My 11-Step Checklist Before I Even Think About Buying a Stock
How I go from "what's this company?" to "I'm willing to bet the farm on this." This is my personal pre-flight checklist.
So, we've talked about my "why"—the ultra-concentrated portfolio and the sleep-well-at-night philosophy. Today, I want to pull back the curtain on the "how."
How do I find one of those rare companies worthy of joining my exclusive 6-stock club?
It's not about a fancy algorithm or a secret Wall Street source. It's about a disciplined, repeatable process. A checklist. It’s my way of making sure I’m not falling in love with a story, but with a solid, understandable business. It protects me from my own biases and forces me to be brutally honest.
Let’s walk through it, step-by-step.
1. Can I Explain This to a 5-Year-Old? (Understand the Business)
This is always, always my first question. If I can't explain how the company makes money in a single, simple sentence, I close the folder and move on. Life's too short to invest in things you don't fundamentally understand.
Google? They sell ads to businesses that want to be found online. ✅
Costco? They sell a membership to get access to cheap, bulk stuff. ✅
A complex biotech firm with a drug in Phase II trials that relies on synthetic protein folding? Nope. Not for me. I’m out. ❌
This isn't about being smart; it's about knowing the edge of my own intelligence. If I can’t explain it simply, I can’t possibly understand the risks.
2. Who Else is in the Sandbox? (Understand the Market & Players)
No company is an island. I need to understand the entire neighborhood. Who are the big dogs? Who are the scrappy up-and-comers? Who are the dinosaurs waiting to die?
I want to know if this is a brutal, dog-eat-dog industry where everyone competes on price (think airlines), or if it’s a cozy oligopoly where a few players control the market and print money (think credit card networks). The structure of the industry tells you a lot about how hard or easy it will be for your company to succeed.
3. Is the Growth Real or a Mirage? (Growth Prospects)
Every CEO will tell you they plan to grow. My job is to be the skeptic. I look at the Total Addressable Market (TAM). Is it a massive, growing ocean of opportunity, or is it a small pond that's already full of fish?
If a company already has 80% market share in a slow-growing industry, its promises of 20% annual growth are probably a fantasy. I’m looking for a credible path to expansion, whether it's entering new markets, launching new products, or simply taking share in a huge, fragmented industry.
4. What's Their Superpower? (The Differentiator)
This is the moat I’m always talking about. Why does a customer choose this company over its rival, even if the rival is a little cheaper?
Is it an untouchable brand? (Like Apple or Nike)
Is it a network effect, where the product gets better as more people use it? (Like Visa or Facebook)
Is it a massive cost advantage? (Like Costco or Geico)
Is it sky-high switching costs, making it a pain for customers to leave? (Like your bank or enterprise software)
A company without a clear, durable differentiator is a ship in a storm without an anchor.
5. Are They Planting Trees or Buying Lottery Tickets? (How They Invest Earnings)
This one is huge. A company’s cash flow is like a river. Where does the CEO direct that flow? Reinvesting it back into the business is the best way to compound wealth, but only if it's done well.
This brings us to ROIC (Return on Invested Capital). In simple terms: for every dollar the company plows back into its operations, how many cents of profit does it generate a year later? A high ROIC (say, 15%+) is a sign of a fantastic business.
But I go a step further and look at ROIIC (Return on Incremental Invested Capital).
ROIC is the average return on all capital ever invested. This can be misleading because old, successful investments can hide newer, dumber ones.
ROIIC looks at the return on just the new money being invested. It answers the question: "How good are they at investing our money today?"
A company with a high ROIIC is a compounding machine. A company with a high ROIC but a low ROIIC is a fading star living on past glories. I want the compounding machine.
6. What's the "Normal" Price? (Industry Valuation)
Before I look at the company's specific valuation, I want to know what's considered normal for the neighborhood. Are semiconductor companies typically valued at 15 times earnings or 30 times earnings? Do software companies trade on a multiple of sales or free cash flow?
This gives me a baseline. It helps me understand the market's general expectations for that sector, so I know if a specific company's valuation is truly an outlier or just par for the course.
7. Is It Cheaper Than Its Twin? (Company Valuation vs. Peers)
Now I zoom in. I take my company and put it side-by-side with its closest competitors. Is it trading at a premium or a discount?
The key here is to ask "why?"
If it’s more expensive, does it have a stronger moat, higher growth, or better profitability that justifies the premium? If it's cheaper, is there a hidden problem, or has the market unfairly punished it for a temporary setback? This is where the detective work begins.
8. Is the Price Tag Justified by the Speed? (Growth Valuation)
A company growing at 25% a year should be more expensive than one growing at 5%. The Price/Earnings to Growth (PEG) ratio is a quick-and-dirty tool for this.
But I take it further. I try to roughly project the company's earnings out a few years based on its growth prospects (Step #3). Then I ask: what price am I willing to pay today for those future earnings? Is the current stock price giving me a good potential return if my growth assumptions are right? This helps me avoid paying for a decade of perfect execution upfront.
9. What's the Captain's Destination? (CEO's Long-Term Plan)
I read the shareholder letters. I listen to the earnings calls. I want to know if the CEO is a mercenary or a missionary.
Is their plan just to hit the next quarterly target, or are they building something to last for decades? Do they talk about short-term stock performance or about long-term customer value and competitive advantages? A founder-CEO or a leader with a lot of their own money in the stock is often a great sign. I'm betting on the jockey as much as the horse.
10. The "Why Bother?" Test (FCF Yield vs. Risk-Free Rate)
This is a hard, non-negotiable numbers check. I need to know if I'm being paid enough for the risk I'm taking.
The risk-free rate is the return I could get from an investment with virtually zero risk, like a U.S. government bond. It's my baseline. Why would I risk my money on a company if I can't earn more than what the government guarantees me?
To check this, I use the Free Cash Flow (FCF) Yield. FCF is the actual, cold, hard cash the business has left over after running its operations. The FCF Yield is simply that cash profit relative to the company's price (its market cap). Think of it like the real interest rate the business is paying you as an owner.
The process is simple:
Calculate the company's Free Cash Flow for the year.
Divide that by the company's total market capitalization. The result is the FCF Yield.
Compare that yield to the current 10-year government bond yield.
My rule: The company's FCF Yield must be at least equal to the risk-free rate. Ideally, it should be significantly higher to provide a "margin of safety" for the risks of owning a business. If it's lower, I have to ask myself, "Why bother?"
11. The Final Gut Check: The Desert Island Test 🏝️
After all the numbers have been crunched and all the boxes have been ticked, this is the final, most important question:
Am I confident enough in this business that I could buy it, watch the stock market close for 5-10 years, and sleep peacefully at night?
If the answer is anything other than a resounding "YES," I don't buy it. It's the ultimate filter. It forces me to focus only on the highest-quality, most predictable businesses and ignore everything else.
And that, my friends, is how you build a portfolio you never want to sell.
Ready to Go Deeper?
This checklist is my compass. It's the framework I use to navigate the market and find the handful of businesses I want to own for the next decade.
But a framework is just the beginning. The real magic happens when you apply it.
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