Investment Checklist

Quality (50%)

Objective: To find the highest quality companies with both quantitative and qualitative characteristics, that are near indestructible, perform well through the cycle, and expand market share in a potentially oligopolistic market.

• New entry difficulty – S&P

1. Does the sector have an oligopolistic market structure with few and limited players? Are there regulatory barriers that impact new entry?
2. Is it difficult for customers to switch or try products from new players? (health concerns, regulatory, security risks, mission critical, old habits)
3. Is funding from VC and PE particularly high in the sector for new players? How likely is it for young entrepreneurial people to build a competing company?
4. What is required to be successful in this sector? How many players can potentially earn abnormal profits (EBIT margin >15%)

• Nature of demand – Microsoft 

5. Is the demand for their products daily (staples), weekly (payments), monthly (software), annual (financial data research), biannual (Phones), five years (car), ten years (Sofa) or more? Is it becoming more or less frequent as innovation occurs?
6. Are customers locked into recurring contracts and to what degree is it recurring? Is it easy to switch out? How mission-critical is the service to the customers overall needs (i.e. is this marketing service or a service important to product curation or safety)
7. How easily can customers do without their product? Can their service be eliminated, and customers remain able to function? (Sell more directly to the customer/client?)
8. If the economy fell into recession, how likely (scale of 1-10) would customers rationalise their products? (lower hours demanded, more discount products, less consumption volume, cuts from customers’ annual budgets)
9. Does demand travel across countries? How many consumers/businesses worldwide use a form of their product?

• Balance sheet strength – Kweichow Moutai

10. Leverage: How leveraged is the company? Are interest expenses less than 5% of total EBIT? Has the company ever breached this number? Is debt/principal payments due in 5 years <50% of total cash position?
11. Does the company have excessive goodwill and intangibles? How much asset write-down has occurred in the last 10-15 years? Research which acquisitions made up the goodwill and how they’ve financially performed since the acquisition
12. Is there excessive additional capital paid into equity to fund business objectives? Is there excessive share issuing, debt issuing or share-based compensation
13. How quickly will inventory be eroded? Is there a fashion risk? Perishable goods risk?

• Profit margin – Hermès

14. Unit economics: On a unit level, do they earn at least a 20% profit margin (per bottle, store, client)
15. Does the company earn an EBIT margin of at least 15%? Does the company earn a net income margin of at least 10%?
16. Lowest cost: Are they the lowest cost producer? How is their cost structure relative to the lowest-cost producer in the industry? Always know who the lowest cost producer is.
17. How does their profit margin change during a cyclical downturn? (Insights from the nature of demand) Reference 2007/08 and pandemic
18. Cost management: Is their S&G&A/Revenue stable over the cycle? Reference 2007/08 and pandemic

• Market & its positioning – L’Oréal 

19. Who is the market leader? Are they growing relative to the market leader? What is the rationale behind their growth relative to number 1? Always know who is number 1 in product quality and market share.
20. What advantages and disadvantages does being number 1 have? (cost advantages? Network effects? Higher switching costs)
21. Is the market a national market or global? Are there limits to going cross-border? What is the threat from the US or Chinese players? We prefer markets where there’s minimal threat from Chinese or US competition.
22. Do they create the industry content, aggregate or distribute it?
23. How likely are the most innovative companies to disrupt the dynamics of this market (reliant on advertising revenue)? Provide services to Big Tech/Pharma?
24. What is the overall addressable market? What problem is it solving, and which other markets are solving this problem? Check if a more innovative market could solve this issue
25. Are there regulatory barriers that might impact their ability to expand into a new country?
26. Volume growth: To what extent is this business reliant on volume growth? Do they need more customers to grow volumes or sell more to each customer via multiple products?

• Pricing power – Ferrari

27. To what extent does pricing power drive revenue growth? Is the business very reliant on raising prices?
28. How many times have prices been raised in the last 10, 15, and 20 years? What was the consumer response when prices were last raised? Was there pushback or noise from customers? Do customers feel happier when prices are increased? Does it have Veblen features?
29. Rivals with cheaper products have more satisfied customers?
30. Can the company justify price raises with a better product or a higher quality product (mainly due to more innovation) to support price increases

• Value chain – Apple

31. To what extent does the company control its ecosystem and fate? How many solutions does its core product satisfy for its customers?
32. Can suppliers raise prices? How much control do they have over suppliers? Are they reliant on one supplier or diversified?
33. Who are their stakeholders? Are there stakeholders outside shareholders who have a voice in management decisions? (labour unions, core fans, government)

• Value created for society – TSMC

34. To what extent does their service or product create value for customers? (make them happier, healthier, more loved, reduce time or effort for tasks?
35. Are there externalities to customers or society? Excessive emissions, health hazards?
36. Has the company been involved in lawsuits and scandals with the government, environmentalists, or customers? (Remember to dig into what happened and the solutions.)
37. Will the world be worse off without their product? How easy can a rival match the value created for society?

