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The Investment Checklist

The Investment Checklist

Michael Shearn
2011
T4 363 pages · about 6h 3m to read Open Librarygoodreads

Seventy questions to ask before buying any business.

Summary

Shearn, who ran a private investment partnership, sets out a structured process for evaluating a business before buying its equity, organised as roughly seventy questions grouped by subject: understanding the business, evaluating the customer, the competitive position, management's quality and integrity, management's capital allocation record, the financial statements, and valuation.

The distinctive material is on customers and management. Shearn argues that most investors examine financial statements before they understand who the customer is, why they buy, how much they would pay to keep buying, and what would make them stop. He gives specific methods for finding this out, including talking to customers, examining churn and repeat purchase data, and identifying whether the customer is captive. On management he sets out how to read proxy statements, compensation structures and share ownership, how to assess whether stated goals were met, and how to evaluate acquisition history and buyback timing as evidence of capital allocation judgement.

The book's premise is that a written checklist enforces the discipline of asking questions an investor will otherwise skip when enthusiastic. Shearn draws on Atul Gawande's checklist work and on Buffett and Munger's stated criteria. The weakness is that seventy questions is more than any process can sustain, the book does not weight them, and there is no evidence that following it improves returns. It is also written for concentrated long-horizon equity investing and does not fit other approaches. Used selectively, as a source of questions to build a shorter personal checklist, it is genuinely useful.

Key takeaways 7

  1. An investor should understand who the customer is and why they buy before examining any financial statement.
  2. Customer captivity, measured by switching cost and repeat purchase behaviour, predicts the durability of margins better than reported profitability does.
  3. Management's capital allocation record, visible in past acquisitions and buyback timing, is the most reliable evidence of judgement available to an outside investor.
  4. Compensation structure predicts management behaviour, so a proxy statement should be read before an annual report.
  5. A written checklist enforces asking the questions an enthusiastic investor will otherwise skip.
  6. An investor should be able to state what would make them sell before they buy, since defining the disconfirming evidence in advance is the only protection against rationalising.
  7. Businesses whose customers would be materially harmed by switching are worth more than businesses with equal current margins and no switching cost.

Who should read it

Concentrated long-horizon equity investors building a written diligence process, used as a source of questions rather than as a checklist to follow in full.

Who recommended it 2 · 2 direct

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Where it sits in the reference 2

Investment philosophy
Investment styles

Topics

InvestingDecision Making