially impact the economics of the business?
What is the state of labor, supplier and customer relations?
What is the current stage of life of the company? Is the company’s reinvestment behavior consistent with its stage of life?
Valuation Checklist: Does the company have
a) an attractive capital structure?
b) favorable long-term supply dynamics?
c) favorable long-term demand dynamics?
What are the company competitive strengths and vulnerabilities?
Does the company have pricing power? What is the nature of the pricing power?
Do you understand the company’s competitive advantage in every respect – products, markets, trademarks, employees, distribution channels, societal trends, and so on – and the durability of that advantage?
What is the nature of the company moat? (i.e. local economies of scale, customer captivity, patents/technology, brand)
What is the nature of the durability of the moat?
How can the company moat be eroded?
- Foreign competition
- Technology changes
- Country specific dynamics
What are potential impacts of changes in technology?
Can a competitor leverage the internet/technology and compete with a lighter business model?
Is the company the low cost producer in its sector? If so, how will the company be able to maintain its low cost status?
What is the potential for scalability?
What is the state of labor, supplier and customer relations?
Do you understand the country’s regulatory/legal framework (if you are investing outside your home market)?
Valuation Checklist: Management
How long has current management been in place? What is their long term record? If short term, what is their previous record?
Did you listen to the company’s conference calls and read the 10K’s through an entire business cycle?
When bad news happens, is management frank, or do they dress up the information?
Is the information presented in the financial statements and conference calls shown in a promotional or aggressive way?
Is financial information presented in a clear and concise way?
Is management good at capital allocation? (provide examples)
- have they added value with acquisitions?
- have they repurchased stock when the stock was undervalued?
- When does management increase share buybacks? (hopefully when company is undervalued)
- have they used free cash flow in the best interest of the shareholders?
- have they diluted shareholder value through excessive use of options/grants?
Are management’s interests aligned with shareholders?
- do they own a material amount of stock?
- have they shown shareholder-friendly behavior?
- Is there heavy insider buying?
- What are management incentives?
How do management salaries compare versus their competitors?
Valuation Checklist: Quality of Earnings
Over a business cycle, is there significant discrepancy between the income statement and the statement of cash flows? If so, why?
Any unusual trends in revenue recognition or expenses?
Are there significant restructuring charges? If so, why?
Are one time items, one time? If not, did you normalize?
What is the trend of revenue and accounts receivable growth?
What is the trend of inventory growth versus sales growth?
Is there negative inventory divergence?
Are interest charges growing rapidly as a % of income? If so, why?
What is the trend and impact of valuation allowances on net income? Why?
What is the trend in bad debt reserves? If there is an increase? Why?
Are there changes in LIFO/FIFO and depreciation methods ? If so, what is the impact on earnings?
Reviewing the cash flow statement, are there any major discrepancies between net income and working capital items?
Review trends for inventory. Is inventory growing quicker than net income, are they expecting growth (or are items not selling)?
Are there big differences between GAAP taxes and income taxes?
What is the trend for deferred tax assets? If deferred tax assets have gone down, and net income up, explain why.
Are company operating metrics (i.e. revenue growth, operating margin, sales to capital ratio, DSO, capital structure, ROIC) consistent with industry averages? If not,