• Is this a good business?
• What are the key success factors to superior performance in this industry? (VAR)
• Define the market opportunity. How do competitive products address this opportunity?
• What are the barriers to entry (“moats”)? (VAR)
• What is the relative power of: (VAR)
• Who controls industry pricing? Does the company/sector have any pricing power?
• How (and how much) can a good company differentiate itself from a bad one in this industry?
• Do you understand this business? Test yourself and describe it to a 10-year-old.
Business Model (VAR)
• What is the selling model: Razor/blades? Services? One-off contracts?
• What are the economics of the base business unit? How does it stack up against competitors?
• Why is the company good (or bad) at what it does? Can the company sustain it?
• Is this company growing by acquisition? How sustainable is that?
• Be able to easily describe the entire sales process – from order to fulfillment.
• What is the executives’ background, and what do their former colleagues, investors, and classmates say about them? Have they been successful in the past? (Very important)
• How is management compensated? Are its interests aligned with shareholders?
• Has management been good at allocating capital?
• Are management members buying or selling stock? How much as a percentage of their holdings, and why?
Company/Cultural Issues (VAR)
• Is this a great company? Is it built to last? What could change this assessment?
• Can you imagine holding stock in this company for 20 years?
• If you had access to unlimited capital, how would you feel about your chances of successfully competing against this company?
• Compare to a weak competitor in the same industry. What is the difference and why?
Financial Measures First Step: Check against all the accounting shenanigans in Howard Schilit’s book Financial Shenanigans: How to Detect Accounting Gimmicks and Fraud in Financial Reports (Amazon.com).
• What is the company’s capital structure, and how does it compare to its peers?
• What are the trends in inventory turns, days payable/receivable, and working capital?
• What are the company’s coverage ratios on interest payments?
• What are the company’s capital requirements and cash flow characteristics?
• How is the company choosing to invest its capital? Capital expenditures? Buybacks? Acquisitions?
• Does the company need to access the capital markets? How soon/often?
• Regarding the company’s sales model, how visible are earnings quarter to quarter, and year to year?
• Is this a fixed or variable cost business? How much cost leverage?
• Do earnings grow as a function of unit sales growth, price increases, or margin improvement? How sustainable is this growth?
• Looking forward, what is the company’s valuation in terms of:
◦ Market value/earnings
◦ Enterprise value (“EV”)/earnings before interest, taxes, depreciation, and amortization (“EBITDA”)
◦ Free cash flow (“FCF”) yield (after-tax FCF/market value)
◦ Market value/sales
• What are the company’s growth rates in terms of earnings, EBITDA, and FCF?
• What are consensus earnings estimates versus your own expectations?
• What are the key leverage points in our own and the Street’s earnings models?
• What has to go right, and where is the most chance for surprise?
• Are the company’s accounting policies conservative and in line with its peers?
• What are the big unknowns? How much can the company control/influence these risks?
• What could cause this investment to be a total disaster? How bad could it be?
Other (Timeline/Timing Issues)
• What are the catalysts (triggers) for the company’s proper valuation to be realized?
• What good news and what bad news will affect the company in the coming year?
• Who owns the stock? Momentum funds? Big mutual funds? Hedge funds?
• How difficult is it to build a significant position (float, volume)?
• Draw a timeline of expected events and dates. What might go wrong and when?