I have been trying to come up with a checklist - Its not a standardised test where a score be generated by an algorithm to choose pass/fail but more of a reminder to view the scrip from different vantage points to ensure past mistakes are not repeated. Its very much a work in progress. Thoughts welcome. I might come across as being all over the place - its because these are the unorganised thoughts from my mental model.
Screening
- D/E – Under 1 definitely. Under 0.5 better. If it’s close to 1, is debt increasing/decreasing over last few years? How is the interest coverage ratio? EBIT > 5 times interest would be nice.
- High RoCE and RoE -> Above 20% must, higher the better. Make exception for commodity/asset plays.
- How is the Sales and Profit growth for recent 3 yrs? (For most) Recent few quarters? (For turnarounds) 5/10 yrs? (For mature businesses)
- Track OPM trajectory. Expanding margins with more scope for expansion is very, very nice. OPM above 40% (non-financial) with great market size – Ignore valuations.
- Capacity utilization? Ensure there is scope for expansion.
- Capex plans? Better to enter companies that have recently completed capex.
- 10 Yr balance sheet view -> Is it growing/shrinking? How/Why?
- Dilution – Lesser the better, none preferred
- Promoter holding – Higher the better. To quantify – Above 70 would be great, above 50 acceptable.
- Cash flow – Positive CFO? Positive 10 Yr FCF? Is the company generating lot of cash?
- Market cap – micro/small better
Business Quality
12. Does the business have repeat customers? How is the client concentration?
13. Recognizable Brand?
14. Does the business have longevity and simplicity?
15. Does product need frequent replacement (very, very good).
16. How is the Marginal utility of the product?
17. Commodities that are consumed irreversibly are good even if they are commodities. Shrimp or Basmati Rice are irreversibly converted while Steel and Aluminum can be recycled in the secondary market.
18. Avoid businesses that allow employees to put their hand in the till (eg. Banks). The very act of business that are in the business of money for making money has a bit of GEB (Godel, Escher, Bach – the book) in it.
19. High Working capital requirement?
20. How is the company managing Inventory?
21. Asset turnover – Historical, base rate for business and current state
22. Does the business depend on subsidies? (Sugar, Textiles etc.) – Avoid.
23. Sectoral headwinds/tailwinds
24. How is the Receivables, debtor days, Cash conversion cycle?
25. Market size, opportunity size, demand trajectory, nature – cyclical vs steady
Fraud-Detection
26. Are Products real? (Fiberweb, Vakrangee)
27. Creative Accounting detected? (Vakrangee)
28. Is this a pump and dump stock? Are we certain we are in the pump part of the cycle? What’s the exit strategy? (Eg. HSCL, Cerebra qualified when they were under 20). Load up and wait if there are classic signs of manipulated price-action.
29. Shareholding Pattern -> Look last 5-7 years to see who major holders are and how it has increased/decreased and compare with prices during the time to detect pump and dump. (Eg. Vakrangee)
30. Has entity recently demerged? Then it’s mostly expensive (Lasa, Sintex Plastics)
Valuation
31. Valuation by DCF if applicable and valuation by P/E – Ignore for high growth
32. Check EV/EBITDA, Earnings Yield, Dividend Yield
33. List and compare with competitors
34. Has price risen up recently? Are you still sure you want to buy right away?
35. Where and how did you hear about it? Was it Moneycontrol/Porinju type source? Was it another renowned value investor? Exercise caution if it’s any of the above.
36. Technicals – Trading well above 20 DMA? Wait. Look at Weekly/Monthly charts for better entry over time over support zones – 20/50 DMA or support trendlines.
37. Stoploss/Trailing Stop necessary? Which?
Holding Term
Long-term -> Low rate of change, Simple products with longevity, Large market size, underpenetrated
Short-term -> Swing trading, sector rotation, asset plays, turnaround in uncertain beaten down sector, commodity plays
Selling
1.Rate of growth + Perception of growth. If rate of growth slows down, perception of growth comes down exponentially and caution has to be exercised before P/E rerating happens. (eg. Sun pharma)
2. Consider endowment effect when considering the price you want to sell