INVESTORS

HANDBOOK

Bloomsbury Capital
Investors Handbook

Copyright 2014 Direk Khanijou & Goh Tee Leng

INVESTORS HANDBOOK

Reading List

EASY

Buffett: The Making of an American Capitalist by Roger Lowenstein

The Snowball: Warren Buffett and the Business of Life by Alice Schroeder
Tap Dancing to Work: Warren Buffett on Practically Everything by Carol Loomis
The Little Book That Still Beats the Market by Joel Greenblatt
The Big Secret for the Small Investor by Joel Greenblatt
F Wall Street by Joe Ponzio
The Warren Buffett Way by Robert Hagstrom
The Warren Buffett Portfolio by Robert Hagstrom
The Little Book that Builds Wealth by Pat Dorsey
One Up On Wall Street by Peter Lynch
Beating the Street by Peter Lynch
Learn to Earn by Peter Lynch
The Most Important Thing by Howard Marks
Damn Right! by Janet Lowe
Money Masters of Our Time by John Train

MEDIUM

Common Stocks and Uncommon Profits by Philip Fisher

The Essays of Warren Buffett: Lessons for Investors and Managers by Lawrence
Cunningham
You can be a Stock Market Genius by Joel Greenblatt
Margin of Safety by Seth Klarman
What Works on Wall Street by James O Shaughnessy
Contrarian Investment Strategies: The next generation by David Dreman
The Manual of Ideas by John Mihaljevic
The Outsiders by William Thorndike
Quality of Earnings by Thorton Oglove
A Random Walk Down Wall Street by Burton Malkiel

HARD

*The Intelligent Investor by Benjamin Graham

Security Analysis by Benjamin Graham and David Dodd
Berkshire Hathaway Letters to Shareholders by Warren Buffett
The Interpretation of Financial Statements by Benjamin Graham
Financial Shenanigans by Howard Schilit
Value Investing: From Graham to Buffett and Beyond by Brue Greenwald

Copyright 2014 Direk Khanijou & Goh Tee Leng

INVESTORS HANDBOOK

Other good books

Outliers by Malcolm Gladwell

Thinking, Fast and Slow by Daniel Kahneman
Influence by Robert Cialdini
Nudge by Richard Thaler
Think Twice by Michael Mauboussin
Getting To Yes by Roger Fisher
The Selfish Gene by Richard Dawkins
The Black Swan by Nassim Taleb
Irrational Exuberance by Robert Shiller
Fooling Some of the People All of the Time by David Einhorn
The Third Chimpanzee by Jared Diamond
How to Win Friends and Influence People by Dale Carnegie
Think and Grow Rich by Napoleon Hill
How to Win at the Sport of Business by Mark Cuban
Surely Youre Joking Mr. Feynman! by Richard Feynman
Sam Walton Made in America by Sam Walton
Andrew Carnegie by Joseph Frazier Wall
Titan: The Life of John D. Rockefeller Sr. by Ron Chernow
The Wealth of Nations by Adam Smith

Online Resources

Graham and Doddsville (http://www.grahamanddoddsville.net)

Value Letters (http://www.valueletters.com)
The Value Edge (http://www.value-edge.com)
Corner of Berkshire & Fairfax (htttp://www.cornerofberkshireandfairfax.ca)
Safal Niveshak (http://www.safalniveshak.com)
Greg Speicher (htttp://www.gregspeicher.com)

The man who doesnt read good books has no advantage over the man who cant read
them.
Mark Twain

Copyright 2014 Direk Khanijou & Goh Tee Leng

INVESTORS HANDBOOK

From Graham to Buffett: Investment Philosophy

The following article is produced with permission from The Value Edge

To everyone embarking on their investment journey, or even seasoned investors, the
main question we should ask ourselves are we more Graham or Buffett?

Many will question this statement. Arent they all value investors?

