A checklist for investing success from a money manager Warren Buffett admires

A checklist for investing success from a money manager Warren Buffett admires

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Michael Shearn may not be one of the most popular investing legends, but he counts investing greats likes Warren Buffett, Charlie Munger and several top hedge fund managers among the admirers and followers of his money management skills and research prowess.
Shearn is the Managing Partner of the Time Value of Money Fund based in Austin, Texas, and author of a critically acclaimed book The Investment Checklist: The Art of In-Depth Research.

In his book, Shearn advises investors to develop an in-depth research process, from generating and researching investment ideas to assessing the quality of a business and its management team.

He further listed out methods to implement a principled investing strategy by maintaining a few checklists.

How to avoid costly investment mistakes

Shearn says investors make the mistake of buying or selling stocks too quickly, and then get caught up in the web of stock price swings and third party market chatter, leading to costly investment mistakes.

He feels investors base purchase decisions on isolated facts and do not take the time to thoroughly understand the businesses they are buying.

This often clouds their judgement and they start taking decisions that are influenced by their emotions. Shearn says investors should follow a thorough and comprehensive research process to understand the value of a business before making an investment decision.

He says this process can be made simpler through the use of straightforward checklists, which can allow investors to identify quality investment opportunities.

Shearn says in his early days when he started out as an investor, his emotions always got the better of him. He used to panic when a company put out a negative news release or the stock price dropped.

He realised this was because he didn’t understand enough about the businesses that he was investing which is why he wasn’t in a position to interpret the news events as they came out.

To counter these negative reactions, he came up with a checklist comprising a series of questions that he answered himself to increase his knowledge about a business.

This checklist put him in a better position to understand how to interpret news events and understand more about a company.

Why a good investment checklist is a must

Shearn believes an essential part of good in-depth research is a good investment checklist. No matter how experienced an investor is, s/he tends to always benefit from having a checklist which can ensure that both positive and negative aspects of the market situation are covered.

He says a well-crafted checklist can make investors focus on the few key aspects of the investment and bring forth the issues that they don’t have answers to, and which can be of huge value in the long run.

Shearn says a checklist can help long-term investors understand the business they own without which they will lack conviction and risk selling due to market volatility, potentially missing out on the long-term gains.

“These checklists will help you consider a fuller range of possibilities in your investment strategy, enhance your ability to value your investment by giving you a holistic view of the business and each of its moving parts, and identify the risks you are taking,” he said in an interview.

Shearn also feels investment checklists and diligent research, too, are filled with some pitfalls.

One obvious trap investors often fall into is getting entangled into endless research data points that are irrelevant to the investment theme.

Filters to shortlist investment ideas

Shearn says having the right filters is one of the most important things in an investment process. Filtering investment ideas based on types of businesses and management teams can help shortlist the right kind of businesses to invest in.

“When filtering through many investment opportunities the stock market offers at any given time, it is important to establish a criteria for the types of businesses and management teams one is looking for. Such criteria serve as a filter, and thus you don’t have to review thousands of investment opportunities and can reject investment ideas quickly… Your criteria can be as simple as looking for a simplified business with a large market opportunity, managed by a great management team, and trading at a low price. You can also set criteria of what you do not want to invest in. For example, you may want to avoid businesses that have high dependency on commodity resources, such as exploration and production (E&P) businesses, because oil prices are difficult to forecast. By articulating and following strict criteria, you can put the odds of making a successful investment in your favour,” says he.

How to understand value of an investment

Shearn says the purpose of investing should be to understand the value of what investors are buying, because if they understand its value, they will know when to buy, when to sell and when to hold.

Shearn says in order to value a business, one needs to know something about the stability of earnings, and more importantly, how those can change in the future.

“You’ve got to ask questions about the company in order to understand and be able to answer whether it’s stable earnings and how they’re going to change. What kind of sales it makes, is it a recurring revenue or is it one-time sale, what are the future growth opportunities are the questions one need to ask. As you go through these questions, you’re actually learning that valuation is actually quite dynamic. It’s not static. It changes. For example, depending on the type of business, if you change a management team, it’s going to have a profound effect on the future earnings of the business,” he says.

Shearn says an investment is most valuable when the business is building its competitive advantage, and not after it already has one over other peers.

“In the past I would spend much time trying to determine if a business had a competitive advantage. Over time, I started learning that actually most value in a stock or an investment comes from the advantage it is building as a business, not after it already has one,” he says.

Shearn also lists out some tips for investors to follow in order to be able to achieve success in investing.

Be disciplined: In order to achieve success in investing, it is essential for investors to remain disciplined and keep a log of the mistakes they make and go through them from time to time to maintain their focus, and not repeat those.

“As my career progressed, I have kept a log of mistakes made, why I made them and what I can do to not repeat them. This has allowed me to be increasingly efficient and focused,” he says.

Keep emotions in check: It is important for investors to keep their emotions in check and not let them influence their investment decisions.

“When managing investments, you must keep your emotions in check and allow logic and rationale to guide your decisions,” he says.

Shearn says envy is the worst human emotion, as it can distract one from focusing on things that matter. “Envy can cause resources to be allocated in less than productive manners and causes people to do things that aren’t who they truly are. As such, you have to be authentic to yourself,” he says.

Be passionate: Investors should focus on things that they are passionate about as it helps to block out envy. “Passion is the fuel for tenacity which allows us to push through obstacles and succeed,” says he.

Pick companies with honest management: Before investing, investors should check whether the management has sincere integrity towards the company and all its stakeholders.

Shearn feels this can be an indication of the true character of the management, as it gets revealed only when it is challenged by difficult circumstances. He said a company that makes sure customers, suppliers and employees are all happy does really well in the long run. Shearn says creating value for shareholders is not about maximising rate of return, but rather providing value to all stakeholders.

Always remember the value of time and money: Investors should use their time wisely, as it is a finite resource that is never replenished. He emphasises that investors should use their time well, and utilize their financial resources wisely. “Money does not buy us happiness, but rather offers financial flexibility and freedom,” says he.

(Disclaimer: This article is based on various speeches of Michael Shearn)
Credit: Stocks-Markets-Economic Times

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