Investment Criteria

Investment Criteria are the specific set of rules, conditions, and filters an investor establishes to evaluate potential investments. Think of it as your personal investment constitution or a pre-flight checklist for your capital. Before you even consider buying a stock, bond, or property, you run it through your criteria. If it doesn't pass, you move on—no exceptions. This disciplined approach is the bedrock of successful value investing, transforming the chaotic art of picking stocks into a more systematic and rational process. It's your primary defense against making emotional decisions, chasing hot tips, or getting swept up in market mania. By defining what makes a “good” investment for you, you create a powerful framework that keeps you focused on your long-term goals and helps you confidently say “no” to the vast majority of opportunities that don't meet your standards.

Imagine a pilot trying to fly a plane without a checklist. It would be chaotic and incredibly risky. Your investment criteria serve the same purpose: they ensure discipline, consistency, and safety. The market is a noisy place, constantly bombarding you with fear and greed. A well-defined set of criteria acts as a filter, cutting through the noise and forcing you to focus on what truly matters.

• Emotional Discipline: It prevents you from buying a stock just because its price is soaring (FOMO, or Fear Of Missing Out) or panic-selling a great company during a market downturn.
• Consistency: It ensures you evaluate every potential investment using the same rigorous standards, leading to a more coherent and understandable portfolio.
• Efficiency: You can quickly discard unsuitable investments, saving you time and mental energy to focus on the most promising candidates.

Your criteria should be a reflection of your investment philosophy. For a value investor, the criteria are typically grouped into four key areas, famously summarized by Warren Buffett: a business you understand, with favorable long-term economics, run by able and trustworthy management, available at a sensible price.

This is about the company itself. You're not just buying a stock ticker; you're buying a piece of an actual business.

• Circle of Competence: Only invest in businesses you can genuinely understand. If you can't explain what the company does and how it makes money to a teenager in a few minutes, you should probably pass.
• Durable Economic Moat: Does the company have a sustainable competitive advantage that protects it from rivals? This could be a powerful brand, network effects, high customer switching costs, or a low-cost production process. A strong moat ensures long-term profitability.
• Simple Business Model: Avoid companies with overly complex, opaque, or constantly changing operations. Simplicity often correlates with durability and predictability.
• Favorable Long-Term Prospects: Is the industry growing or shrinking? Is the company's product or service likely to be in demand a decade from now? You want a business with tailwinds, not headwinds.

Even a great business can be ruined by poor management. You are entrusting your capital to the people running the company.

• Integrity and Candor: Is the management team honest with shareholders, even when the news is bad? Read their annual reports and shareholder letters. Do they speak in plain English or hide behind jargon?
• Rational Capital Allocation: How does management use the company's cash? Do they reinvest it wisely in the business, pay down debt, buy back shares at attractive prices, or make smart acquisitions? This is one of the most critical jobs of a CEO.
• Shareholder-Oriented: Does management treat shareholders as true partners? Look for executives who have a significant portion of their own wealth in the company's stock—their interests are more likely to be aligned with yours.

A strong business and great management should be reflected in the financial statements. These are the quantitative checks.

• Consistent Profitability: Look for a track record of strong and stable earnings. Key metrics like Return on Equity (ROE) or Return on Invested Capital (ROIC) should be consistently high, indicating an efficient and profitable business.
• Strong Balance Sheet: The company should not be burdened with excessive debt. A low Debt-to-Equity Ratio is a sign of financial prudence and resilience during economic downturns.
• Abundant Free Cash Flow (FCF): This is the cash a company generates after paying for its operating expenses and capital expenditures. A business that consistently produces strong FCF is like a financial fountain, with plenty of cash to reward shareholders and reinvest for growth.

This is where value investing truly comes to life. A wonderful company is not a wonderful investment unless you buy it at an attractive price.

• Margin of Safety: This is the cornerstone of value investing. You must buy a stock for significantly less than your estimate of its underlying worth, or Intrinsic Value. This discount provides a cushion against errors in judgment or bad luck.
• Sensible Valuation Multiples: While no single metric is perfect, look for a reasonable Price-to-Earnings (P/E) Ratio, Price-to-Book (P/B) ratio, or Enterprise Value-to-EBITDA (EV/EBITDA) multiple compared to the company's own history and its peers.
• Attractive Dividend Yield: For investors seeking income, a healthy and sustainable dividend can be a key criterion. It provides a regular return and can be a sign of a mature, cash-generating business.

Your investment criteria should be a living document. It's a guide, not an unbreakable law. As you learn more and gain experience, you should revisit and refine your criteria. However, you should never abandon them in the heat of the moment to justify a tempting but questionable investment. The goal is not to find a company that checks every single box perfectly—those are rare. The goal is to use your criteria to build a portfolio of high-quality, well-managed businesses bought at reasonable prices.