Indeed generally speaking, it is true, yet still different in methodology and mindset. In a
tribute video to the Legacy of Benjamin Graham by Columbia Business School, Buffett
illustrates this vast difference aptly. Whilst praising his mentor, he subtly mentioned
how his investment route has deviated from Grahams original philosophy. Essentially
the point he was driving at was Grahams philosophy being more about buying cheap
average companies and diversifying. While himself, he took on more concentrated
positions in quality companies at reasonable valuations.

He was not looking at all for the great business, he was looking for mediocre to a little
bit better than that..businesses that were selling very very cheap..and it worked very
well. But, of course the irony is that the shareholders of Graham made more money out
of Geico which is the antithesis of the company that he would normally invest in.
Warren Buffett
With Graham, it was just a numbers game. Buffett, on the other hand preferred a more
qualitative approach when analysing companies. He would visit companies, understand
the business model and the economic moat it creates, talk to management and consider
the potential of the company in the next 5 to 10 year horizon. The difference between
Graham and Buffett would be that the former felt that such qualitative analysis was
useless and at times counterproductive.
The beauty of investing would be that we need not swing at every pitch. We can keep
waiting for that one perfect pitch before deciding to swing our bat and theres no
umpire who would call you out. Buffett is someone who is constantly waiting for that
home run pitch. Whereas Graham, was just concerned about hitting base hits after base
hits.

Copyright 2014 Direk Khanijou & Goh Tee Leng

INVESTORS HANDBOOK

Warren is brilliant. There is nobody that has ever been like him, and there never will be
anybody like him. We cannot be like him.
Walter Schloss
This is by no means discouraging you from striving to invest like Buffett. From Buffetts
partnership letters and interviews, he has a tremendous amount of investing knowledge
that us investors can learn from. However, the caveat here would be we should
understand our own strengths when it comes to investing. The skill set Buffett has is
something innate and difficult to replicate not impossible but difficult. Someone who is
able to would probably be that one in a million. While with Graham, his investment
philosophy and style is something much easier to copy. Essentially, he wanted to create
a strategy that anyone would be able to replicate easily. Given simple mathematics and
a focus mindset, any average joe would too be able to emulate aspects of his investing
methodology.

Both investment philosophies are proven strategies that work and have performed
exceptionally. The crux would be understanding that us as an individual, what are our
strengths and playing to it.

Copyright 2014 Direk Khanijou & Goh Tee Leng

INVESTORS HANDBOOK

Ratios

Cash Flow per Share You want it to be positive and youd love it to be big.
Companys cash flow divided by the number of shares outstanding.

Current ratio Measure of companys ability to pay its short-term bills. Current
assets/current liabilities. Reveals how easily a company can deal with
unexpected expenses or opportunities. Usually expressed in the number of
times, such as current assets are three times current liabilities or 3:1.

Dividend Yield A financial ratio that shows how much a company pays out in
dividends each year relative to its share price. In the absence of any capital gains,
the dividend yield is the return on investment for a stock.
Earnings per Share (EPS) King of growth measures. Earnings divided by shares
outstanding. Go negative when company loses money. Problem with EPS is that
its subject to manipulation and market pressure. If EPS increases quarter after
quarter at a faster ate, thats called earnings momentum or earnings
acceleration.

Net Profit Margin A ratio of profitability calculated as net income divided by
revenues, or net profits divided by sales. It measures how much out of every
dollar of sales a company actually keeps in earnings.

Price/Book ratio (P/B) If the ratio is less than 1 means youre paying less for
the stock than its liquidation value. If the company goes bankrupt, you should
still get your money back. If the ratio is more than 1, youre paying more than
the stocks liquidation value. However, does not capture intangibles such as
brands and trademarks.
Price/Earnings ratio (P/E) A valuation ratio of a company's current share price
compared to its per-share earnings.

Price/Sales ratio (P/S) A valuation ratio that compares a companys stock price
to its revenues. The price-to-sales ratio is an indicator of the value placed on
each dollar of a companys sales or revenues.

Price/Cash Flow ratio (P/CF) A low price/cash flow ratio is a good indicator of
low valuation and positive returns ahead.

