Sometimes management has misaligned incentives with the long term interest of a business.  In these cases it can lead to odd management decisions and actions that negatively impact the value of the company.  This is often revealed in management’s compensation schemes, and often in the background and how they arrived in their position.  If management is grossly misaligned with the interests of the business this will be an issue.

If management has misrepresented anything or failed to disclose information that would be important to shareholders, that is an indication of a problem.  Sometimes management can be so overly focused on selling the stock of the company (rather than reporting on the business and where it is going) that it prevents shareholders from effectively assessing the value of the business.  If management has misrepresented anything, failed to disclose relevant information, or is overly sales oriented in their reporting on the company, it will likely have a negative impact on the value of the company now and in the future.  One way to review management performance and forthrightness is to review historical reports with a view to determining if the reports were accurate and provided a reasonable outline of what would happen in the business, and then comparing that with what actually occurred.

Management should be oriented to providing value to shareholders.  Sometimes they can be focused on acquisitions, growth for the sake of growth, hiring more than required, or other activities that might be seen to be good for the manager’s career but not necessarily for the company.  Other times they might be focused on social good or other interests that might not be directly related to increasing shareholder value.  If management exhibits behaviors that are less focused on shareholder value, an assessment of the extent and reasonableness of these other priorities is required.  If they are too extensive or distracting to the point where there will be significant negative impact on shareholder value, the investment should most likely be avoided.

Companies do not operate in a vacuum.  Quite often there are prevailing themes or sentiments that are working either for or against the company.  Ideally the industry, sentiments, and characteristics of the company are all pushing the company forward and are not working against it.  Even good companies in tough industries are unlikely to do well, and poor companies in industries that are doing very well may still perform well relative to the market as a whole.  If industry conditions or company characteristics are unfavorable, it will be difficult to achieve a good return.  However, it should be noted that industries, like companies, can turn around and if it looks like that could be the case, then a company may still be a good investment.

This is something that competitors will have difficulty copying that provides the company with an advantage or otherwise makes the company’s position defendable in the marketplace.  The idea of a moat is something that defends the company from competitors, and where the wording moat comes from.  This can really be anything, but common sources of moats or sustainable competitive advantage may include: brand, network effects, economies of scale or scope, intellectual property, difficulty or inertia from customers switching to competitors, key relations with government leading to sole source contracts or ability to operate unavailable to others, access to particular resources or real estate unavailable to others, several years of technical advances competitors cannot easily catch up with, and many more.  When companies have some of these factors working in their favor it makes them defensive and often more profitable.  If companies have none of these or similar factors working for them, there is a good chance that their advantage will be competed away quickly, most likely leading to poor long term returns.

If company management is actively buying the business, it is a good sign that they believe in the future of the business and that it may be undervalued at this time.  Management has access to information that is not readily available to the market and when management is buying, that behavior suggests their information is favorable.  The magnitude of management buying is also part of the indicator, with more buying being a stronger indicator.  Note that smaller amount of buying could be evidence of exercising options that may have an expiry date or similar transaction activities that may not be a sign of management’s belief in the company.  Note also that many free sources of information online on companies readily show management buying activities.

Opposite to management buying activities, if management is selling then that could be evidence management believes the company is overvalued or has poor future prospects.  This is again relevant as management has access to information that is not available to outside shareholders.  It should be noted however there are many reasons management might be selling that have nothing to do with an assessment of the company: such as wanting funds for personal purposes, other investing activities, personal legal matters, exercising options or similar that are coming due (which would show a buy and a sell in most cases).  However, if selling is in a significant magnitude, and from multiple executives, that is generally a significant negative sign about the future prospects of the company.  Note that many free sources of information online on companies readily show management selling activities.

This can be difficult to know, particularly for certain companies or industries that might be complex, but knowing the answer to this is generally tied to how well you understand the company, and the industry.  If you understand the company well, you will know the factors that are key in determining the company’s future prospects.  These can be deduced from the industry the company is in, as companies in the same industry often share factors of success, and it can also be obtained from the company reporting where they often mention these factors. You can deduce the factors on your own if you understand the company and industry well enough.  Generally, if you are having a hard time figuring this out it is a sign you do not understand the company well enough and should pass on the opportunity or risk making a mistake.

This will be a moment where you might want to leverage a tool such as Excel or similar to complete the projections.  You are free to do so if you wish, however if they are hard to determine, or are not sufficiently compelling with a significant room for error, it is a sign that the opportunity may not be that substantial.  Additionally, this question is flagging an over reliance on the story about the company or industry, or flagging that there is not enough track record or information available to know what the future might look like.  If there isn’t enough information to provide a reasonably good idea where the company is headed, then it is questionable what you are basing your investment decision on; that it probably isn’t deductive reasoning, and that it’s possibly emotionally or feeling based, which generally will lead to poor results.

This is checking on if you are looking to jump in and out of a stock, or if any of the information you are basing your investment decision on is short term in nature, which generally negatively affects long run returns.  Much of the information readily available applies to the current quarter or less time frame as that is where many market participants are focused.  This can in turn lead to short term thinking which negatively impacts long run returns.  Reviewing this item will help to avoid short term thinking and decision making, both of which would negatively impact long term returns.

