Checklists are an important tool for value investors. They
protect us against our inherent mental shortcuts/biases and a
need to "jump to conclusions." They also make sure that we have
thought about a pre-decided set of downsides and are not fitting
the data to derive a particular conclusion. This last point is
best explained by a story.
A Russian General was driving across a remote village during
the World War II when he came across a set of circles on a large
wall. At the center of each circle there was a bullet shot. He
was mightily impressed and stopped his vehicle to find the
shooter. He thought that a good target shooter like this one will
be a great addition to his company. He accosted a villager and
inquired about the person who was responsible for such a
phenomenal shooting. "Oh ! He is the son of the shoemaker. But
you don't understand - he is a weird fellow" - quipped the
villager. "Why so ?" - asked the General. Well, he first shoots
on the wall and then draws a circle around it.
It is also important that the checklist is brief and to the
point. A long-winded checklist resists thorough testing, and many
significant details may be ignored at the expense of some minute
and significantly less important facts. Hence, I made a very
small checklist of things I want to have before I consider buying
a company. The list is an amalgamation of several value investors
- A business that I understand.
- A good and strong balance sheet.
- Run by able and reasonably honest management.
- A business with competitive advantage.
- Margin of safety or selling at a discount.
With such a simple set of rules one would think that I will be
able to follow them. But a majority of the stocks I hold do not
satisfy at least one of these qualities. Before going any further
let me rate my top five holdings based on these checklist items.
Each item (except Moat) may get one of five values: Exemplary,
Fair, Moderate, Poor, Disastrous. Also, the margin of safety is
rated according to the price I paid, and not the current price.
||Circle of competence
||Margin of safety
|Bank of America
Roche fails the financial strength test and this is one of the
most important rules on the checklist. When I bought Roche it had
an SFR 36 bn in debt as opposed to an SFR 7.3 bn in equity.
ArcelorMittal is in a commodity business with no moat. Its debt
is rated junk and the amount of my understanding of Iron and
Steel consumption and demand is flimsy at best.
France Telecom does not have a great management and for some
reason they are expanding in Africa for their growth. I do not
doubt that Africa may offer huge growth potential but the income
per customer there will be even worse than the income per
customer in India - which Vodafone found out the hard way.
At this point I find myself quite divided. I understand that I
should be able to eliminate at least a few of my holdings by
testing them against each item in my checklist - in a emotionless
way. But I am unable to do so. Then I get down to the individual
companies I find that I have reasons for not selling - and good
reasons. So I end up taking a walk and the cycle repeats.
I will be happy to hear suggestions.
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