Return on Equity (ROE) The amount of net income returned as a percentage of

shareholders equity. Return on equity measures a corporation's profitability by

Copyright 2014 Direk Khanijou & Goh Tee Leng

INVESTORS HANDBOOK

revealing how much profit a company generates with the money shareholders
have invested.
Return on Assets (ROA) An indicator of how profitable a company is relative to
its total assets. ROA gives an idea as to how efficient management is at using its
assets to generate earnings.

Return on Invested Capital (ROIC) A performance measure used to evaluate

the efficiency of an investment or to compare the efficiency of a number of
different investments.

Free Cash Flow Yield Free cash flow yield offers investors a better measure of a
company's fundamental performance than the widely used P/E ratio. Investors
who wish to employ the best fundamental indicator should add free cash flow
yield to their repertoire of financial measures.

Copyright 2014 Direk Khanijou & Goh Tee Leng

INVESTORS HANDBOOK

Super-Investors

Warren Buffett
Charlie Munger
Benjamin Graham
Walter Schloss
Bill Ruane
Philip Fisher
John Templeton
Peter Lynch
Joel Greenblatt
William ONeil
Bill Miller

Warren Buffett:
Buys quality companies at bargain prices
Economic Moat
Read his Partnership Letters

Benjamin Graham:
Likes P/B to be less than 1
Low P/E ratios, preferably below 10
Dislikes debt
Margin of Safety
Mr. Market

Walter Schloss
Bought cigar-butt companies trading at 1/3 net working capital
Very diversified portfolio 60-100 companies because he wanted to sleep well
and claimed not to be a good judge of business trends or management capability
- unlike Warren Buffett
Cared very little about the nature of business
Companies whose current stock price was below its book value per share
Companies with real assets and little to no debt
Preferred to look at the Balance Sheet rather than Income Statement
Rarely talked to managements relied on numbers
Liked stocks with long histories and track records
Would look at stock at or near 52-week low
Would sometimes buy after dividend cut. Investors usually overreact to dividend
cuts which provide a golden opportunity to invest
Was not afraid to hold cash
Likes high insider ownership
Likes low P/E

Copyright 2014 Direk Khanijou & Goh Tee Leng

INVESTORS HANDBOOK

Philip Fisher
Investors should buy businesses with the ability to grow sales and profits over
the years at rates greater than their industry average
Recommends a focused portfolio of superior companies
Concentrate on companies within your circle of competence
Conduct scuttlebutt where possible

Peter Lynch
Growth investor
Likes companies with lots of cash and little debt
Rule of thumb is that a companys P/E should equal its earnings growth rate. He
writes, If the P/E of Coca-Cola is 15, youd expect the company to be growing at
about 15% a year. But if the P/E is less than the growth rate, you may have
found yourself a bargain.
Before buying a stock he recommends a two minute monologue that covers the
reasons hes interested in it, what has to happen for the company to succeed
and the pitfalls that stands in its path

Copyright 2014 Direk Khanijou & Goh Tee Leng

INVESTORS HANDBOOK

Introduction

Its not supposed to be easy. Anyone who finds it easy is stupid.

Charlie Munger

Investing cant be reduced to an algorithm and turned over to a computer. Even the
best investors dont get it right every time. The reasons are simple. No rule works. The
environment isnt controllable, and circumstances rarely repeat exactly.

Investing, like economics, is more art than science. And that means it can get a little
messy. This means it cant be routinized.

To accomplish successful investing, you need either good luck or superior insight.
Counting on luck isnt much of a plan, so youd better concentrate on insight. In
basketball they say, You cant coach height. Its almost as hard in investing to teach
insight. As with any other art form, some people just understand investing better than
others. They have or manage to acquire that necessary trace of wisdom that Ben
Graham so eloquently calls for.

Mr. Market

Ben Graham said you should imagine market quotations as coming from a remarkably
accommodating fellow named Mr. Market who is your partner in a private business.
Without fail, Mr. Market appears daily and names a price at which he will either buy
your interest or sell you his.

