The Checklist – How to analyze a business for long term investing?

Most of us spend time analyzing just the financial metrics of a business, but successful long-term investing requires a deeper understanding beyond numbers. It demands insight into the business model, industry dynamics, and management’s history, capabilities, and vision. To achieve this, asking the right questions is crucial.

To do so, over the last few years, I’ve compiled a comprehensive checklist of key questions that has helped me better understand the businesses I analyze. Using this checklist ensures a systematic approach to research, reducing bias and ensuring thoroughness. You can use this checklist to get started with your research.

Business

• What does it make? All the products or services the business offers.
• How does it make revenue?
• Who are the real customers? A person who is paying might not be the customer. Example – The company pays for the 401K account but employees are the real customer.
• Is there a key customer? Big customer can give immense buying power to the customer and also increases survival risk. Example – what if a startup has only one customer who suddenly refuses to buy?
• Do customers pay for the service? Sometimes the customer might not pay at all. Example – Facebook, Instagram, Twitter, etc.
• What are the payment terms offered to customers? (If you want to learn about payment terms – click here)
• What is the income of the average customer ? (If applicable)
• Is the product or service customer’s want or need?
• What % of customer’s income do they charge?
• Who are the suppliers?
• Is the business dependent on any key suppliers?
• What are the payment terms offered to suppliers?
• Who are its major competitors?
• (If) How is this business different than its competitors? Example: Low cost provider, better customer service, unique product feature, early market entrant, market share leader etc.
• Does this business have an identifiable business model ? Example – Marketplace business, brokerage business, B2C, B2B, etc. This will help list down important KPIs.
• Is it a high fixed-cost business?
• How strong is the economy of scale?
• What are the KPIs of this business?
• Does it have pricing power? If yes, why? Is it due to brand value, unique value proposition, location advantage, regulations, etc.
• Who are the stakeholders of this business? Example: Customers, Suppliers, Employees, Management, Government, etc. List down all you can think of.
• Is the stakeholder priority clear and balanced? Example: Costco clearly states that customers, and employees have a higher priority than shareholders. Their actions, and outcome match.

Management

• What is the history of CEO and other key management personnel ? Background, Education, previous jobs, etc. This will help you understand the person better.
• How long has the CEO been the part of the company? Longevity is important.
• What has been the tenure of other executives in the company?
• Is the CEO transparent and truthful ? Look for their commentary on the competition. If they belittle competition’s success, its a red flag.
• Has the CEO and the management achieved their communicated goals in the past?
• How did the CEO explain about the mistakes that he made in the past?
• What are the future goals the CEO has set for the company? Are they long term or short term focused?
• What is the CEOs and Management’s ownership percentage? Higher the better.
• What does the management’s compensation look like? Is it higher than the industry average? if yes, why?
• Is the management’s compensation growing at a faster rate than company? if yes, is it due to external conditions or not?
  
  

Capital Allocation

• Is the long term ROIC (5 year average) higher than cost of capital? If not, what is the reason? (You can find the answer in management’s commentary)
• Is the ROIC higher or lower than industry peers? If yes, why?
• Does it pay dividends ? If yes, what is the dividend pay-out ratio? (Higher payout ratio could be bad)
• What is the stock buy back history and strategy under current management? (Buybacks are not always good. Buying back at higher prices is bad for long term shareholders)
• Does the management focus on EBITDA instead of operating earnings in their commentary? (This could be a red flag because depreciation and amortization are real costs in the long run)
• What is their RSU policy for the employees? RSUs can be good for retention but it should be considered as a real cost as it dilutes the shareholders in the long run.
• What is the Debt/Equity ratio?
• Is the Debt/Equity ratio higher than it’s peers?
• What are the terms of debt? Look for the interest, payment tenure, and due date.
• Did the management provide any justification or reasons while raising debt?
• What is the long term ROE ? Look for ROE for at least one economic cycle.
• What are the factors that are driving the ROE? Use this framework to analyze ROE.

Using this checklist will help you develop a deep understanding of different aspects of the business. It may help you identify red flags and save you from investing in company that you would have invested in only because of its financial numbers. It might also help you uncover the moat of a business that the market might be failing to recognize.

NOTE: This is an ongoing and live checklist. When I come across things that are important but I missed (I often do), I will come here and add to the checklist. If you find this checklist helpful, bookmark this page (or at least print it), and have it in front of you while analyzing a business.

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