In Football, the two minute drill is a game situation that occurs often in the last 2 minutes of the half or the end of game. The offense tries to move the ball quickly to score before the end of regulation. This offense often goes into a no-huddle spread offense where the QB calls plays as the team lines up.
"Sports & Stocks" by Bud Labitan
In Value Investing, my version of a two minute drill is based on finding HQB, a High Quality Business. It is biased towards the core ideas of Charlie Munger. Munger likes to own a highly profitable business that does not require continual reinvestment. In his 1995 speech, "A Lesson on Elementary, Worldly Wisdom As It Relates to Investment Management & Business," Munger said: "We've really made the money out of high-quality businesses. In some cases, we bought the whole business. And in some cases, we just bought a big block of stock. But when you analyze what happened, the big money's been made in the high quality businesses. And most of the other people who've made a lot of money have done so in high quality businesses.”
Here is my version of a two minute drill for finding a High Quality Business. When scanning the financial statements of a business on Morningstar.com’s website, I ask myself these questions:
1. Does the business produce positive FCF, Free Cash Flow?
2. Does it have a NPM, Net Profit Margin > 10% (higher is better)
3. Does it have a D/E, Debt-to-Equity ratio < 2/1 As my nephew Christian says: “Companies with more money have a higher chance of surviving from debt.” The D/E ratio one can be tricky because young companies are financed mainly by equity. On the other end of quality, great enduring and profitable businesses like Coca-Cola can handle more debt, especially in low interest rate periods. So, be careful in thinking about D/E !
4. Does it produces a ROE, Return-on-Equity >10% (higher is better)
If it passes these four steps, you have completed my two minute drill. And, you have filtered out a lot of mediocre businesses.
Now that you have credible investment prospects, start thinking about the four filtering steps of Buffett and Munger:
1. Understandable first-class businesses.
2. Enduring competitive advantages.
3. Able Trustworthy First-class managements.
4. Bargain price relative to intrinsic value estimate.
You may wonder why it is important to do this deeper dive into the qualitative filtering steps. These next steps of “slow thinking” or “second level thinking” will prevent you from making the mistake of buying a “Value Trap.” A Value Trap is a business prospect that may look good by the numbers, but, it may have deteriorating advantages or untrustworthy managers.
In Baseball, a team could be tricked into trading for, or, buying the contract of a pitcher with good stats, but in reality, the pitcher may have a deteriorating arm that could cause him to retire early.
The best valuations are the ones where you have applied both quantitative and qualitative evaluations.
As Louis Pasteur said, “Chance favors the prepared mind.”