Even though the business you own that the two of you own may have economic
characteristics that are stable, Mr. Markets quotations will be anything but. At times he
feels euphoric and can see only the favorable factors affecting the business. When in
that mood, he names a very high buy-sell price. At other times he is depressed and can
see nothing but trouble ahead for both the business and the world. On these occasions
he will name a very low price.

Mr. Market has another endearing characteristic: He doesnt mind being ignored. If his
quotation is uninteresting to you today, he will be back with a new one tomorrow.
Under these conditions, the more manic-depressive his behavior, the better for you.
Mr. Market is there to serve you, not to guide you.

If he shows up some day in a particularly foolish mood, you are free to either ignore him
or to take advantage of him, but it will be disastrous if you fall under his influence.
Indeed, if you arent certain that you understand and can value your business far better
than Mr. Market you dont belong in the game. As they say in poker, If youve been in
the game 30 minutes and you dont know who the patsy is, youre the patsy.

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Circles of Competence

If we have certain strength, it is in recognizing when we are operating well within our
circle of competence and when we are approaching the perimeter.
Warren Buffett

Im no genius. Im smart in spots, and I stay around those spots.
Thomas Watson Sr.

Munger on Diversification

The idea of excessive diversification is madness.

If you took our top 15 decisions out, wed have a pretty average record. It wasnt
hyperactivity, but a hell of a lot of patience. You stuck to your principles, and when
opportunities came along, you pounced on them with vigor.

Whats funny is that most big investment organizations dont think like this. They hire
lots of people, evaluate Merck versus Pfizer and every stock in the S&P 500, and think
they can beat the market. You cant do it.

Stocks and Hamburgers

A short quiz: If you plan to eat hamburgers throughout your life and are not a cattle
producer, should you wish for higher or lower prices for beef? Likewise, if you are going
to buy a car from time to time but are not an auto manufacturer, should you prefer
higher or lower car prices?

But now for the final exam: If you expect to be a net saver during the next five years,
should you hope for a higher or lower stock market during that period? Many investors
get this one wrong. Even though they are going to be net buyers of stocks for many
years to come, they are elated when stock prices rise and depressed when they fall.
They rejoice because prices have rose for the hamburgers they will soon be buying.
This reaction makes no sense. Only those who will be sellers of equities in the near
future should be happy at seeing stocks rise. Prospective purchasers should much prefer
sinking prices.







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Efficient Market Theory (EMT)

EMT proponents observed correctly that the market was frequently efficient, however,
they went on to conclude incorrectly that it was always efficient. The difference
between these propositions is night and day.

Some asset classes are quite efficient. In most of these:
The asset class is widely known and has a broad following
The class is socially acceptable, not controversial or taboo
The merits of the class are clear and comprehensible, at least on the surface
Information about the class and its components is distributed widely and evenly

Paul Johnson: Inverting these conditions yields a test of market inefficiency. For
instance, in the first case, if an asset is not widely known and broadly followed, it might
be inefficiently priced; in the second case, if an asset is controversial, taboo, or socially
unacceptable, it might be inefficiently priced; and so on for each of the other two cases.

Risk

According to academicians who developed capital market theory, risk equals volatility,
because volatility indicates the unreliability of an investment. Volatility is used as the
proxy for risk as a matter for convenience.

Doesnt I need more upside potential because Im afraid of losing money makes an
awful lot more sense that I need more upside potential because Im afraid the price
may fluctuate.

Best to define risk as the probability of a permanent loss of capital.

Lets say you make an investment that works out as expected. Does that mean it wasnt
risky? Maybe you buy something for $100 and sell it a year later for $200. Was it risky?
Who knows? Perhaps it exposed you to great potential uncertainties that didnt
materialize. Thus, its real riskiness might have been high. Or lets say the investment
produces a loss. Does that mean it was risky? Or that it should have been perceived as
risky at the time it was analyzed and entered into?

