Buffettology Investing Checklist

This is what I picked up from Buffettology .
It's quite a good checklist to go thru' and I'm confident of my picks as I've gone thru' the company in a systematic way.

Qualitative Analysis
1) Does the company have any identifiable consumer monopoly or brand-name products, or does it produce or sell a commodity product?
2) Do you understand how it works? (REALLY..Understand)
3) Is the company conservatively financed?
4) Are the earnings of the company strong - with an upward trend?
5) Does the company allocate capital only to business within its realm of experise?
6) Has the company been buying back its shares?
7) Does mgmt's investment of retained earnings appear to have increased per share earnings and therfore shareholder value
8) Is the company's return on equity above average?
9) Does the company show a consistently high return on total capital invested
10) Is the company free to adjust prices to inflation (pricing power)
11) Are large capital expenditures required to constantly update the company's plant and equipment

Quantitative Analysis
1) Is the Company's stock price suffering from a market panic, a business recession, or an individual calamity that is CURABLE?
2) What is the inital rate of return on the investment and how does it compare to the return on U.S Treasury bonds (or whatever govt bond your shares are based in)?
3) What is the company's projected annual compounding return as an equity/bond
4) What is the projected annual compounding return using the historical annual per share earnings growth. (Remember to weed out outlier)

What we can learnt from this market downturn

Image via Wikipedia Hope everyone have taken a lesson from this market downturn.

The Key takeaway :-
1) Diversify your investment. Don't put all into 1 or 2 stocks. Why risk it all on 1 or 2 stocks you can't even control. The management can do stupid things and its beyond your control. Whoever tells you to concentrate your investment and get rich? Warren Buffett? But he did mentioned that when he buys into a company, the first objective is to gain control and if not, he will get a significant stake enough to exercise pressure on the management. So, he had eliminated the factor that we small investors can't - direct/indirect influence on the management thru' his significant holdings.

2) Don't speculate, don't do short-term trading... but do monitor your investment at least monthly and rebalance quarterly or less frequently as necessary. In effect, this forces you to sell stocks that have run very high and buy into companies or assets that are underperforming but with potential to gain.

3) Please go and attend a course on understanding financial statements and buy some management books to read. Try to understand the management considerations of CEOs and you will know whether the company is operating good or not. Also, read up on management strategy ... at least try to understand what makes up competitive advantage, whether it is sustainable.

4) Debt level - this one is a killer for all companies (big or small). It is leverage and when times are good, it will be performing. But when times are bad, it will be disastrous.. So, monitor this one... In good times, when u see debt level too high... u will have to start thinking about what happens if the company cannot service or refinance its debt. Look at its interest cover, debt to equity ratio. Look at the annual cashflow and see whether the company is expending a significant of it on debt.

Warren Buffett's Letters to Berkshire Shareholders

Image via Wikipedia If you want to know more about value investing but are often put off by most books out there that tries to explain investing in such a boring manner, Warren Buffett's letters to Berkshire's shareholders are easy read.

It is easy read as it is not very technical but it gives you a good grasp of what to look out for in a business.
http://www.berkshirehathaway.com/letters/letters.html

Along similar veins would be Peter Lynch's books.

So go ahead and pick up the letters or the book and start your journey into value investing. I am primarily a fundamental investor but rely on simple technical analysis to know the trend of the stock. Conflicting ain't it?

Warren Buffett's Investing Checklist

Image by Getty Images via Daylife

Warren Buffett's Investing Questions

Before Warren Buffett invests a dime, he asks:

• Is the company in an industry with good economics? That is, is it not in an industry competing on price?
  
  
• Does the company have a consumer monopoly or brand name that commands loyalty?
  
  
• Can anyone with an abundance of resources compete successfully with the company?
  
  
• Are the earnings on an upward trend with good and consistent profit margins?
  
  
• Is the debt-to-equity ratio low, or is the earnings-to-debt ratio high? Can the company repay debt even in years when earnings are lower than average?
  
  
• Does the company have high and consistent returns on invested capital?
  
