Guru Checklists

(Posting on behalf of a senior investor)

Bruce Berkowitzas checklist for investing

Bruce Berkowitz is an investing legend. A former star at Lehmanas, he setup his own fund, Fairholme Capital Management, in 1997 and went on to win accolades and riches galore, among them, Fund Manager of the Decade.

For all that kudos, Berkowitzas investing style is simple. At a recent conference he outlined a checklist for investing, a simple filter through which he runs potential investments.

  1. _Can you kill it?_Cyclicality and spurts of growth can be mistaken for quality. He advocates a test to determine what it will take to kill a business. This exercise illuminates true competitive advantage; McDonalds wonat die because someone makes a better burger. Location, advertising and brand are what make it mighty. Similarly, Google, today a titan, is vulnerable to a better search algorithm.
  2. _Is the company essential?_No matter how profitable a business is today, if its success depends on subsidies, loopholes or tax treatment, itas vulnerable. Businesses likeMcMillian Shakespearetake note.
  3. _What can the company make?_Berkowitz tries to estimate the potential of a business. This can be hard; who would have expected Appleas iPad to turn into the raging success it is? But methodically going through this process can eliminate false hopes and uncover new potential.
  4. _Is management honest?_Good management will not always guarantee a good investment but bad management will always end in disaster. This is more a test of managementas honesty than quality. The point is to avoid dishonest bosses.
  5. Catalysts?Cheapness can be justified in many ways. Berkowitz makes sure he understands why the market has discounted a stock, and then tries to imagine how that problem may be solved. Is an asset sale, a cyclical turnaround or a breakup likely? The important point here is that problems arenat simply to be avoided a they are opportunities.

Following this checklist may not make you a billionaire, but it is a helpful starting point for improving your skills.

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A Value Investor’s Checklist Before Buying Stocks

Yesterday I came across an excellent blog, - A Resource for Intelligent Investors Link: . This particular post is an analysis of Union Pacific Corporation (UPC Link: ) as an investment. Other railroads have been analyzed in ModernGrahamas recent posts. I am not particularly interested in railroads, but ModernGrahamas classical value investment strategy and their methodology are attractive.

The analysis boils down to asking a series of questions and studying the answers. There are three categories of questions: Business and Management Review, Financial and Value Review - Defensive (stringent criteria for cautious investors), and Financial and Value Review - Enterprising (for investors who are willing to assume more risk).

You may not agree with all of the questions (personally, I use a lower threshold for market capitalization, and I have an expectation of dividend growth), but if you donat know the answers, you definitely need to do more research before investing. You wonat find many companies that meet all the criteria in this elevated market, but if you do, you have probably found a good investment. And if do you choose to invest in a company that doesnat meet the criteria, at least you will know what you are getting into up front.

I have separated out and clarified the questions for further study:

Business and Management Review

  1. Is the business simple and understandable?
  2. Does the business have a consistent operating history?
  3. Does the business have favorable long term prospects?
  4. Is management rational?
  5. Is management candid with its shareholders?
  6. Does management act in the best interest of shareholders?

Financial and Value Review:

Defensive Investors:

  1. Is the size of firm over 2 billion market capitalization?
  2. Strong financial condition - is the current ratio (current assets/current liabilities) greater than 2.0?
  3. Earnings stability - has there been positive net income for the prior ten years?
  4. Dividend record - have there been consistent dividend payments over the past ten years?
  5. Price to earnings analysis - is the current P/E ratio below 20?
  6. Price to assets analysis - is the P/B ratio below 2.5?

Enterprising Investors:

  1. Strong financial condition - is the current ratio (current assets/current liabilities) above 1.5?
  2. Earnings stability - has there been positive net income for the past five years?
  3. Dividend record - does the company currently pay a dividend?
  4. Earnings growth - are earnings for the company greater than five years ago?
1 Like - the source article from above, thought it will be instructive for us to see how a checklist is applied diligently.

Company Review: Union Pacific Corporation (UNP)

Company Profile:Union Pacific Corporation (obtained via Google Finance)

Union Pacific Corporation (UNP) operates primarily as a rail transportation provider through Union Pacific Railroad Company (UPRR or the Railroad), its principal operating company. UPRR is a Class I railroad that operates in the United States. UPC has approximately 32,426 route miles, linking Pacific Coast and Gulf Coast ports with the Midwest and eastern United States gateways and providing several north/south corridors to key Mexican gateways. UPC serves the western two-thirds of the United States and maintains coordinated schedules with other rail carriers for the handling of freight to and from the Atlantic Coast, the Pacific Coast, the Southeast, the Southwest, Canada and Mexico. Export and import traffic is moved through Gulf Coast and Pacific Coast ports, and across the Mexican and Canadian borders. The Railroad’s commodity revenue consisted of six commodity groups: agricultural, automotive, chemicals, energy, industrial products and intermodal.

Business and Management Review**
**_1) Is the business simple and understandable?
_Union Pacific is in the transportation business.Transportation is a simple and understandable business.The companyas main focus is rail transit and they operate 8,400 locomotives on over 32,400 route miles in 23 states.