If a company is founder led there are two significant factors that often positively impact the management of the company.

1.     The founder often knows the company extremely well, and understands where it has been and where it is going, having built up that understanding since inception.

2.     Very often the founder has significant personal stake in the company which closely aligns their incentives toward making decisions in the best interests of shareholders.

If the company is not founder led, examining the management for incentives, length of tenure in position, how much their personal wealth is tied to the success of the company and similar can provide an indication of if they are likely to act like owners.  The farther the management team is from this ideal, the closer scrutiny of their decisions and behaviors is required.  It should be noted that many companies are not founder led and that not being founder led is not necessarily on its own a reason to not pursue the opportunity.  Also, some founders end up having other priorities, so it isn’t automatically a good sign.  Taking this into account with other screening questions and examining management behavior overall is key for this screening question.

Some of the greatest management teams and individual managers are great capital allocators.  Capital allocation is also usually straight forward to review and assess.  In this case reviewing management’s recent decisions regarding capital allocation is the goal, along with assessing if they were (or are likely to be) effective, along with if they are in the best long term interests of shareholders.  One thing to watch for is management completing share buybacks when the share price is high relative to historic norms.  This may keep the share price high, but is often not in the long term interests of shareholders.  As an individual investor, it can be helpful to consider whether or not management is acting in line with what you think would be your interests.  If managements decisions are quite different from what you would expect then it is possible this is not the best opportunity.

Sometimes many of the characteristics of an opportunity look good, and will generally pass most checklist items, however the underlying company may simply not be a good company.  It could be that it just isn’t run that well, or is not positioned that well in the industry, or something that doesn’t otherwise come up on the checklist but doesn’t look good or creates undue uneasiness.  The company might be smaller than you are used, or have arbitrary recent success that does look sustainable.  A general assessment of the long term record and sustainability of the business is important, as well as general belief that the future of the company looks promising.  The unfortunate truth is that majority of stocks in the stock market are bad investments in the long run, and avoiding those bad investment is key to good returns.  It is generally better to buy a solid company at a reasonable price than a questionable company at a good price.

This is primarily about the length of time the business has been operating.  If the track record of the company is short, it can be difficult to make an assessment of the company, and equally difficult to make corresponding projections about the company’s future.  If the company has only been operating for two or three years it will be difficult to obtain enough information to determine if it is a good company.  Newer companies come with a lot of risk as they are generally unproven, they are still working out internal process and procedure, and they are quite often reliant on continued investment rather than operating income to continue as businesses.  With few exceptions it is best to avoid these types of companies as future results will likely be difficult to assess.  Exceptions to this might be if a new company is initiated by a known management team or possibly spun out of an existing quality company.  However, acknowledging the elevated risk these situations present remains important.

Often an investment will look good from the perspective of potential return, however will also have significant risk.  Investments may also be reasonable and offer outsized risks despite the reasonableness of the return.  Overall we are seeking opportunities that have outsized return potential for limited or no downside risk.  If an investment has high potential returns, but also high potential risk of significant negative returns, then it is not an ideal long run investment.  This is in line with the key principle of not losing money.  Generally if there is significant risk of losing funds, no matter what the upside potential of the investment, it is best to avoid.  You only have to be wrong on one or two of these types of investments to significantly negatively impact your long run returns.

Businesses are often cyclical in nature and follow business cycles and business super cycles.  These often match economic cycles or are tied to them, and are a result of adaptations to supply and demand forces over time.  Not all businesses follow cycles (think essential good and services) but others definitely do (most commodities for example).  Knowing whether a business has cycle properties or not can be key to knowing if the present is a good time to invest.  If it is likely to be at or near a peak, many of the current number and projections will look very good and the business may look like a very good investment.  However if the cycle turns, the numbers will turn as well, making the investment perform poorly on the negative part of the cycle.  This can be a normal business cycle over the course of a few years or a decade or possibly part of a super cycle that might have a pattern over perhaps a hundred years or so.  If nearing an inflection point of a super cycle, the current business cycle may have little to no impact one way or the other.  Predicting business cycles is more art than science but you should likely be able to discern if the business (or industry) is more likely to be closer to a bottom or a top of a cycle.  If you are unable to tell with some reasonable certainty where the investment is in a cycle, then it is likely best to avoid investing in it.  If it is at the top of a cycle, then it should be avoided, if at the bottom it could be a good opportunity.  Somewhat ironically, cycle stocks will often look quite compelling at the top of their cycles and quite uncompelling at the bottoms, so identifying this quality in business is both important for avoid losses and obtaining good returns.

Much of the ongoing information about stocks and the stock market is irrelevant to long term investing.  When researching an investment, it is easy to absorb sources that are focused on quarterly or shorter time frames and not the long term.  While this does create buying opportunities for long term investors from time to time, it is something to keep in mind when reviewing an opportunity.  If you have absorbed too much short term information then your view of the long term could easily become misguided.  Other checklist items also deal with this issue in some ways, but in this case, this question enables an objective step back and self-assessment regarding your own activities with a view to as objectively as possible consider your research and determine if it is based on long term fundamentals or if it has been unduly influenced by short term concerns.

