Reformed Millennial Investment Checklist

What to do before investing - a guide.

RM Business Investing Check List

General:

  • Have we waited at least 3 months since we first developed our thesis and valuation expectations before deciding to buy the stock?

  • Have we bounced our investment thesis off of an industry expert, or someone capable of providing a dissenting opinion?

  • Have we conducted a pre-mortem?

  • Does reporting consistently change and/or is it opaque?


Value Proposition & Customer:

  • What value is the business providing?

  • How does the business make money?

  • Can we define exactly who the customer is?

    • Is this a need-to-have, or a nice-to-have? Is this product or service critical to the customer?

    • What is the share of that customers wallet? Is this offering a small percentage of the customer budget?

  • Is there a substitute for the product or service? If it didn’t exist, what would the customers or users need to do instead?

  • Does any single customer represent more than 10% of revenue?

  • Are any of their customers or customer cohorts ‘unhealthy’?

  • How are the customer end-markets evolving?

  • What is the customer life-cycle? Do you touch them once every twenty years, or is it a monthly or yearly recurring touch-point?

  • What is the customer retention rate?

  • Can we find any customer feedback or commentary? Are there any recurring themes?


Competitive Advantage:

  • Can we identify a competitive advantage like network effects, brands, patents, regulated monopolies, high switching costs, first mover benefits, or scale?

    • If we can’t clearly identify a competitive advantage today, can we identify signs that the business might develop one?

    • If the company’s CEO left tomorrow, how long would it take, if ever, to create a successful competitor? Are there any major barriers to new entrants?

  • Who does the company compete with? Can their competitors copy/replace what the company is offering over time?

  • Does the company have pricing power? How elastic is demand? Can we find examples in the past to illustrate demand elasticity or lack thereof?


Industry:

  • What are the key drivers for the industry?

    • How has the industry evolved over time?

  • Is the total addressable market (TAM) expanding or shrinking?

    • Are there long-term positive or negative secular themes that will change the opportunity set?

  • What does the competitive landscape look like?

    • What is the businesses market share?

    • Is there extreme fragmentation or concentration?

    • Is the same number of businesses competing in the space today as there was 5 and 10 years ago?

    • Can we identify a business in this industry that has failed in the last 10 years, and why?

    • How do industry participants compete: capital, service, price, etc?

  • Has there been a flood of new capital into the space?

    • Has there been an increase in IPO activity in the sector?

    • Are businesses issuing more equity than in the past?

    • Is leverage for the industry much higher than the 10Y historical average?

  • How cyclical is the industry?

  • Is this a profitable industry?

    • What has been the minimum and maximum ROIC for the industry over the last 20 years? What is the range of ROIC within the industry today?

    • What was peak-to-trough ROIC/margins/sales in previous recessions?

    • How do these characteristics compare to the overall market?

    • Has the rank order of relative profitability (ROIC) changed meaningfully in the last 5 and 10 years?

  • Does the company operate in any geographies with volatile legal, political, or regulatory environments? Do any of these represent more than 10% of sales?

    • Is there a regulatory body that can meaningfully impact industry profitability?

    • Are there any outstanding legal or political risks?

  • Is this a business that can pass on inflation to customers?

  • Are employees unionized or not?


Strategy:

  • How do they deliver on the value proposition?

    • Is the business generating an upfront payment or recurring revenue stream

    • How do they try to understand their customer needs?

    • How do they think about strengthening their position? Can they build on their competitive advantage?

  • How do they acquire customers?

    • Do they rely on an internal sales team? Partners? Do customers come to the business directly?

    • How do they approach marketing?

    • Do they offer customer incentives?

  • How do they operate the business?

    • How do they approach manufacturing?

    • How do they approach distribution?

    • Can they reduce input costs by changing suppliers, bringing processes in-house, etc? Is there a road map to do so?

    • Is any single supplier their only option for a given input to the product or service? How do they manage procurement?

  • How do they manage risk? Do they use natural or financial hedges to reduce volatility in cash flows?

  • Capital allocation

    • Is the company willing to return cash to shareholders if they can’t find accretive ways to deploy it?

      • Has the company repurchased stock in the past, and if so has it been opportunistic or mechanical?

    • Is M&A a likely contributor to future growth? If so, what criteria does the management team use to evaluate transactions?

      • What type of M&A are they pursuing (roll-ups, transformational, etc)?

      • What drives synergies: costs or revenue? Can competing acquirers achieve the same synergies, or do they have other advantages?

      • What is their M&A track record?

      • Does the company look to retain key people at the entities that they acquire?

    • How does the business rank order investment opportunities, organic or otherwise? Is it clear that they rank opportunities on the best performance metrics, like life-cycle ROIC instead of cash on cash yield in year one?