_2) Does the business have a consistent operating history?
_In 1848, the Galena and Chicago Union Railroad began operating.Later, this company would eventually become the Union Pacific Railroad after some mergers.In 1862, President Lincoln signed into law the Pacific Railroad Act a designating the Union Pacific as one of the two railroads responsible to build the first transcontinental railroad (which was completed in 1869).Over the years, Union Pacific has dealt with bankruptcy, countless mergers, recessions, depressions, and 33 different U.S. Presidential Administrations.Throughout its history, it has been a railroad operator without question.
From a financial standpoint, UPC has paid a dividend for over 10 years, and has had only one year with a net loss in the last 10 years.

_3) Does the business have favorable long term prospects?
_The rail industry will continue to be around until we no longer need to move materials too heavy to fly.In other words, the rail industry should be around a very, very long time.Union Pacific should be able to survive any stress that may come its way as it has proven through its survival of multiple issues throughout its history.The company maintains a strong advantage in its well-recognized brand image and the sheer size of the company.

_4) Is management rational?
_Management appears to be rational in its efforts.Having reviewed the company, we believe in managementas strive toward operation efficiency, safety, better fuel efficient locomotives and other aspects of the companyas long term plan.We have found no reason to doubt managementas rationality.

_5) Is management candid with its shareholders?
_In the companyas annual reports, the letter to shareholders is one of the more informative letters we have seen.Details of the corporationas strategies, issues that came up, and some forward looking statements are included.In addition, the company has an impressiveinvestor relationssite.While youare there, check out the history section for the general public.It has some very interesting reading!

_6) Does management resist the institutional imperative?
_We believe the management has always resisted the institutional imperative.Unfortunately (or maybe fortunately, as it led to some of the laws that govern businesses today and support investors) the history of Union Pacific in the nineteenth century includes tales of bribery and fraud a but we donat need to worry about todayas management.

Financial and Value Review

__1) Size of firm
_At a market cap of over $24 billion, the company passes the requirement of $2 billion.

_2) Strong financial condition
_The companyas current ratio is not suitable for the defensive investor.

_3) Earnings stability
_The company had a net loss in 1998 so it does not pass this requirement either.

_4) Dividend record
_Union Pacific has paid a dividend for over 10 years.

_5) Earnings growth
_Earnings per share have not grown suitably in the last 10 years for the defensive investor.

_6) Price to earnings analysis
_With a PE ratio (usingour Methods) of 24.94, the requirement of under 20 is not met.

_7) Price to assets analysis
_Since the PB ratio is 1.67, it makes up for the high PE ratio, and the company passes the final 2 tests.

_Having passed only 4 of the required 8 tests for the defensive investor following Benjamin Grahamas value investing strategy, we do not believe Union Pacific is suitable for the defensive investor.

__1) Strong financial condition
_With a poor current ratio, the company fails this test.

_2) Earnings stability
_The company has achieved a positive net income for over 5 years.It passes the test.

_3) Dividend record
_The company currently pays a dividend.Pass.

_4) Earnings growth
_Earnings are greater today than they were 5 years ago.

_We find the company to be suitable for the enterprising investor.

__Our valuation model finds a fair value to be around $95.

__Since the company is currently trading at $90, we feel it is fairly valued but may be a suitable investment for the enterprising investor.

Neither of us held a position in Union Pacific Corporation at the time of publication. Also, please read ourdisclaimerandOur Methods.

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A Warren Buffet styled aInvestment checklista Is it covered?

Business tenets

1). Is the business understandable?

2). Do you know how the money is made?

3). Does the business have a consistent operating history?

4). Does the company have favourable long term prospects?

5). Is there a big moat around the business (a high thresholdof entry) ?

6). Is it a business that even a dummy could make money in?

7). Can current operations be maintained without too muchneeding to be spent?

8). Is the company free to adjust prices to inflation?

9). Have you read the annual reports of the main competitors?

Management tenets

10.Has the management demonstrated a high degree ofintegrity (honesty)?

11.Has the management demonstrated a high degree ofintelligence?

12.Has the management demonstrated a high degree ofenergy?

13.Is management rational?

14.Is management candid with shareholders (evidence in thepast of open disclosure to the shareholders when therehave been problems)?

15.Has management resisted the temptation to grow quicklyby merger?

16.Has management the strength not to follow theinstitutional imperatives ( avoid following current businessand sector fads)?

17.Has the business been free of a major merger in the last 3years ( many merger failures come out of the woodworkwithin this period) ?

18.Are stock options tied to SMT performance ratherorganisationas performance (if your team wins you do notpay a .35 hitter the same as a .15 hitter.)

19.Are stock options treated as an expense?

Financial tenets

20.Is the return on equity adequate?

21.Is the company conservatively financed?

22.Has the company had a track record of earnings growth inmost years above the stock market average?

23.Are the profit margins attractive (better than industry)?

24.Has the company created at least one dollar of marketvalue for every dollar of earnings retained?

Value tenets

25.Is the value of discounted earnings greater than thecurrent market value?

26.Have you discounted at a rate equal or greater than the 10

year bond rate (risk free rate) ?

