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The Comprehensive Investment Checklist: Part 1

Among the many investment books I have read, only a few have inspired me enough for me to write about them in some detail.

One of them would be The Investment Checklist by Michael Shearn. He serves on the investment committee of Southwestern University, which oversees the school’s US$250 million endowment, and is also a member of the advisory board for the University of Texas MBA Investment Fund.

Through a series of articles, starting from this piece, I will be listing down the main questions in his investment checklist and providing a brief explanation for each. For the more detailed version, I would encourage readers to purchase his book. The first segment of the checklist would be “Understanding the Business – The Basics,” and is what I’m covering here.

1. Do I want to spend a lot of time learning about this business?

If it’s a business which shows good promise and is easy to understand, it may be worth the investor’s time to dig deeper and to engage in due diligence. This can be a high-level filter — if a business is either too complex or too opaque, it may be better to give it a pass.

2. How would you evaluate this business if you were to become its CEO?

This is an interesting perspective and refers to the investor pretending to take on the role of the chief executive officer (CEO) of the business he is researching. Which areas will he look into and how deep would he go towards understanding the business to satisfy himself with his knowledge?

3. Can you describe how the business operates, in your own words?

If the business cannot be described in simple terms, this implies that it may be too complex to understand easily, or it may be dealing with products which are too technical for the layman to comprehend.

4. How does the business make money?

A very basic question, but an absolutely necessary one to be able to answer convincingly. Some businesses go through a complex web of transactions to earn their money, and it may not be readily apparent to the investor on how exactly the company makes money.

5. How has the business evolved over time?

A business which stays static is doomed to fail, as the business environment is dynamic and continuously evolving. An investor should learn how a business has adapted over the years to respond to new trends or challenges, and whether it has been successful in doing so.

6. In what foreign markets does the business operate, and what are the risks of operating in these countries?

The above point relates to exposure to countries which may have unique legal, regulatory, political or operating risks. I had written previously on how one should go about assessing the regions one’s portfolio is exposed to. The investor should now go one step further to assess the risks in each jurisdiction where the company earns a significant portion of its revenue.

The next part of the series would look into the customer aspect for the business and the questions relating to that. [Editor’s note: The second part of this series has been published. It can be found here.]

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