1. Does the business have a strong balance sheet, preferably with net cash?
- Does the business have net cash or net debt?
- Are the company's debt and net debt levels increasing or decreasing?
- How does the company use debt? Is it strategic (issuing long-term debt at today's record-low interest rates), is it out of necessity, or is management mortgaging the company's future to buy back stock and increase the dividend while underinvesting in growth and adaptability?
- What is the cyclical nature and capital intensity of the industry? Is the business both cyclical and capital intensive (something that is often a bad combination)?
- Does the company have a lot of operating leverage and financial debt leverage (a bad combination if sales start to fall)? Operating leverage works both ways: If sales fall, earnings fall faster, and the company's interest coverage ratios fall, making it more difficult to service its debt.
- What is the company's cost of debt (the interest rate it pays to borrow money)? What are its maturities on its debt (repayment schedules)? And can the company withstand rising interest rates?
- What percentage of the debt is fixed-rate versus a variable rate?
- What amount of debt is corporate debt versus bank debt?
- What are the size of pension obligations and operating leases?
- What is the company's credit rating?
- What are the company's financial health ratios including net debt to free cash flow, interest coverage, debt to equity, debt to total capital, net cash to total assets, net cash to market cap, and goodwill (intangibles) to total assets?
- If we ever have another economic shutdown as we experienced in the first and second quarters of 2020 in response to the global coronavirus pandemic, how long can the company's cash on its balance sheet cover the company's total annual expenses on the income statement (assuming the company generates zero revenue)? This is the ultimate stress test.
2. Can the business generate organic revenue growth powered by a large market opportunity and/or long-term tailwinds?
- What is the total addressable market (TAM) and is the market growing?
- What long-term secular themes are powering the company's growth?
- Does the business have a product or service that is relevant and in high demand?
- Is the business completely customer- and product-obsessed?
- Does the company create joy for its customers?
- Is the business committed to investing in innovation and long-term growth through research and development (R&D), capital expense, and recruiting and retaining top talent? What I'm ultimately trying to figure out is if the business is innovating and adapting to maintain growth and relevance in a rapidly changing digital world.
- Does the business have clear opportunities to reinvest capital at high rates of return?
- What is the company's go-to-market strategy?
3. Does the business have rising or stable margins, with particular emphasis on gross margins and net operating profit after tax (NOPAT) margins?
- What is driving the margin increase or decrease? Pricing power? Scale, high operating leverage, and incremental margins? A new product launch? A shift in the mix of the business from selling lower-margin to higher-margin products or services? Acquisitions or divestitures? Cost-cutting programs? A change in corporate tax rates or other regulations?
- Does the company have a fixed-cost or variable-cost business model?
- Is the product mission-critical for customers but accounts for only a small percentage of customers' cost of doing business?
- Does the business have a culture of profitable growth or a culture of growth at any cost?
4. Can the business generate high (or increasing) returns on invested capital (ROIC) and growing earnings and free cash flow (FCF)?
- Does the company have a unique business model or is there something else unique about the business that is hard to replicate?
- Are the barriers to entry high?
- Are the barriers to success high?
- Is the company a market share leader, and does it have limited competition? Is its market share growing?
- Does the business have the very best product and the very best customer service in the industry? Is the product or service integrated into the fabric of the customer's business? Is there a very close relationship with customers that creates constant feedback and innovation?
- Is the business fundamental to our way of life? In other words, if the business suddenly disappeared, would the world be set back five, 10, or even more years?
- Does the business have defensible competitive advantages?
- What are the sources of its competitive advantages? (culture, adaptability, brand and other intangibles, high switching costs, scale, network effects)?
- Is the company investing to protect its moat? (Most companies don't have moats and those that do often have declining legacy or shrinking moats, but the rare few have wide and sustainable moats).
- Is the company investing in building new moats over time?
- Do I understand the competitive environment, market-share trends, the rationality (or lack thereof) of pricing in the industry?
- Did I perform a DuPont Analysis?
- Is management compensation based on ROIC (or a similar return-based metric) or FCF?
- Does management base its capital allocation decisions on ROIC (or a similar return-based metric)?
- Do management's language and writings constantly refer to metrics such as profitable growth, ROIC, and FCF?
5. Is the business led by an exceptional CEO and quality leadership team?
- Is the CEO also the founder or co-founder?
- Does the CEO have high inside ownership of the company?
- Is the CEO focused on building long-term profitable growth over short-term earnings per share (EPS)?
- Is the CEO someone I'd want to work for?
- Is the CEO compassionate, capable, candid, and committed?
- Does the CEO have a soul in the game, in addition to skin in the game?
- Has the CEO created and nurtured a healthy and enduring corporate culture?
- Has the CEO created an ESG-centric culture that permeates every level of the business, including having an executive compensation plan that's partly based on ESG-related criteria (see Accenture)?
- Is the CEO a first-ballot entrant in the Management Hall of Fame (if such an award existed)?
- Does the CEO have a strong No. 2 in a role such as CFO or Chief Operations Officer?
6. Does the business have recurring revenue and/or pricing power?
- What is the source of the company's recurring revenue? Is that source long-term contracts? If so, how long are the contracts? Is that source subscription services? Is that source a consumable (use-once-and-dispose item)? Is it a daily habit or pleasure? Is it a mission-critical product or service?
- How often does the company increase prices and by how much?
- How enduring are pricing power and recurring revenue?
7. Does the company have a medium (or lower) risk profile?
- Does the business have too much debt?
- Does the business suffer from mismanagement or poor leadership?
- Does the business have deteriorating vital signs (rising debt and net debt, declining revenue, or ROIC that is falling for the wrong reasons)?
- Does the business have commodity exposure?
- Is the business cyclical and capital intensive or does it sell products with short lifecycles?
- Is there a business-model risk?
- Are there low barriers to entry?
- Is the business experiencing industry headwinds -- long-term trends working against the company?
- Is there a potential for disruption or obsolescence?
- Is the business overly exposed to customer or supplier concentration?
- Is the business overly reliant on global supply chains?
- Does the business have poor earnings quality with red flags?
- Does the business have poor customer service?
- Does the business have a toxic or unhealthy corporate culture?
- Is there a lack of data privacy at the business?
- Is there a lack of transparency from management?
- Is there a lack of succession planning, especially when the business is run by the aforementioned first-ballot hall of fame CEO?
- Is the business overly focused on short-term earnings and underinvesting in R&D and other important areas to maintain long-term adaptability?
- Is there a brand or reputational risk?
- Is the business operating in an industry with burdensome regulation?
8. Is the business executing well (is it experiencing strong business momentum)?
- Is it maintaining high organic revenue growth or is top-line growth even accelerating?
- Is it taking market share from competitors?
- Is it winning new contracts?
- Is it able to increase prices while maintaining high demand?
- Is it winning recognition for having the best product or service or being the best place to work?
- Is it recruiting and retaining top talent?
- Are its margins and returns on invested capital rising?
- Is it successful in integrating any acquisitions?
10. Does the business have multi-bagger potential?
- Is the business committed to innovation and adaptability? Is the management committed to investing to future-proof the business?
- Does the company's product or service fundamentally change the way we work or live?
- Does the business reflect what I think the world will look like in the future?
- Does the company's product or service save the customer time or money?
- Does the business have embedded optionality either through large net cash on the balance sheet, a strong core business that redirects cash flows to fast-growing adjacent businesses, or a business that was a first mover in an emerging frontier-market opportunity (such as virtual reality, robotics, autonomous driving, 5G, the Internet of Things, or space travel)?