• Culture – L’Oréal

38. How long does their CEO and top management stay in their positions? How many leaders have held positions for more than 10 years? How many key staff have left for peers in recent years?
39. Are there new entrants happy to stay and speak highly of their bosses and culture? (check Glassdoor and other online reviews, interview staff)
40. Compensation: What drives bonuses and full compensation over the short and long term? (Search corporate governance or ESG reports)
41. How much does pay drive employees? Are there non-financial benefits/objectives for being in this industry? (If a peer offered more money, would employees leave easily?

• Test of time – L’Oréal

42. Have they survived war, pandemic, recession and other economic shocks? How did they perform during these periods?
43. Have they survived bad management? Does the founder still control the business? 

Growth (25%)

Objective: To find a growing business that can defend its sales against peers, customers’ volatile habits and recurringness. The target is at least 12% earnings growth with less than an 85% chance of losing existing sales.

Defensive Growth

44. Nature of Demand: How many products does the customer require each year? Is it recurring?
45. What is the churn rate? How many customers who exit return in the near term? Why do they leave? How easy is it for customers to switch to the rival product?

Attacking Growth

46. Pricing power: Can they easily raise prices? If yes, how many times in a 5-year period and what percentage?
47. Volume power: How many new products/stores/services can be sold annually? What drives their volume power and how is it impacted through the cycle?
48. New products: How often do they launch new products? Do new products travel globally? What proportion of growth typically comes from new products
49. Acquisition power: Can they acquire businesses to fund growth? What is their track record over the last 10 years with acquisitions? Do they need to issue debt or equity to acquire peers? Is the market oligopolistic? If so, will regulation stop acquisitions?
50. To what degree are you confident this company will grow? Cut costs (1-10), raise prices (1-10), raise volume (1-10)
51. Is there operating leverage in the business model? What percentage of costs are fixed? (Make sure to find the industry average of fixed costs/revenue.)

Valuation (15%)

Objective: To find companies undervalued relative to their quality and growth. Typically, companies below <20x forward earnings. If the earnings multiples are above 20x, it is either near-indestructible and among the 100 highest quality companies, and there is a 90% chance of growing earnings >15% for the next 5 years. It might have a bloated cost structure due to spin-off, past management or recent investments, which accelerate earnings but not revenue growth.

52. To what degree can you accurately forecast earnings for the next 3-5 years? Is there sell-side analysis available? Are they beating earnings? Are they upgrading earnings estimates in the last 5-6 quarters?
53. What multiple is the business currently trading at if you depressed revenue and margins, assuming a recession? (Reflect on company and industry data from the 2007 financial crisis)
54. Using their normalised earnings margin? Does it trade below a 20x P/E ratio? What is the PEG ratio? 15% grower at 15-18 earnings, 20% grower at 20- 25x earnings, 25% grower at 25- 30x earnings – (this is only applicable for businesses that pass the quality test and the nature of demand)
55. What is their free cash flow multiple? Apply the same P/FCF rule.
56. EV/EBIT – Is the gap between EV/EBIT and P/E big? Is there excessive minority interests or debt?
57. Are they consistent dividend payers or consistently buying back shares? Assess the policy for buybacks.

Sentiment (10%)

Objective:To purchase the company during a period of negative sentiment, either at the country, sector or company-specific level. Near multiple lows on a 3,5- or 7-year basis.

58. Are you acquiring near EV/EBIT or P/E 5-year or 7-year low? (Remember to adjust the multiple for cycles)
59. When you search the company or industry, do you see lots of negative news? Both financial downturn news and how much of the negative sentiment is due to issues that will affect fundamentals? (Preference for companies that don’t have fundamental issue fears)
60. Are there recent insider buys or sales? Has new “smart money” been attracted to this company in new share purchases? Are they buying back shares?