Warren Buffet's Investment Checklist | Process Street Warren Buffet’s Investment Checklist – Process Street

Record basic details

First, you should record the basic details of the company you are interested in investing in for future reference. Use the form fields below to do so.

Questions To Ask:

Is the business simple and understandable?

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First up, you need to evaluate if the business you're interested in is simple and understandable; if you can't fully grasp the purpose of it, neither will others. Record your evaluations in the dropdown form field below.

"An investor needs to do very few things right as long as he or she avoids big mistakes." Above-average returns are often produced by doing ordinary things exceptionally well.

Does the business have a consistent operating history?

Buffett's experience has been that the best returns are achieved by companies that have been producing the same product or service for several years. Once again, record your observation of this aspect (and the time period of any consistent history) in the form fields below.

Does the business have favourable long-term prospects?

Buffett sees the economic world as being divided into franchises and commodity businesses. He defines a franchise as a company providing a product or service that is (1) needed or desired, (2) has no close substitute, and (3) is not regulated. Look for the franchise business.

You should also ask yourself the following question (if the answer is "no", don't go for it).

A company that provides average or below-average investment returns but generates cash in excess of its needs has three options: (1) It can ignore the problem and continue to reinvest at below average rates, (2) it can buy growth, or (3) it can return the money to shareholders. It is here that management will behave rationally or irrationally. In Buffett's mind, the only reasonable and responsible course is to return that money to shareholders by raising the dividend, or buying back shares.

Is management candid with the shareholders?

Now you need to ask for some more information of the company and assess whether the management is candid with its shareholders. Fill in the form fields below and see the end of this task for Buffet's words on the topic.

Buffett says, "What needs to be reported is data - whether GAAP, non-GAAP, or extra-GAAP - that helps the financially literate readers answer three key questions: (1) Approximately how much is this company worth? (2) What is the likelihood that it can meet its future obligations? and (3) How good a job are its managers doing, given the hand they have been dealt?" "The CEO who misleads others in public may eventually mislead himself in private."

Does management resist the institutional imperative?

Next is the assessment of whether or not the management resists the institutional imperative. Record your observations in the form field below, and see the end of this task for Buffet's breakdown of the topic.

According to Buffett, the institutional imperative exists when:

  • 1
    An institution resists any change in its current direction
  • 2
    Just as work expands to fill available time, corporate projects or acquisitions will materialize to soak up available funds
  • 3
    Any business craving of the leader, however foolish, will quickly be supported by detailed rate-of-return and strategic studies prepared by his troops
  • 4
    The behaviour of peer companies, whether they are expanding, acquiring, setting executive compensation or whatever, will be mindlessly imitated

Is the focus on Return On Equity?

Once again, you need to ask yourself a question about the chosen company; are they focusing on Return On Equity? Record your observations in the form field below.

"The primary test of managerial economic performance is the achievement of a high earnings rate on equity capital employed (without undue leverage, accounting gimmickry, etc.) and not the consistent gains in earnings per share."

What is the rate of "owner earnings"?

Now you should find out the rate of "owner earnings" and record this in the form field below. If you're unsure as to the specifics of this term, see the end of this task for Buffet's breakdown.

Buffett prefers to modify the cash flow ratio to what he calls "owner earnings" - a company's net income plus depreciation, depletion and amortization, less the amount of capital expenditures and any additional working capital that might be needed. Owner earnings are not precise and calculating future capital expenditures requires rough estimates.

Is there a high profit margin?

It's time to consider whether or not there is a high profit margin. As always, record the details of this in the form fields below.

In Buffett's experience, managers of high-cost operations continually add to overhead, whereas managers of low-cost operations are always finding ways to cut expenses. Berkshire Hathaway is a low-cost operation with after-tax overhead corporate expense of less than 1 percent of operating earnings, compared to other companies with similar earnings but 10 percent corporate expenses.

Has the company created at least one dollar of market value, for every dollar retained?

You're almost there; you should now get to calculating the company's market value opposed to the amount retained. Fill in the form field below with this ratio, and if it is not at least 1:1 for every dollar retained, do not continue.

Buffett explains, "Within this gigantic (stock market) auction arena, it is our job to select a business with economic characteristics allowing each dollar of retained earnings to be translated into at least a dollar of market value."

What is the value of the business?

Now you should record the rough value of the business in the form field below. As always, Buffet's breakdown of the topic is at the end of this task to guide you.

Price is established by the stock market. Buffett tells us the value of a business is determined by the net cash flows expected to occur over the life of the business, discounted at an appropriate interest rate, and he uses the rate of the long-term U.S. government bond.

Can it be purchased at a significant discount to its value?

Once you know roughly what the business is worth and it has passed all of your prior checks, you need to see if it can be purchased at a significant discount to its value. Record the discount in the form field below.

Having put a value on the business, Buffett then builds in a margin of safety and buys at prices far below their indicated value.

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