My Investing Template
It can be very difficult to compare investments, especially when there is so many great public companies now. This can cause major headaches when trying to allocate capital. The opportunity cost of capital is a very real dilemma that every investor consciously or not deals with every day.
Take for example, you discover two companies you want to invest in, but you only have the capital to invest in one of these companies. How do you make the decision to pick between investments? This is an issue most investors face frequently. Ranking your strongest conviction companies can also be tough. For this reason, I have developed a screening template which gives companies a score out of 100 (the idea came from Brian Feroldi & Brian Stoffel of The Motley Fool). This allows me to compare potential investments in a predominantly unbiased manner. However, as you will see there are biases built into the screener also.
When analysing any potential investment, I put the company through my investment screener template. The initial review takes around 30-60 mins to complete and this is solely a test to see if the company is worth spending more time researching. There are 5 sections in the checklist and is scored out of 100. Scoring is ranked as follows:
· 90+: Buy now if the company is not too big (law of large numbers)
· 80+: Good Investment
· 70+: Investible
· Under 70: Stay away (for now).
There are always exceptions to the rule and once a company scores well in the test, that is when the real research begins. However, if a company scores exceptionally well, I may buy a starter position straight away. I am also a big advocate for having some “Skin in the Game” as fuel to learn more about a company.
I will explain each section in detail below. I am aiming to start posting my company reviews and scores on my Twitter and Substack account going forward. The aim here is keep myself honest and understand when I am breaking my investing rules. Ì would be interested to hear any other metrics that you find important when evaluating companies.
MOAT
MOAT - Points – Maximum 25 out of 100
This section accounts for 25 out of the 100 points broken down into:
· Up to 20 points for the strength of the MOAT; and
· 5 additional points if I feel the MOAT is expanding.
This section contains the most personal bias. It also requires the most detailed research. I usually make a quick call on the strength of the MOAT and come back to study later.
What is a MOAT
A company must have a large economic MOAT for me to consider an investment in the company. Investopedia defines a MOAT perfectly as:
“The term economic moat, popularized by Warren Buffett, refers to a business' ability to maintain competitive advantages over its competitors in order to protect its long-term profits and market share from competing firms. Just like a medieval castle, the moat serves to protect those inside the fortress and their riches from outsiders”
In my view, there are 4 main types of MOATs, these are:
1. Network Effect – The more people who use a product, the more valuable it becomes. The classic example here is the Telephone, the first telephone created was useless as they had no one to ring. Some Network effects can be obvious, such as social media platforms, however others can be more subtle such as Netflix. The more people that use Netflix, the more cash Netflix has to create great content, thus making the platform more valuable. Network effects are a great type of MOAT and if you can spot a network effect early, then exponential growth can provide amazing returns. Examples include:
· Social Media: Friends invite Friends - Facebook, Twitter, Pinterest, TikTok
· P2P Payment Apps: Again, Friends invite friends - Revolut, Cash App (Square), Venmo (Paypal), SoFi
· Streaming Services: More Viewers allow for greater content to be produced – Netflix, Disney +
· Marketplaces / e-Commerce: more buyers attract more sellers – Amazon, Etsy, Shopify, FarFetch, Ozon, Jumia
· Enterprise Software – Land and expand business model, the more users in a company, the greater value it has - Slack, Teams, Asana, Atlassian
2. High Switching Costs – If it is difficult or better yet near impossible for a customer to change to a competitor, then these high switching costs would be a MOAT. If the reason is solely cost related, this is not a strong MOAT as competitors will generally compete on price eventually (although see MOAT number 3 for a durable cost advantage). This can be difficult to analyse for a B2B provider as we may not have access to the products. In this instance, using a company’s net dollar retention rate is a great way to find out how important the product is to a company (i.e. how much a customer spends on a product compared to the same period in the previous year). Examples of this type of a MOAT include:
· SAAS Providers: once a software gets embedded in a company, it is rare the customer changes - Slack, Zoom, Adobe, DocuSign
· Apple: is in a world of its own here, the company’s ecosystem is so strong that very few leave the company.
· Accounting Software: Intuit, Xero, Blackline
· Banks: Very few people ever change bank accounts
· POS Systems: when companies train employees on a POS system, it is difficult to change – Square, Lightspeed, Shift4Payments, Shopify, Stripe
3. Low Cost Production / Durable Cost Advantage - Not many companies have a sustainable cost advantage over their competitors (i.e. can produce a good or service for cheaper than competitors) but when a company does, that is an amazingly strong MOAT. Examples include:
· Amazon: No other marketplace can compete with Amazon’s distribution network
· Walmart: The buying power of Walmart means it can purchase products for cheaper than competitors.
