Here is my ultimate checklist that I always follow before considering any business for investing.
Right Stock at Right Price for Right Time
Have you ever invested in a stock on someone's advice to make profit and then has to wait for months, maybe years, to recover capital? Not anymore.
The first checklist of my investment is the need for cash that I am deploying. If I cannot invest for at least few years will not consider investing.
Don’t invest in stocks if your time horizon is in months to a year or two. Better to be trading in stocks or if you are an investor consider mutual funds but not stocks for sure.
So if I have the funds here is my ultimate checklist that I always follow before considering any business for investing.
1. Pricing Power of Business?
Any business can flourish only if it has products that are either needed or desired.
If there is no substitute for a product a company is producing, the company goes into my investment list. This is the first check that I do for any company that I consider for investing and if I see a close substitute of product, I generally tend to avoid it.
This one check list helps me avoid many sectors as a whole like telecom, aviation which are big NO.
2. Regulated Profit
I generally tend to avoid companies where we have regulatory actions by the government on price or profits. This helps me to avoid sectors like oil, gas, alcohol and tobacco.
Oil and Gas as a sector are also a big NO for me because companies do not have the pricing power of the price of their products from customers. Price of gas or oil produced by a company is set by government. So companies need to be improving efficiency to remain profitable at the price point set by the government.
3. Simple Business Model
I don’t like to be investing in companies that hold other companies and is a group of companies. It can lack the clarity of the capital requirement for each of those business operations and how the profit is being accumulated on the balance sheet of each of those businesses.
It may be that I lack the needed skills to understand the complexity of such businesses but I prefer to invest in companies that I find simple to evaluate and understand.
4. Growth Outlook
Is the industry growing and how fast can the company grow with the industry?
There are many companies that have outgrown the sector and they are a complete avoidance for me as a core business. May consider them when they expand to different vertical or industry.
The criteria that I set is
- Can the current business grow at least for the next decade?
- Does the company has potential to grow faster than it’s peers?
Avoid if any one of the above two questions’ answer is a no.
5. Profitable Operations
I don’t invest in businesses that aren’t able to operate profitably.
There are many ratio to track this, but I prefer EBIT (earnings before interest, tax) which should always be positive and can never be in negative for any company.
Negative EBIT on a consistent basis means they cannot operate efficiently so there is no hope whatsoever.
Companies that plan to become profitable in the future for me are easily an avoid. Invest once they are profitable and not now. Listed companies cannot be and should not be a startup but a complete profitable business.
6. Research and Innovation
How often the company is coming up with new and innovative products for its customer?
Is the company spending enough on research (marketing research or product research) and development to come up with new and exciting products for its customers on a more consistent basis?
Companies in the 21st century can’t prosper without research and development.
7. The Debt Factor
I have seen multi national companies become penny stocks and go bankrupt with a burden of debt.
I generally tend to avoid companies that has debt to equity ratio of more than one but an exception that I do is if the company is profitable despite high debt for an elongated period of time and is reducing the debt every year, I am fine investing in the company but with a very keen eye on its debt than anything else.
8. Operational Efficiency
How is ROCE or return on cash employed and RONW or return on net worth?
If the company has a very good return on cash employed and if they have high debt, I do consider it because they are working to reduce debt with operational efficiency to grow profitability in business.
A growing net worth is a challenge for the management to cumulatively earn better return on net worth. An increase in return on net worth over an elongated period of time determines the efficiency of the management.
9. Value in Price
The last but the most important factor to consider is the price at which it is available currently.
Does the business provide a significant value at the current price? If it does not, sit tight with cash for it to become cheaper and be available at a discount.
Over to you
What points do you consider when investing in a stock? Share them in comments below.