This is a check for the dividend component of an opportunity, if the dividend is part of the motivation to consider the investment.  If it is not, then even if the investment has a dividend it is less important to the investment decision.  However, it should still be noted that sudden changes in dividend policy and amounts by any company can have significant affects on both the perceived and actual value of a company.  If the company has a meaningfully sized dividend, examining the payout ratio and related information will be somewhat helpful in determining the state of the company’s dividend and the likelihood of a change to dividend policy.  In the case of dividends, historic dividend payments matter, as most companies that pay meaningful dividends are looking to maintain a track record of dividend payments, often tied with a steady rate of growth for that dividend.  If there is an extensive track record of dividends, then that suggests dividend stability.  If it looks like something might change to the negative in a company’s dividend policy, it may be best to avoid that investment.

Companies that are considered growth companies are valued based heavily on how much they are likely to grow rather than what they currently operate at.  This has a tendency to lead to wild current valuation metrics, as these metrics are often considered irrelevant for long term growth companies.  More specifically, a few years of high growth will limit the utility of any current assessment of valuation.  The downside to this, is that all companies eventually stop growing at rapid paces.  When the growth slows, or stops, and particularly if this happens unexpectedly, the company’s stock price can correct sharply downward, as more traditional means of valuation are applied to align the company’s stock price.  This screening question is meant to drive consideration of the likelihood of this happening and, if a correction seems likely, help avoid that downward correction.  If it can be determined that there is considerable growth left for the company, then this becomes less of a concern.  A point to note here, is that sometimes after a growing company goes through a correction based on slowing growth, it is an over correction, and leads to a good long term buying opportunity.  If it looks like the business might be heading for a correction, and everything else looks good, it might be worth monitoring to see if this situation does end up occurring.

This is a check on the financial health of the company.  A company can have everything else going for it, but if it looks like the company may have trouble meeting its debts, it can be very difficult to determine what might happen and the company should be avoided.  It is important to check the short term (current ratio) ability to meet liabilities as well as the long term, with more importance given to the short term.  Companies will do strange things that can devastate shareholder value when faced with debt problems.

Similar to the previous checklist item, with this we are looking for any signs that additional equity financing might be required; essentially does it look like the company will have to offer considerable additional equity to public markets.  This can be both positive and negative for the current shareholders, as additional equity financing can increase the value of the company beyond the financing when done for the right reasons.  Here we are looking for signs that it might not be for the betterment of the company if an additional equity offering is done.  This would be the case if there was some recent lackluster performance, or trends in the company’s industry are less favorable than they were previously.  In these and similar cases it is likely that additional equity financing will be destructive to shareholders value.

This is a very broad checklist item and could very well have a number of related checklist items added to it.  This is a catch all that is ensuring you have in fact spent quality time with the company’s financial statements, including balance, income, and cashflow statements.  You should be checking for anything that looks like it could be an issue, such as: anything affecting the company’s stability, negative trends, questionable resulting ratios, cash management problems, and many other possible issues.  Most companies do not have perfect financial statements, and most likely you will uncover some issues upon examination.  The central follow up question becomes are these acceptable and are there reasons for these issues, or do they point to potential problems significant enough to leading to avoid this company as an investment?

Similar to the review of financial statements, this is included to ensure you check valuation metrics such as trailing and forward price to earnings, price to sales and price to book ratios, among others.  Different valuation metrics will have different significance and utility based on the investment, but those that are significant and applying them should point to the opportunity being fairly or undervalued.  If these are less favorable, then the reason they are less favorable should be understood and if not acceptable the investment should be avoided.

Sometimes companies will have plans for major corporate events, or there might be indications that a major corporate event might happen.  An assessment should be done, based on the probable event or events, to determine if they are likely to be favorable or unfavorable for shareholders.  This can sometimes be very difficult to determine and if that is the case, avoiding the investment is often the best choice.  Likewise, depending on the event, sometimes the price of a stock has already built in some or all of a major corporate event occurring, and if it doesn’t occur this could lead to a significant positive or negative change in valuation.  The extent of this being built into the price should be assessed, and a determination should be made around the impact of the event not occurring.  Depending on the circumstances, this can create an opportunity for significant gain or loss.  If it is difficult to determine it is likely best to avoid the business, as this can trend toward more speculatively oriented behavior and less investment oriented behavior.  Ideally, in cases where a significant corporate event may be pending we are looking for situations where there is little chance of loss and significant chance of gain; other situations should be avoided.

This screening question is optional, similar to the same screening question in the primary initial screening.  Include this if you wish to avoid investments that you are not aligned with, noting again that this creates a smaller pool to choose from, and is likely to reduce long run returns as a result.  This is included here at the end of detailed screening as you may have learned more about the company during the detailed screening activities.  Some of what you learned may have caused you to consider your alignment with the investment, and this check is included as to revisit alignment at the end of detailed screening before you move on.