Fooled by Randomness, by Nassim Taleb, is the authority on this subject. He talks about
the alternative histories that could have unfolded but didnt. How often in our business
are people right for the wrong reason? These are the people Nassim Taleb calls lucky
idiots and in the short run its certainly hard to tell them from skilled investors.

Many futures are possible, but only one future occurs. The future you get may be
beneficial to your portfolio or harmful, and that may be attributable to your foresight,
prudence or luck.
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Return alone and especially return over short periods of time says very little about
the quality of investment decisions. Return has to be evaluated relative to the amount
of risk taken to achieve it.

People usually expect the future to be like the past and underestimate the potential for
change.

We hear a lot about worst-case projections, but they often turn out not to be negative
enough. Heres a story of the gambler who lost regularly: One day he heard about a
race with only one horse in it, so he bet the rent money. Halfway around the track, the
horse jumped over the fence and ran away. Invariably things can get worse than people
expect. Maybe worst-case means the worst weve seen in the past. But that doesnt
mean things cant be worse in the future. In 2007, many peoples worst-case
assumptions were exceeded.

Its only when the tide goes out that you find out whos been swimming naked.
Warren Buffett

Investing Simplified

To invest successfully, you need not understand beta, efficient markets, modern
portfolio theory, option pricing, or emerging markets. You may, in fact, be better off
knowing nothing of these. That, of course, is not the prevailing view at most business
schools, whose finance curriculum tens to be dominated by such subjects. In our view,
though, investment students need only two well-taught courses How to Value a
Business, and How to Think About Market Prices.

Your goal as an investor should simply be to purchase, at a rational price, a part interest
in an easily understandable business whose earnings are virtually certain to be
materially higher 5, 10, and 20 years from now. Over time, you will find only a few
companies that meet these standardsso when you see on that qualifies; you should
buy a meaningful amount of stock. You must also resist the temptation to stray from
your guidelines: If you arent willing to own a stock for 10 years, dont even think about
owning it for 10 minutes. Put together a portfolio of companies whose aggregate
earnings march upward over the years, and so also will the portfolios market value.









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Transaction Costs

Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir
Isaacs talents didnt extend to investing: He lost a bundle in the South Sea Bubble,
explaining later, I can calculate the movement of the stars, but not the madness of men.
If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover
the Fourth Law of Motion: For investors as a whole, returns decrease as motion
increases.

Compounding is the 8th wonder of the world. Do not interrupt it unnecessarily.
Albert Einstein

Aesop and Inefficient Bush Theory

The formula for valuing all assets that are purchased for financial gain has been
unchanged since a very smart man first laid it out in about 600 B.C.

The oracle was Aesop and his enduring investment insight was a bird in the hand is
worth two in the bush (or a girl in a convertible is worth five in the phonebook). To
flesh out this principle, you must answer only 3 questions. How certain are you that
there are indeed birds in the bush? When will they emerge and how many will there be?
What is the risk-free interest rate (which we consider to be the yield on long-term U.S.
bonds)? If you can answer these three questions, you will know the maximum value of
the bush and the maximum number of the birds you now possess that should be
offered for it. And, of course, dont literally think birds. Think dollars.


Common yardsticks such as dividend yield, P/E ratio, P/B and even growth rates have
nothing to do with valuation except to the extent they provide clues to the amount and
timing of cash flows into and from the business. Indeed, growth can destroy value if it
requires cash inputs in the early years of a project that exceed the discounted value of
the cash that those assets will generate in later years. Growth is simply a component
usually a plus, sometimes a minus in the value equation.
Warren Buffet

Value is destroyed, not created, by any business that loses money over its lifetime, no
matter how high its interim valuation may get.








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Intrinsic Value

Intrinsic value: The discounted value of the cash that can be taken out of a business
during its remaining life.

Intrinsic value is an estimate rather than a precise figure, and it is traditionally an
estimate that must be changed if interest rates move or forecasts of future cash flows
are revised. Using precise number is, in fact, foolish; working with a range of possibilities
is the better approach.
Warren Buffett

No matter what a company makes, its still the same question: How much cash do we
get and when? The name attached to the cash doesnt matter.