  • Is their approach to any of the above points consistent? Or have they pivoted in the past?


Performance:

  • Is there a sufficient historical track record to evaluate?

  • Does, or has, the company earned a ROIC or ROE in excess of their cost of capital?

    • If so, for how long have they generated excess returns?

    • If not, do we see a path to that happening?

    • How does this return compare to the peer group?

  • What has the cash conversion ratio been for the last five years?

  • Is there a history of asset impairments/write-downs?

  • Is there any capital that is a drag on returns, and should have been utilized differently?

  • Do asset-specific KPI’s meet expectations?

  • Have they historically managed their financial position well?


Financial Position:

  • How do their debt metrics compare to their peer group and to history?

    • Is leverage higher than peers, or average levels for the business?

    • Are there financial covenants the business must maintain? Will the company breach those covenants in a recessionary environment?

    • What is the rating agency outlook? Is it likely that the company will need new external equity?

    • Are debt maturities staggered? If not, is there a looming refinancing, and how will the company manage it?

  • Are there any off-balance sheet liabilities?

  • Does the company have any long-term contracted obligations?

  • Is there a dual-class share structure?

    • Are there any obligations to other holders, like Incentive Distribution Rights?

  • Does the company have preferred share and/or hybrid capacity?

  • What is the potential impact from dilutive securities?

  • Is non-cash NWC a big part of the business?

    • Is it large as a percentage of revenue? Is it shrinking or growing as a percentage of revenue?

    • If it is negative, is there a large potential cash outflow if revenue falls?

  • Do they pay a dividend, and if so, what is the payout ratio?

    • Do they have a DRIP?

    • Have they been funding the dividend through asset sales or increased leverage? Ultimately, is it sustainable with internally generated cash flow?

  • Are sustaining capital requirements in-line with DD&A? Is there a reason they might be different? Can they meet these spending requirements in a recession?

  • Is the business capital intensive? How do they plan to fund incremental capital expenditures?


Management & Governance:

  • Does the management team have some competitive advantage, as people? Do they bring unique experience? Can we identify any shortcomings?

    • What is their previous track record running a business or business unit?

    • What is the consensus view of management?

  • Are they more comfortable with succeeding unconventionally than failing conventionally?

    • Can we observe behavior that sacrifices near-term profitability for the long-term benefit of the business?

  • What metrics are management compensated on? Are these appropriate drivers of shareholder value? If ROIC/ROE/EPS growth isn’t one of those metrics, are we confident that management has an incentive to most efficiently allocate capital?

    • Do insiders own a significant amount of stock?

    • Have insiders sold any stock in the last year? More broadly, how has insider ownership changed over time? Can we find good justifications for insider selling? If not, this is a brown M&M?

    • Does management use non-GAAP metrics in guidance, and if so, is that reasonable?

  • How does the management team allocate their time?

    • Are they obsessed with stock price and constantly meeting with investors? Or;

    • Are they intently focused on running their business?

  • Is the founder still running the business or on the board? Is this a good or bad thing?

  • Is the business run in a centralized or decentralized way, both financially and operationally?

    • What are employee incentives?

  • Is there a “key person” risk?

  • Can we gauge employee turnover? What about management turnover? Board turnover?

  • What do employees have to say about the company through Glassdoor or other channels? Can we gauge company culture through another channel?

  • Are the skills and diversity matrices for the board of directors appropriate?

  • Do board directors have sufficient financial interests in the company?

  • Are board directors distracted by too many other professional endeavors?

  • Is there an unhealthy relationship between any board directors and management?


Valuation:

  • Have we identified the key drivers?

    • Where do our expectations differ from what we think the market price implies?

    • Why do we think we have an edge, and/or can we understand why the market is wrong?

    • Are any of the key drivers impossible to forecast, ie. is uncertainty incredibly high?

    • What is the source of the data that impacts our view of the key drivers? Is that source reliable? 

  • Have we done a bear and bull case scenario analysis? Is risk skewed to the upside?

  • Is the business fully cash taxable? If not, when will they be?

    • Have we considered the impact of net operating loss balances and other tax pools?

  • Are there any unusual accounting policies?

  • Does the business expense anything that in principle is actually a capital item? Is this well understood by the market?

  • What percentage of costs are fixed? Is operating leverage high?

  • What is FCF conversion? Is it consistently above or below 100%?

  • Is there a capital expenditure cycle, and if so, where are we in the cycle? How does this compare to their peers?

  • Is there any large unfunded liabilities, like pensions?


All information provided is for educational purposes only and does not constitute investment, legal or tax advice, or an offer to buy or sell any security. For our full disclosures and disclaimer, visit our website: https://gold-im.com/disclaimer/