· Netflix: The Netflix audience allows Netflix to attract shows (such as comedians) for cheaper than competitors.
· Alphabet (Google): Google’s audience allows for it to have large spread of costs for advertising.
4. Intangible Assets – An intangible asset is an asset that is not physical in nature and therefore it can be difficult to value. These are often misunderstood and therefore misvalued to allow for great returns for investors. There are many different types including:
· Brands: The value of a brand allows for a company to have pricing power to earn supernormal profits for their products. There are many great brands in the world, Nike, Lulelemon, Apple, Peloton, HIMs (my favourite emerging brand)
· Patents: Pharmaceutical industry
· Government Protection: Either through licences or too important to fail such as utilities
· Legal Monopolies: Facebook, Google, Axon
Counter Positioning - Another interesting type of MOAT which isn’t listed in my checklist is the counter positioning of a company. The reason it is not listed is due to its rarity, but if you find a company with this type of MOAT, returns should be huge. Counter positioning is when a disruptive company implements a business strategy that is so different to the incumbent competitors that for the competitors to compete with the disrupting company, it would have a cannibalise its own business model. The main examples in recent times are:
· Tesla: Traditional automakers have been extremely slow to invest in electric vehicles. By admitting electric vehicles are the future, the traditional automakers must destroy their very profitable businesses.
· Netflix: In the 90/00s Blockbuster had a thriving home video and DVD rental business until Netflix came along. Blockbuster eventually tried to compete but to do so, the company had to realise their traditional business was finished.
· Peloton: This one is not as obvious as the other two (as it is currently playing out) but Peloton’s home gym model is disrupting the gym industry. Gym’s cannot compete without admitting their leases, property, etc is a waste of space. I will aim to write a full post on Peloton’s MOAT as it is an intriguing company to analyse from a MOAT perspective.
2. Financials
Financials - Points – Maximum 28 out of 100
This section accounts for 28 points out of 100 with anywhere from 3 to 5 points given for each section. This section is clear cut and there is no bias from me here. I like to invest in high growth companies and therefore, these financial metrics reflect the types of investments I go for. These include:
· Revenue Growth (scale max 5 points): High Revenue growth is extremely important for me. High growth demonstrates market fit and scalability. I allocate points based on the following scale:
o Under 15%: 0
o 15% - 20%: 1
o 20% - 30%: 2
o 30% - 40%: 3
o 40% - 50%: 4
o Over 50%: 5
· Gross Profit/Margin (scale max 5 points): Gross profit is Revenue less the direct costs to acquire that Revenue. The higher the gross profit percentage, the greater the business it is. I allocate points based on this scale (with an extra point if gross margins are expanding):
o Under 40%: 0
o 40% - 50%: 1
o 50% - 60%: 2
o 60% - 70%: 3
o 70% - 80%: 4
o Over 80%: 5
· Non-GAAP Profitable (0 or 3 points): I am comfortable withcompany’s using non GAAP metrics for profitability, however, I also understand its limitations (I am a non-practising accountant). The main difference between GAAP and non-GAAP profitability is whether a company expenses share based payments (there are good arguments for and against SBP being a legitimate expense which I will not get into here). Other expenses which may be removed are one off large costs (such as Covid19 expenses). In my opinion, share prices can really accelerate when a company turns from losses to profits and therefore, being non-GAAP profitable on its own is not entirely a bad thing.
· Net Cash (0 or 5 points): I like antifragile companies with strong balance sheets. Therefore, I allocate 5 points to a company with more Cash than Debt on its balance sheet.
· Revenue per Employee (scale max 5 points): This may seem like an unusual metric to judge a company on; however, I love this metric. It demonstrates how a company is scaling without the need to hire more staff. Companies with high revenue growth and few employees can have excellent returns over the long term. I allocate points based on this scale:
o Under $200k/employee: 0
o $200k - $400k: 1
o $400k - $600k: 2
o $600k - $800k: 3
o $800k - $1m: 4
o Over $1m: 5
· Free Cash Flow (0 or 5 points) – Whether a company is FCF positive is imperative to a company’s long-term success. If a company is not FCF positive and burning cash, it is likely that the company will require additional financing either through debt or an equity raise (which dilutes your ownership). Similarly, to the non-GAAP profitability metric above, finding companies that are about to turn FCF positive can result in amazing returns. Therefore, the fact that a company is FCF negative is not on its own a deterring factor.
