Hardbound

A Checklist For Long-Term Investors

An extract from Saurabh Mukherjea's book, 'The Unusual Billionaires'

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Published 5 years ago on Aug 26, 2016 5 minutes Read

As analysts, my community is trained to comprehensively and objectively analyse a company and provide a recommendation to investors to buy or sell that company’s stock at its current market price. I routinely study annual reports, read interviews of company promoters, and follow news that affects the Indian economy and industries. I also have access to some of India’s topmost business leaders, and these interactions provide me with a perspective on industries on the Indian economy. These resources-financial accounts, meetings and primary data collection-help me in my work and have also helped me write this book. The distillation of this research and study has thus far focused on the companies that have most often featured in the Coffee Can Portfolios. However, I appreciate that as readers you might not have the same time and resources at your disposal. Hence, to make this book more useful for you (beyond the value of the Coffee Can construct), I have prepared a checklist which is inspired by Atul Gawande, the famous American surgeon, writer and public health researcher.

Writing about checklists in his 2007 column for the New Yorker, Gawande spoke of how line infections during surgery were so common that they were considered routine. He went on to give an example checklist to address just this one problem of line infections. ‘On a sheet of plain paper, he plotted out the steps to take in order to avoid infections when putting a line in. Doctors are supposed to: (1) wash their hands with soap, (2) clean the patient’s skin with chlorhexidine antiseptic, (3) put sterile drapes over the entire patient, (4) wear a sterile mask, hat, gown, and gloves, and (5) put a sterile dressing over the catheter site once the line is in. Check, check, check, check, check.’ The results were dramatic: in the following years, when results were tracked, the checklist had prevented forty-three infections and eight deaths, and saved US$2 million in costs.

Investment in stock is a tough, rigorous and complex process. The checklist that follows is by no means a comprehensive one. Instead, it distils the key lessons from the journeys of the seven companies that you have just read about in the preceding chapters. Before you read this checklist, I must point out that no checklist can be a magic wand that transforms the process of finding valuable stocks into a quick, leisurely exercise. I have met many students, friends and retail investors who are on the lookout for the next ten-bagger, but have no patience to sift through and rigorously analyse companies. For them, this checklist will be of little use! As the great Fidelity fund manager, Peter Lynch, said, ‘What distinguishes investment winners, as you’ll see in this book, is the willingness to dig deeper, search more widely and keep an open mind to all ideas-including the idea that you might have made a bad call. He or she who turns over the most rocks, looks over the most investment ideas, and is unsentimental about past choices is most likely to succeed."

Instead, the checklist is designed to help those readers who are genuinely committed to understanding and researching companies. Think of it as a route map that you can use to focus your research efforts better as you go through the journey of understanding and researching a company.

More generally, in the investment management industry and elsewhere, a checklist helps us to stay focused and enforce an effective, objective and thorough decision making process. Taking another leaf out of Gawande’s book, in order to remain simple and practical, my checklist focuses only on critical elements. As Gawande writes in The Checklist Manifesto, ‘Good checklists, on the other hand are precise. They are efficient, to the point, and easy to use even in the most difficult situations. They do not try to spell out everything –a checklist cannot fly a plane. Instead, they provide reminders of only the highly skilled professional using them could miss. Good checklists are, above all, practical.’

My checklist is limited to three major heads: industry attractiveness, management quality and competitive advantages. While each of these broad categories, in turn, has numerous subheads within them, I have restricted the checklist to simple question for the sake of making the material easier to follow.

One last thing to keep in mind is that this is a checklist for evaluating businesses and not stocks. In other words, the aim of this book and this chapter is to help you identify outstanding businesses which have a high probability of producing outstanding results in the long turn. The book is not intended to help you construct speculative trading strategies that will successfully generate short-term returns. Why, you might ask, am I biased towards long-term focused investment strategies?

Whilst there are other successful modes of investing in the equity market-for example, some speculators use share price charts to trade in and out of the stocks over the course of a single day-their ability to deliver sustained market outperformance over long periods of time,(say, three years or more) is unproven in the Indian context.

In more mature markets, such as those found in some developed economies, which have much greater liquidity and greater transparency, short-term trading has been successfully practiced over long periods of time by legendary American investors such as George Soros, Julian Robertson and Michael Steinhardt.

However, given that India is the least liquid* amongst the world’s fifteen largest equity markets, the only viable option open to those who want to deploy large sums of capital successfully is long-term investing. Hence, this book has focused on how a handful of companies have consistently delivered good results over very long periods of time. In doing so, they have created astonishing amounts of wealth for their shareholders.

*Liquidity for a stock is usually measured by how much trading (measured in million US$) takes place in that counter on a daily basis. This is called the Average Daily Value or ADV. ADV: Market Cap is therefore a simple measure of how liquid a stock market is. Most large stock markets have a ratio of around 0.30 per cent, i.e. 0.30 per cent of the market cap is being traded in that market on a daily basis. For India, the corresponding figure, in June 2015, was 0.18 per cent even if we sum up the liquidity on the NSE and the BSE.