You should always have a checklist before you buy a stock
Do I want to spend a long time learning about this business
How do you evaluate this business if you were to become the CEO. You should research this business as if you will be the next CEO which will be taking over the business
Can you describe how the business operates in your own words
Each of the business segments
Industry size and terns
Insight into the competitive environment
How does the business make money
How has the business evolved over time
Is success of business due to management brillance or is it
being at the right place at right time
In what foreign markets does the business operate and what are the risks in operating in these countries
Need to understand how committed the management is to invest in foreign countries
To build brand awareness, a business must invest long term in a foreign country
How long has the business being operating in the foreign country.
Is the business investing in R&D to adapt to specific tastes of the customers in foreign country
Has the company assigned a specific Regional manager to emerging markets
Is Revenue Growth translating into Profit growth
If a company does not provide adequate information ie: profits from certain regions
What are the risks to the companies foreign earnings Country risks Brazil complicated tax code China’s protectionism in wind turbine industry
Currency risks Mexico has a highly volatile currency Companies tend to reduce this risk by
investing the money back in the same country
Who is the core customer of the business
Is the customer base concentrated or diversified. Need to have a diversified customer base rather than one with a concentrated customer base. The loss of one customer should not affect the business. Check if the % a business have for one customer
Is the customer base concentrated or diversified. Need to have a diversified customer base rather than one with a concentrated customer base. The loss of one customer should not affect the business.Check if the % a business have for one customer
What is the customer retention rate for the business. Loyal customer base generates more predictable sales. Customer also serve as advocates for a business. Watch for declining loyalty program numbers as this is an indicator that the customer retention is declining. It is useful to interview sales staff to see if there is an incentive to retain existing customers.
What are the signs that the business is customer oriented. The more frequently the business interacts with its customers, the more the customers are happy. You can quickly return a defective t.v to Cotsco without asking any questions
Customers are not loyal to businesses with poor customer service
Find out if a business solves customer problems quickly and easily
Costco cuts its prices when commodity price falls
Southwest airlines doesn’t charge its customers for 2 bags
How does the management stay close to its customers
CEO personally reads all the customers emails
What pain does the business alleviate for the customer
A medical disposal company avoid potential liabilities that come from disposal of medical syringesx
To what degree is the customer dependent on the product or services from the business
Need to have
Company which manufactureres heart pacemakers
Need to have but not immediately
Need to have but not critical
Travel, New car, New house
If the business dissapeared tomorro, what impact would it have on the customer base
Ask what a customer will do if the business dissappeared tomorrow
38 Have the managers been buying or selling the stock?
It is very important to keep up with the purchases and sales of stock made by the management by monitoring Form 3,4,5 and 13-D filings
Insiders transactions signal where senior management really believes that their company are going without the corporate spin
They can be a useful indicator as to whether a stock will out perform or under perform
You must be careful not to jump to conclusions from an executive officer who is buying or selling stock without first examining the motivation
behind the purchases or sales and whether the buying and selling is material to the total net worth of that executive officer
You have to be aware that the top executive may be attempting to manipulate the stock
In order to be a useful signal, the insider buying or selling must be significant compared to the total net worth of the insider – for example
representing 15% more of their total ownership. Unless you see these high convictions purchases, then these purchases and sales
are just noise and you need to be careful not to regard them as useful indicators
For example a CEO bought 100$ million worth of stock which sounds like a big sum. However it was very small compared to his net worth of 17.3$ billion
Couple of examples when insider purchases were useful indicators
Carl Kirkland took a loan with his vacation house + plane he owned to buy as collateral to buy stocks
Jamie Dimon bought 60$ million worth of shares
Example of good sale indicator
If you senior managers or board members selling a lot of shares, this is not a signal that you should sell your stock
But it is a signal that you should question their long term faith in the business
If you see a stock whose price is continually dropping, yet insiders are selling, then this is a warning sign
Determine the Motivation when mangement purchases or sells company stock
If you are unable to determine the motivation behind the purchases or sales, then you do not have enough information
to draw a conclusion and you need to be more careful to not make assumptions.
Managers who sell the stock to meet margin calls
When the stock market crashed in 2008, many managerds had to sell the stock to meet margin calls
One such case was the CEO of Cheapstake Energy who sold 94% of his holdings to meet margin calls
Accessing the quality of the mangement – Competence. How the management operates the business
We will focus at management styles, stratergic planning and day to day operations, organization structures, how managers treat their employees, whether they know to hire well, whether the mangement know how to intelligenly handle their expenses whether the management is displined or undisciplined in making capital allocation decisions
Always partner with a proven and a competent management teams since it will free your time to focus on other opportunities
If you partner with incompetent teams, you have to spend a lot of time monitoring their actions
39 Does the CEO manage the business to benefit all the stakeholders?
If you were to ask investors whether stakeholders value is more important than customer service at a business, most would answer that it is. What they fail to consider is that the shareholder value is a byproduct of a business that keeps its customers happy. Infact many of the best performing stocks over the long term are the ones that balance the interests of all the stakeholders groups including customers, employees, suppliers and other business partners
John Mackey CEO of Whole Foods has coined the term Conscious capitalism to define business desinged to benefit all of their
stakeholders such as customers supplier employees and investors. Instead of subsribing to the theory the purpose of a business if to maximise profits, this theory believes that increase in shareholder value are the byproducts of helping customers and employees and vendors to reach their highest potential
Mackey compares happiness to illustrate his point
Long term profits come from having a deeper purpose, great products, satisfied customers, happy employees, great suppliers,
and from taking a degree of responsibility for the community and environment we live in.
