Avoid Losses With This 44 Point Investment Checklist by Tim du Toit, Quant Investing
Some time ago I came across an interesting article in The New Yorker magazine called The Checklist written by Atul Gawande the multi-talented surgeon who is also the author of an interesting book I read called Complications: A Surgeon’s Notes on an imperfect Science.
A checklist is an insult
The article is quite long but it boils down to that in spite of strong evidence to the contrary, highly trained people think it’s below them to use checklists as they already know what to do and working through a checklist is an insult to them.
For much of the past decade, Crispin Odey has been waiting for inflation to rear its ugly head. The fund manager has been positioned to take advantage of rising prices in his flagship hedge fund, the Odey European Fund, and has been trying to warn his investors about the risks of inflation through his annual Read More
From the article:
“But this time he found few takers.
There were various reasons. Some physicians were offended by the suggestion that they needed check-lists. Others had legitimate doubts about Pronovost’s evidence.”
This was in spite of these findings:
“Within the first three months of the project (the introduction of a checklist), the infection rate in Michigan’s I.C.U.s decreased by sixty-six per cent.
The typical I.C.U.—including the ones at Sinai-Grace Hospital—cut its quarterly infection rate to zero.
Michigan’s infection rates fell so low that its average I.C.U. outperformed ninety per cent of I.C.U.s nationwide.
In the Keystone Initiative’s first eighteen months, the hospitals saved an estimated hundred and seventy-five million dollars in costs and more than fifteen hundred lives.
The successes have been sustained for almost four years, all because of a stupid little check-list”
All this from a check-list with steps as simple as “wash hands with soap”
Why even a simple checklist can help your returns
Checklists work best in a complex environment where the performing of certain steps is critical. In flying it is taken as a given that highly trained pilots work through checklist for virtually every eventuality.
An aeroplane is a complex entity, so is medical procedures and I want to argue so is investing.
Why use a checklist when investing?
When evaluating a company there are so many factors that are beyond your control.
You however, through research, know what increases the probability of you making profitable investment decisions.
What is thus important is that you focus on what you can control in your research and analysis. And that is where an investment checklist can help you.
A checklist is especially helpful when you use a screener because it decreases the time you need to find out if an idea on the screener it worth analysing further.
Your investment checklist
- Can I in one sentence say exactly what the company does? (Thanks Cristina)
- Is operating cash flow higher than earnings per share?
- Is Free Cash Flow/Share higher than dividends paid?
- Debt to equity below 35%?
- Debt less than book value?
- Long Term debt less than 2 times working capital?
- Is the debt to EBITDA ratio less than 5? (Thanks Guy)
- What are the debt covenants?
- When is the debt due?
- Are Pre-tax margins higher than 15%?
- Is the Free Cash Flow Margin higher than 10%?
- Is the current asset ratio greater than 1.5?
- Is the quick ratio greater than 1?
- Is there growth in Earnings per Share?
- Is management shareholding > 10%?
- Is the Altman Z score > 3?
- Does the company have a Piotroski F-Score of more than 7?
- Is there substantial dilution?
- What is the Flow ratio (Good < 1.25, Bad > 3)
- What are management’s incentives?
- Are management’s salaries too high?
- What is the bargaining power of suppliers?
- Is there heavy insider buying?
- Is there heavy insider selling?
- Any net share buybacks?
- Is it a low risk business?
- Is there high uncertainty?
- Is it in my circle of competence?
- Is it a good business?
- Do I like the management? (Operators, capital allocators, integrity)
- Is the stock screaming cheap?
- How capital intensive is the business?
- Does management have the ability to naturally re-invest in the business at a high return?
- Is the company highly profitable?
- Has it got a high return on capital?
- Has the business got an enormous moat?
- Is there room for future growth?
- Does the business have strong cash flow?
- What has management done with the cash?
- Where has the Free Cash Flow been invested?
- Are there any odd (outlier) financial data over the past five years?
- Is the company in an industry that experienced a bubble over the last 5 years?
- Does the cash belong to the company (important if you use enterprise value)?
- Is EBIT / Assets > 20%
25 years in the making
I have put this investment checklist together over a period of more than 25 years and often make changes as I read about something interesting or learn something from experience.
I also do not have a formula that if a company fails X amount of points on the checklist I do not consider it.
The checklist however gives me an indication of what problem areas the company has and where I have to do further analysis.
Feel free to use the above points in your analysis process and let me know if you have any additional points you have in your investment checklist clicking here.
Your checklist analyst
Tim du Toit