  
• Does the company retain earnings for growth?
  
  
• Does the business have high maintenance cost of operations, high capital expenditure or investment cash outflow? (If so, that's not good.)
  
  
• Does the company reinvest earnings in good business opportunities? Does management have a good track record of profiting from these investments?
  
  
• Is the company free to adjust prices for inflation?

In short, he makes companies jump through a lot of hoops before he considers putting them in his portfolio.

Source : InvestmentU

Rule 2 - Take Profit, Cut Loss, Money Management

Image via WikipediaWhile a buy and hold strategy for equities is advocated by many financial advisors or even gurus, they are using timeframe of investment as a basis for making that argument. Usually, the time frame they are talking about is 15 years onwards as historical returns have shown in the long run, equities do outperform bonds and other asset classes and it averages around 7-10%. If you are interested in long run averages in stock and why stock is a good investment, you can read Stocks for the Long Run by Jeremy Siegel

However, in the short-run, you better have some idea of money management and when to take profit and cut loss. In other words, a bit of active management is required on your part.

For the whole portfolio, an approach called rebalancing is necessary. Rebalancing means selling your outperforming asset class and buying your underperforming asset class. The rebalancing frequency often suggested is semi-annully or yearly as anything more frequent might not give you any added returns. This requires you to examine your portfolio asset allocation and "rebalance" your asset classes percentage back to the desired allocation percentage. This will shift your portfolio back to your desired risk-return characteristic.

Rebalancing, if done correctly, will force you to 'Sell High(sell outperforming asset), Buy Low(buy underperforming asset)'. It's a discipline enforced on you to take profit.

For individual invesments within the asset classes, you need to adopt a disciple of taking profit and cutting losses. This is because no one can get a 100% accuracy on his/her investment views. You might have done serious mental work on which investment might be the next performer but what if you are wrong? Are you going to stick to your investment and usually, you become emotionally attached to your invesmtent. Or when your high flying investment takes a 20% drop, do you think it's time to re-evaluate your decision on the investment?

A way to achieve an emotionless investing approach to taking your profit and cutting your loss is to adopt a trailing stop loss strategy. This requires a fair bit of active monitoring on your part. Whenever you buy into an investment (especially stocks), do a mental trailing stop loss strategy of 20%. This requires you to ensure that your investment never drops more than 20% off its highest traded price. I use 20% as it is within my comfort level and I do not get stop out so frequently. You will have to find a percentage you feel comfortable with, though anything below 10% is most likely detrimental to your strategy as you can see the annualized volatility for stocks is around 15%.

Yes, the investment might rally after the 20% drop, but what if you are wrong? The investment might languish in that trading range for a long time. There are so much investment opportunities out there, don't let a bad investment decision tied you up.

If you bought into an investment and your investment soared 50%, you still need to do a mental trailling stop loss. Should the investment drops 20%, you take your profit! This ensures you have a 30% profit in hand for other investment opportunities and not wait for the investment to drop further and reduce your profit.

Lastly, for whatever investment you made, you need to adopt a proper money management technique. Run your investment portfolio like you are a fund manager! Adopt proper position sizing by allocating no more than 5%(maximum) of your total investment value into any investment. This way, you can ensure that a 20% loss on any of your investment will translate only to an insignificant 1% loss in your total investment value.

You might argue that this also means that a 20% gain in any of your investment will translate to only 1% gain in your total investment value. Look at the BIG PICTURE! If you were a good investor and allocate 5% to every investment, you will have 20 investments in your portfolio. If you achieve a 20% gain in all of your investments within a 1 year period, your total gain for your portfolio will be 20%! Congratulations! You are on the same level as Warren Buffet who averages 23% on compounded annual growth. Just kidding, you have to achieve that at least 10 years in a row for any one to believe you are in the same league as Warren Buffett.

So remember, do not over-allocate and let one bad investment decision deciminate all your gains accumulated by other investment. In the long-run, you will be better off!

Yes, you won't get rich fast, but you won't be a pauper either.