3. Potential / Fragility
Potential / Fragility - Points – Maximum 29 out of 100
This section accounts for 29 points out of 100 with each metric given a score of 3, 4 or 5 points. The metrics that make up this section include:
· Revenue Type (0 or 5 points): Not all Revenue is created equally. My two favourite types of Revenue are:
o Recurring Revenue: predictable leading to less customer retention costs and churn; and
o Marketplace Revenue: Asset light model which scales well.
· Pricing Power (0 or 5 points): Can a company raise prices without losing customers?
· Optionality (0 or 5 points): I don’t like companies that are dependant on one product or service line, optionality makes a company anti-fragile.
· Top Dog or First Mover (0 or 3 points): I like betting onthe best companies or disruptive companies first mover advantage.
· Runway Growth (0 or 4 points): If a company does not have a long runway ahead of it, I do not want anything to do with it. Usually demonstrated by the Total Addressable Market (TAM) for its products.
· Customer Acquisitions (0 or 3 points): Companies with low customer acquisition costs are generally more profitable. A High Net Promoter Score suggests there is strong word of mouth advertising from customers (Peloton, Apple)
· Customer Dependence (0 or 4 points): Are customers dependant on your product or would it be cut in a recession.
4. Management & Culture
Management & Culture - Points – Maximum 18 out of 100
This section accounts for 18 points out of 100. I find it very difficult to invest in a company that does not have a strong company culture and leadership. The metrics that make up this section include:
· CEO – Skin in the Game (0 or 10 points) – I love investing in companies that are either founder led or if the CEO has a high percentage of his wealth in the company.
· Glassdoor Ratings – Employees (0 or 3 points) – Glassdoor ratings are the easiest and quickest way to get a feel for what the company is like to work in. I use the employee’s ratings for this.
· Glassdoor Ratings – CEO Approval (0 or 2 points) – Glassdoor ratings are the easiest and quickest way to see how staff rate the CEO. By investing in a company, you are trusting the CEO with your money. I use the approval of CEO rating for this.
· Mission Statement (1 to 3 points) – I like a company with a clear & concise mission statement for stakeholders. Not something along the lines of “Our Mission is to make the world a better place”
5. Risks
Risks – Negative Points – Maximum -50 out of 100
This final section is where a company can lose points for negative aspects of its business or the industry it operates in. These include:
· Customer Concentration (0 or -5): If a company relies on one customer for more than 10% of its Revenue.
· Product Concentration (0 or -5) – If a company relies on a single product for more than 50% of its Revenue.
· Outside Forces (0 or -10) – It is a real negative where a company’s business relies on the price of a commodity that it has no power over. Examples include:
o Oil prices
o Distributors
o Brokers/Agents
o Bitcoin Price (although I do like this one)
· Executive Remuneration (0 or -5): Where a company’s CEO and other leader’s remuneration packages are excessive or do not align with shareholders interest.
· Reckless with Stock Issuing (0 or -5): Where a company is constantly diluting shareholders with reckless share options.
· Highly Competitive Industry (0 or -5): I like legal monopolies; highly competitive industries are not good for generating abnormal profits.
· Complicated Financials (0 or -5): Life is too short to be stuck looking at complicated financials – banks and insurance generally fits into this category although I previously worked as an analyst in an insurance company and feel I have an advantage here. To be clear, Banks and insurance companies’ financials are complicated to be in line with regulation, if a company has unnecessarily complicated financials, this is a huge red flag.
· Covid19 impact (0 or -5): This one may have to get updated soon as recovery stocks begins to show amazing returns but for now, this metric is important for now.
· Company Size (0 or -5): I am big believer in the law of large numbers. For me to invest in a company it must have 10 bagger potential. Therefore, companies with a market capitalisation of greater than $100bn will not make the cut. I usually try to invest in far smaller companies (sub $10bn market cap).
Summary
This checklist is a quick snapshot of how I begin to research a company, it is in no way full due diligence. However, I find it useful to make sure I look at information I find critical when analysing a company. I am aiming to begin posting my individual company reviews on Twitter and Substack over the coming weeks and keep a Google Sheets Template attached to my Twitter account.
Any feedback would be much appreciated and as always sharing the blog would be great.