Updated: Jul 18
As investors, our SOP comes in the form of an investing checklist. This checklist helps us to filter out companies that are attractive to own.
What should be included in the checklist?
A good checklist is selective. It covers common mistakes and leaves out those that are rarely made or that don’t matter. Checklists involve a large element of routine. The consequences of a single error can be devastating. This is why they are widely used in niche occupations like like surgeons and pilots. Vocations that allow little to no room for error.
A checklist should be detailed, but not too lengthy. Keep it short and simple for practicality. The list will constantly evolve with the ever-changing market environment. Ideally, we should all have our own checklist of questions that we continually review over time.
1. What if I am wrong?
Before allocating capital to any investment, this is the number ONE question to ask. Most people only focus on “How much can I make?”. They fail to ask the question “How much can I lose?”
If I am wrong about this company, what is the likely reason for it? This is especially true if you’re investing in high growth companies, where the outlook can change at the snap of a finger. High returns attract competition, like bees to honey. It’s important to understand where your company stands in its industry, and who its key competitors are.
2. What’s my target return?
Before investing any of our hard-earned cash, it's wise to have a target return of how much we want to generate in mind.
If your goal is to grow your portfolio by 20% per year, choose companies that are growing at a minimum of 20% per year. On average, the share price of companies increase (or decrease) in line with the company’s growth (or decline).
3. Does the company have good management?
Some characteristics of good management:
Look for founder-led companies. Some examples include Tesla’s Elon Musk.
Listen to what they do, not what they say.
Does the management have strong record on execution?
4. Is the company trading at a discount?
Valuation still matters. Value investing is not dead, meme investing is.
There used to be a time when people said value investing was dead, a time when growth stocks were mooning. This is no longer the case. Have your own valuation method which you can fall back on, whether it be a discounted cash flow (DCF) or other valuation methods.
5. Put yourself in the shoes of a business owner
Think of investing like buying a business. You won't panic sell just because the share price of your business goes down (provided the businesses is still doing well). If you are buying the business, would you trust the current management team to run it? Look at the business from an entrepreneurial point of view, not as an outsider.
Focus on building up a good defence, before going on the offense. Growth stocks are like strikers. At first glance, they might be exciting to own. But when they drop 70%, 80%, or even 90%, the excitement will surely turn to disappointment. It's important to get the fundamentals right by protecting your downside, before focusing on the upside. This is where a checklist comes in to give us a framework that separates the wheat from the chaff.