The paradox of profits is that, like happiness they are best achieved by not aiming direct for them
Some examples of businesses that manage the business for customers and other stakeholders instead of maximising profits are below
CEO of Cotsco treats employees fairly and make sure that customers receive a good value, shareholders will benefit over the long haul
CEO of Strayer educationsaid he was not going to focus on amny of the metrics such as revenue growth,operating income growth,
and margin expansion.He focussed on academic outcomes rather than profits.We wanted to increase the intangible value of the company
by increasing the level of learning outcomes
40 Does the management team improve its operations day to day or does it use a stratergic plan to conduct its business?
Beware of any CEO who believes that one stratergy or a single stroke will transform their business. These CEOs typically make big announcements
such as they will take the business from number 3 to the number 1 spot in 5 years by revolutionizing the way they do business, by making a transformational acquisition or by leaping into a new hotmarket
A Stratergic plan is a detailed roadmap to success such as a 5 year plan that sets specific targets that must be met. As a result, a stratergic plan can also be an inflexible plan that outlines how a business will operate for the next 2,5,10 years. If a project or product does not meet the goals of the plan, then it is dismissed. Therefore seizing opportunities become less of a priority for the business
Most successful busineses are built on hundreds of small decisions instead of one well formulated stratergic plan.
When most successful entrepreneurs start their businesses, the build their businesses day by day, focussing on customer needs and letting
these customer needs shape the direction of their business. It is the stream of every day decisions over time that accounts for great
outcomes instead of big one time decisions
Another common theme among businesses that improve day by day they operate on the premise that is best to repeatedly lauch a product or a service with a limited number of customers so that they can use customer feedback to modify the product. The operate on the premise
that it is ok to learn from mistakes and that it is critical to obtain customer feedback to shape the stratergies.
Example: Coach conducts more than 10,000 customer interviews before it launchese new luxury handbag and accessory products.
Based on the information it collect, Coach will alter the design of the product or drop the product that tests poorly.
As a result, Coach has a direct line to the pulse of its customers and is able to avoid numerous market misfires.
CEO of Netflix mailed himself a CD in a envelope when he was developing the business. When the envelope arrived undamaged, he had spent only the
cost of the postage to test one of the business’s key operational risks.
In contract businesses that depend on stratergic plans often spend millions of dollars on research data compiled by consultants instead of customers.
over a long period of time before they launch a product or a service
Example: Motorola launched its iridium phone. Only 50,000 people subscribed to its service instead of millions of subscribers that Motorola had
anticipated. As a result of this, Iridium declared bankruptcy. Unfortunately the phone needed to receive the satellite signal was the size of a brick and the users had to be outdoors to get the reception. Both of these were major stumbling blocks that Motorola had not fully concerned when it was developing the service.
Here are a few CEOs who do not follow well stratergic plans but instead improve the business day by day
CEO of 99 cent stores said that people who make long term projection usually do not have accountability and people often forget
what they said years before.He did not think you could have a plan for more than 2 years from now.
CEO of Teledyne belived the best plan was no plan. He believed that the best way to approach an uncertain world with an opn mind
CEO of Staples believes that you should not get hung up on business plans. But whatever the plan says, the company wil do
just the opposite.Initial business plan say that they would not deliver. However today most of the revenue comes from delivery.
CEO of AIM Management group said that they did not have a plan when they started the company. They followed opportunities
as they came along the way, depending on what opportunities presented itself.
Why do Stratergic plans fail?
Statergic plans fail because they often shut out other opportunities. When an opportunity comes up and it does
not fit in the stratergic plan of a business, then the management will unlikely pass it up. The truth is that
most of the management teams will often stumble upon the best ideas
For example in the 1990s Pfizer stumbled upon the best selling drugs, Viagra. The company was developing
a treatment for Angina when the users of this drug reported of increased errections.
Do not confuse Stratergic Plan with Long term plan
You can think of long term planning as a vision that is always in the head of the CEO as he/she builds the business
For example a CEO may have a long term plan to become the highest rated business in customer satisfaction
or have the lowest employee turnover in the industry
Highest Risk Stratergic Plan: Setting Financial goals
The reason GM failed because it focussed on market share and it had built a cost base structured for at least
that level of market share
By competing in too many market segments, and not leaving the segments where they could not adapt quickly
enough to make money, GM lost the gamble it had made to try to gain market share from Toyota
Editor of Morningstar offers a great analogy of why it is dangerous to set specific financial targets. It is like
you are driving somewhere and you tell yourself you will drive to a certain destination at an average speed of 63mph.
Instead the way you should do it is to go as fast as road conditions will allow. If you have set projections, you might go too fast
and crash or maybe it is a wide open road and you can gun it.