Since Atul Gawande wrote The Checklist Manifesto, investors have increasingly utilized checklists in their investment process.  The purpose of a checklist is to compensate for our human shortcomings.  As humans, we are prone to overlook even the simplest of factors which could lead to a poor outcome.

Due to the rising popularity of checklists, there are a number of templates available for free for budding investors or even the seasoned professional.  I don’t recommend the serious investor to take this route.  An investor should lean on his/her experience and personal idiosyncrasies to craft his/her own checklist.  Going this route will likely lead to better recall and use of the checklist.

My checklist is quite long, numbering 11 pages or so.  For reasons mentioned above, I refrain from publishing my checklist and instead encourage readers to craft their own.  To get started, below are some guidelines on how I approached my checklist.

I – Initial Filters
In this section, I included a brief list of filters to help me quickly weed out opportunities.  Items to consider include (i) can I understand the asset and predict, with reasonable certainty, cash flows 10 years from today, (ii) does the asset have a sustainable competitive advantage, (iii) are the managers of the asset ethical, energetic, and competent, (iv) is valuation in a range of reasonableness, and (v) how could I be wrong.

II – Competitive Advantage
Things to consider here include (i) source of competitive advantage (branding, customer captivity, economies of scale/experience, network effects, intellectual property, sustainable low cost production), (ii) sustainability of the advantage, (iii) nuclear analysis (breaking up a business into its component functions), and (iv) competitive games.

III – Financials
A number of questions surrounding the financial statements.  I pay particular attention to return on tangible assets, market share / market share trends over time, and the capital structure.  For certain industries, I look at a few additional metrics.  For instance, in retail operations, I track sales growth vs. inventory growth to monitor inventory build.

IV – Management
A few questions on management including track record, capital allocation strategy, short term vs. long term focus, ownership, and strategy.

V – Final Check
This is the most important section.  I include a number of questions to challenge my own thinking.  Some include (i) what mood am I in when making the investment decision, (ii) what are bears saying and why are they wrong, (iii) why is the selling shareholder selling me the security at that particular price, (iv) have I thought about the investment using Jacobi’s inversion theory, and (v) am I suffering from confirmation bias, availability-misweighing tendency, impatience, or first conclusion bias.

Crafting a checklist is one of the greatest uses of time for a serious investor.  The base only has to be built once.  Items can be added or subtracted over a lifetime based on experience and observation.


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