27.Have cash flows been based on net income, plusdepreciation, depletion, and amortization, less capitalexpenditure and additional working capital requirements?

28.Has the company been temporarily punished for a specificrisk that is not a long term risk (the market tends to overpunish the share price)?


Philip Arthur Fisher (September 8, 1907 a March 11, 2004) was an American stock investor best known as the author of Common Stocks and Uncommon Profits, a guide to investing that has remained in print ever since it was first published in 1958.

Fischer specialized in innovative companies driven by research and development. He practiced long-term investing, and strove to buy great companies at reasonable prices.Motorola was one of his biggest bets, which he held till death.

Perhaps the best-known of Fisher’s followers is Warren Buffett who has said on some occasions that “he is 85% Graham and 15% Fisher”.

Fishers 15 Points

Fisher’s famous “Fifteen Points to Look for in a Common Stock” from “Common Stocks and Uncommon Profits” are a qualitative guide to finding well managed companies with growth prospects. According to Fisher, a company must qualify on most of these 15 points to be considered a worthwhile investment:

1). Does the company have products or services with sufficient market potential to make possible a sizable increase in sales for at least several years? A company seeking a sustained period of spectacular growth must have products that address large and expanding markets.

2). Does the management have a determination to continue to develop products or processes that will still further increase total sales potentials when the growth potentials of currently attractive product lines have largely been exploited? All markets eventually mature, and to maintain above-average growth over a period of decades, a company must continually develop new products to either expand existing markets or enter new ones.

3). How effective are the company’s research-and-development efforts in relation to its size? To develop new products, a company’s research-and-development (R&D) effort must be both efficient and effective.

4). Does the company have an above-average sales organization? Fisher wrote that in a competitive environment, few products or services are so compelling that they will sell to their maximum potential without expert merchandising.

5). Does the company have a worthwhile profit margin? A company can show tremendous growth, but the growth must bring worthwhile profits to reward investors.

6). What is the company doing to maintain or improve profit margins? Fisher stated, “It is not the profit margin of the past but those of the future that are basically important to the investor.” Because inflation increases a company’s expenses and competitors will pressure profit margins, you should pay attention to a company’s strategy for reducing costs and improving profit margins over the long haul. This is where the moat framework we’ve spoken about throughout the Investing Classroom series can be a big help.

7). Does the company have outstanding labor and personnel relations? According to Fisher, a company with good labor relations tends to be more profitable than one with mediocre relations because happy employees are likely to be more productive. There is no single yardstick to measure the state of a company’s labor relations, but there are a few items investors should investigate. First, companies with good labor relations usually make every effort to settle employee grievances quickly. In addition, a company that makes above-average profits, even while paying above-average wages to its employees is likely to have good labor relations. Finally, investors should pay attention to the attitude of top management toward employees.

8). Does the company have outstanding executive relations? Just as having good employee relations is important, a company must also cultivate the right atmosphere in its executive suite. Fisher noted that in companies where the founding family retains control, family members should not be promoted ahead of more able executives. In addition, executive salaries should be at least in line with industry norms. Salaries should also be reviewed regularly so that merited pay increases are given without having to be demanded.

9). Does the company have depth to its management? As a company continues to grow over a span of decades, it is vital that a deep pool of management talent be properly developed. Fisher warned investors to avoid companies where top management is reluctant to delegate significant authority to lower-level managers.

10). How good are the company’s cost analysis and accounting controls? A company cannot deliver outstanding results over the long term if it is unable to closely track costs in each step of its operations. Fisher stated that getting a precise handle on a company’s cost analysis is difficult, but an investor can discern which companies are exceptionally deficient–these are the companies to avoid.

11). Are there other aspects of the business, somewhat peculiar to the industry involved, which will give the investor important clues as to how outstanding the company may be in relation to its competition? Fisher described this point as a catch-all because the “important clues” will vary widely among industries. It is critical for an investor to understand which industry factors determine the success of a company and how that company stacks up in relation to its rivals.

12). Does the company have a short-range or long-range outlook in regard to profits? Fisher argued that investors should take a long-range view, and thus should favor companies that take a long-range view on profits. In addition, companies focused on meeting Wall Street’s quarterly earnings estimates may forgo beneficial long-term actions if they cause a short-term hit to earnings. Even worse, management may be tempted to make aggressive accounting assumptions in order to report an acceptable quarterly profit number.

13). In the foreseeable future will the growth of the company require sufficient equity financing so that the larger number of shares then outstanding will largely cancel the existing stockholders’ benefit from this anticipated growth? As an investor, you should seek companies with sufficient cash or borrowing capacity to fund growth without diluting the interests of its current owners with follow-on equity offerings.

14). Does management talk freely to investors about its affairs when things are going well but “clam up” when troubles and disappointments occur? Every business, no matter how wonderful, will occasionally face disappointments. Investors should seek out management that reports candidly to shareholders all aspects of the business, good or bad.

15). Does the company have a management of unquestionable integrity? “If there is a serious question of the lack of a strong management sense of trusteeship for shareholders, the investor should never seriously consider participating in such an enterprise.”



Can we get one example or already implemented example url with this checklist if possible.