What youre trying to do is to look at all the cash a business will produce between now
and judgment day and discount it back to the present using an appropriate discount rate
and buy a lot cheaper than that. Whether the money comes from a bank, an Internet
company, a brick companythe money all spends the same. Why pay more for a
telecom business than a brick business? Money doesnt know where it comes from.
Theres no sense in paying more for a glamorous business if youre getting the same
amount of money, but paying more for it. Its the same money that you can get from a
brick company at a lower cost. The question is what are the economic characteristics of
the bank, the Internet company or the brick company. Thats going to tell you how much
cash they generate over long periods in the future.
Warren Buffett

First, we try to stick to businesses we believe we understand. That means they must be
relatively simple and stable in character. If a business is complex or subject to constant
change, were not smart enough to predict future cash flows. Incidentally, that
shortcoming doesnt bother us. What counts for most people in investing is not how
much they know, but rather how realistically they define what they dont know. An
investor needs to do very few things right as long as he or she avoids big mistakes.

Second, and equally important, we insist on a margin of safety in our purchase price. If
we calculate the value of a common stock to be only slightly higher than its price, were
not interested in buying. We believe this margin-of-safety principle, so strongly
emphasized by Ben Graham, to be the cornerstone of investment success.
Warren Buffett

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Predictions

The art of prophecy is very difficult, especially with respect to the future.

Mark Twain

There are 60,000 economists in the US, many of them employed full-time trying to
forecast recessions and interest rates, and if they could do it successfully twice in a row,
theyd all be millionaires by now As far as I know, most of them are still gainfully
employed, which ought to tell us something.
Peter Lynch

Misuse of EBITDA

Every time you see the word EBITDA, you should substitute the words bullshit
earnings.

Rules and Filters

Buffetts 4 investment criteria:
Can I understand it? If it passes this filter,
Does it look like it has some kind of sustainable competitive advantage? If it
passes this filter,
Is the management composed of able and honest people? If it passes this filter,
Is the price right? If it passes this filter, then we write a check

Quantification

Leaving the question of price aside, the best business to own is one that over an
extended period can employ large amounts of incremental capital at very high rates of
return. The worst business to own is one that must, or will, do the opposite that is,
consistently employ ever-greater amounts of capital at very low rates of return.
Warren Buffett

We cant expect to get a higher return on investment over time than the underlying
business produces on its invested capital over time.

Over the long term, its hard for a stock to earn a much better return than the business
that underlies it earns. If the business earns 6% on capital over 40 years and you hold it
for that 40 years, youre not going to make much different than a 6% return even if you
originally buy it at a huge discount. Conversely, if a business earns 18% on capital over
20 or 30 years, even if you pay an expensive looking price, youll end up with a fine
result.
Charlie Munger
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Contrarianism

To buy when others are despondently selling and to sell when others are euphorically
buying takes the greatest courage, but provides the greatest profit.
Sir John Templeton

You must do things not just because theyre the opposite of what the crowd is doing,
but because you know the crowd is wrong.

The very coalescing of popular opinion behind an investment tends to eliminate its
profit potential. For example, the investment that everyone believes to be a great idea.
In my view by definition it simply cannot be so.

If everyone likes it, its likely the price has risen to reflect a level of adulation form which
relatively little further appreciation is likely. Sure, its possible for something to move
from overvalued to more overvalued, but I wouldnt want to count on it.
Yogi Berra: Nobody goes to that restaurant anymore; its too crowded. Its just as
nonsensical to day Everyone realizes that investments a bargain. If everyone realizes
it, theyll buy, in which case the price will no longer be low. Buying what everybody likes
doesnt make large amounts of money. Buying what everybody underestimates makes
one rich.

Investor sentiment was extreme in October 2008. Valuations were incredibly cheap, and
stocks offered wonderful returns looking forward. In fact, over the next two years
returns were spectacular. Unfortunately, stocks first fell another 20% from the already
low October 2008 levels before they eventually turned around in March 2009.
Joel Greenblatt

Skepticism and pessimism arent synonymous. Skepticism calls for pessimism when
optimism is excessive. But it also calls for optimism when pessimism is excessive.

