Checks

Checks in the world of investing aren't the paper slips you use to pay bills. Instead, think of them as your personal detective work—a rigorous, systematic process of verification and analysis that a prudent investor performs before committing capital. For a value investor, this is the heart of the craft. It’s about looking under the hood of a company, kicking the tires, and making sure the shiny paint job isn't hiding a rusty engine. Legendary investors like Benjamin Graham and Warren Buffett built their fortunes not on wild guesses but on a foundation of deep, meticulous checks. This process involves scrutinizing everything from financial statements to the quality of management and the company's position in the marketplace. The goal isn't just to find winners but, more importantly, to avoid the losers that can lead to a permanent loss of capital. It's the disciplined homework that separates investing from speculation and puts the odds firmly in your favor.

Why go to all this trouble? Because the investing world is littered with traps for the unwary. Corporate reports can be painted in an overly optimistic light, Wall Street analysts can have conflicts of interest, and exciting narratives can often mask fundamentally weak businesses. Performing checks is your primary defense against these dangers. This disciplined process helps you achieve two critical objectives:

• Risk Mitigation: The first goal of a value investor is not to lose money. By thoroughly checking a company's financial health and business model, you can identify red flags—like excessive debt or dwindling market share—before they wreak havoc on your portfolio.
• Identifying True Value: Sometimes, great companies are misunderstood or temporarily out of favor with the market. A thorough checking process allows you to see past the noise and identify businesses trading for less than their intrinsic worth, creating an opportunity for substantial returns. It's the key to finding that coveted margin of safety.

In essence, checks are the antidote to the emotional decision-making and herd mentality that often plague investors. It's the rational framework that guards against the biases described in behavioral finance.

While every company is unique, a solid checklist provides a structured way to approach your analysis. It can be broadly divided into two categories: the numbers and the story behind them.

This is where you put on your green eyeshade and dig into the financials. The goal is to verify the company's health, profitability, and valuation using cold, hard data.

• Financial Strength (The Balance Sheet):
  1. Low Debt: Is the company conservatively financed? A high debt load can be fatal in a downturn.
  2. Liquidity: Does it have a healthy current ratio (typically above 2) and sufficient working capital to meet its short-term obligations?
• Profitability (The Income Statement):
  1. Consistent Earnings: Has the company demonstrated a long-term history of stable and growing earnings per share (EPS)? Avoid companies with erratic, unpredictable profits.
  2. High Returns: Look for a consistently high return on equity (ROE) and return on invested capital (ROIC), which indicates management is effective at generating profits from shareholders' money.
  3. Healthy Margins: Are profit margins stable or expanding? This shows the company has pricing power and cost control.
• Cash Flow (The Cash Flow Statement):
  1. Cash is King: A company must generate cash to survive and thrive. Is free cash flow (FCF) strong and positive? FCF is harder to manipulate than earnings and represents the real cash available to reward shareholders.
• Valuation (The Price You Pay):
  1. Sensible Price: Is the stock trading at a reasonable valuation? Use metrics like the price-to-earnings ratio (P/E) and price-to-book ratio (P/B), but always in the context of the company's industry and historical levels.

Numbers only tell part of the story. The qualitative aspects reveal whether a business has what it takes to prosper over the long term.

• The Business Itself:
  1. Understandable: Can you explain how the company makes money in a simple sentence? If not, it's probably outside your circle of competence.
  2. Durable Competitive Advantage (“Moat”): What protects the company from competitors? This could be a strong brand, patent protection, high customer switching costs, or a low-cost advantage. A business without a moat is a castle built on sand.
• Management Quality:
  1. Integrity and Talent: Is the management team honest and capable? Read their shareholder letters. Do they speak candidly about mistakes?
  2. Shareholder Alignment: Do executives have skin in the game through significant insider ownership? Is their compensation reasonable?
  3. Capital Allocation Skills: Is management skilled at reinvesting profits? Their decisions on acquisitions, share buybacks, and dividends will determine the future value of your investment.

For the truly dedicated investor, checks extend beyond financial reports. Popularized by the legendary investor Philip Fisher, the scuttlebutt method is an investigative technique for gaining a ground-level understanding of a company. It involves talking to people who are connected to the business to get an unvarnished perspective. This could mean:

• Talking to customers: Are they happy? Would they switch to a competitor for a small discount?
• Speaking with suppliers: Do they respect the company? Does it pay its bills on time?
• Interviewing former employees: What is the company culture really like?
• Analyzing competitors: What are their strengths and weaknesses relative to your target company?

Scuttlebutt provides the color and context that you'll never find in an annual report.

After you've checked the business, the financials, and the management, there's one final, crucial check: check yourself. Are you buying this stock for rational, business-like reasons? Or are you being swayed by market hype or fear? A thorough checklist builds the intellectual conviction needed to buy when others are fearful and to hold on for the long term, which is the true path to investment success.