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

Distribution channels

Marketing strategies

Manufacturing activities

Regulatory requirements

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

Example:Car Maintenance

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.

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