Most people say, Were not going to try to catch a falling knife; its too dangerous.
They usually add, Were going to wait until the dust settles and the uncertainty is
resolved. When buying something has become confortable again, its price will no
longer be so low that its a great bargain. Therefore, as contrarians, you should catch
falling knives with care and skill.

Conventional Behaviour
Unconventional Behaviour
Favourable Outcomes
Unfavourable Outcomes

Average good results

Average bad results

Copyright 2014 Direk Khanijou & Goh Tee Leng

Above-average results
Below-average results

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Knowing What You Dont Know

We have two classes of forecasters: Those who dont know and those who dont know
they dont know.
John Kenneth Galbraith

Focus on what is knowable. The future and the macroeconomic climate is not
knowable

It aint what you dont know that gets you into trouble. Its what you know for sure that
just aint so.
Mark Twain

Pulling It All Together

Underpriced is far from synonymous with going up soon. Being too far ahead of your
time is indistinguishable from being wrong. It can require patience and fortitude to hold
positions long enough to be proved right.

Theres usually someone who gets it exactly rightbut its rarely the same person twice.
The most successful investors get things about right most of the time. Keynes: It is
better to be roughly right than precisely wrong.

Business Evaluation

Filter 1 Can I understand the business predictability?
Reasons for demand How certain am I that people are likely to continue buy
this type of product or service in the future? What has happened in the past and
what is likely to happen in the future? Cyclically in demand? Capacity versus
demand?
Return characteristics Industry and company return characteristics and change
over the last 10 years?
Industry structure No of competitors and size? Who dictate the terms in this
industry? What is needed to make money in this industry? Position within the
industry? Do I know who is going to make the money in this market and why?
Real customer Who decides what to buy and what are his decision-criteria?

Filter 2 Does it look like the business has some kind of sustainable competitive
advantage?
Competitive Advantage How certain am I that they are likely to buy the
product or service from the company rather than from someone else? Are the
reasons virtually unchanged from what they were ten years ago? Are these
motivations likely to be unchanged over the next ten years?

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Value How strong and sustainable is this advantage? Have the advantages
become stronger and more durable over the years? What can destroy or reduce
them? Barriers to entry? Brand loyalty? Vulnerable to change in demand or
prices? Easy to copy? Short product life cycle? Customer cost and incentive to
switch supplier? Annual cost differential against competition? Capital
investments needed? Bargaining power? Obsolescence risk? New customer
alternatives? Change in buying habits or power? Competitor potential to
undercut prices assuming same cost structure? What is needed to make sure the
advantages stay sustainable? Growth opportunities left? Is the demand for the
product likely to grow? Untapped unit volume demand? Pricing power?
Profitability Can the advantage be translated into profitability and why? How
does the company make money? How much capital is needed to produce
incremental revenues? Financial characteristics return on capital, gross
margins, sales growth, cost and capital structure and efficiency? Normalized free
cash flow? Advantages of scale? Critical variable?

Filter 3 Able and honest management?
Is the management composed of competent and honest people that
understands and focuses on creation of value?

Filter 4 Is the price right?
Can I buy at a price that provides a good return with a huge margin of safety
measured against other available alternatives and with evidence from facts and
figures?

Filter 5 Disprove
How can the business get killed? If the company could kill one of its competitors,
who would it be and why? If the company would go away for 5 years which
competitor would they bet on and why? How resistant is the business to
adversity? Assume the company paid out all its equity capital, would it still have
any value? Could someone with the access to billions of dollars and talent,
successfully compete with the company? How much damage could a competitor
do if he doesnt care about returns? Recession sensitivity? Execution risk? Will
new technology help or hurt?

Filter 6 What are the consequences if Im wrong?

And with that, we have nothing more to add.

Copyright 2014 Direk Khanijou & Goh Tee Leng

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