Why is the product or service valuable to its customers? What makes it better than the alternatives?
How elastic is customers’ demand to changes in price?
2. Can I (approximately) estimate the key financial characteristics 10 years out?
How much bigger or smaller will the addressable market be? How will market share change?
How does the cost structure change with changes in sales over the long-term?
How will the capital-intensity of the business change?
What is a reasonable range for future return on invested capital? For future free cash flow?
3. Can the balance sheet withstand severe temporary adversity?
If a severe recession starts tomorrow, will the company go bankrupt? Will it be forced to issue distressed securities and dilute the value of the company to existing shareholders?
Does the company have large debt maturities that make it reliant on the capital markets for refinancing?
What are the debt covenants on the bank loans? How much can sales drop before these would be violated?
4. Is the management honest?
When I read the proxy statement, is the compensation structure fair to both the management and the long-term shareholders?
Have I seen management make choices that hurt them financially in the short-term, but which are the right decisions for the long-term benefit of the shareholders?
Does the management team communicate both the good and the bad news honestly, or just selectively communicate only the good news?
5. Is the management competent?
What is their record of capital allocation? Have they done large, “strategic,” acquisitions which later destroyed capital? Have they bought back shares when the stock was cheap or did they sit on their hands then and only buy it back when the price was high and everything seemed rosy?
How does the company’s operating performance (organic sales growth, margins, capital intensity) compare to its peers over time?
6. What fundamental developments would be responsible if this investment were to fail?
If I were 5 years in the future doing a post-mortem analysis on why the business did much worse than I had originally envisioned, what happened?
What are the biggest threats to the company?
7. What evidence over time would confirm my thesis?
What data points do I want to see on a quarterly basis that make me more confident that my thesis is correct? How would I separate evidence that truly supports my thesis from positive results achieved for temporary/unsustainable reasons?
8. What evidence over time would disconfirm my thesis?
What data points do I want to see on a quarterly basis that make me believe my thesis is incorrect?
How do I separate temporary problems due to an economic cycle or other short/intermediate-term problems from evidence of structural problems?
9. Does the valuation of the security afford a large margin of safety vs. my intrinsic value estimate?
What is a reasonable range of intrinsic values for the business? How sensitive is this range to key inputs?
What is the discount that the current price affords to the base, or the most likely, estimate of intrinsic value?
How much downside is there currently to the worst case?
What other investments would I have to forego right now in order to invest in this company? How does their risk/reward profile compare to this one? Their expected return?
What possible future investment opportunities might I be foregoing if I make an investment in this company? Is the risk and return profile sufficiently attractive on an absolute basis in order to risk foregoing these future opportunities?
If you are interested in learning more about the investment process at Silver Ring Value Partners, you can request an Owner’s Manual here.
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