Chapter One: Adopt a Checklist Approach to Investing
Real-time final draft manuscript | Quality Value Investing: How to Pick the Winning Stocks of Enduring Enterprises
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Chapter One
Adopt a Checklist Approach to Investing
A successful journey favors the prepared.
Like airline pilots during takeoff and landing, quality-driven value investors adopt checklists to ensure they perform the due diligence necessary for long-term portfolio safety and success, ultimately reaching their destination.
Chapter One introduces the checklist approach to stock picking. It emphasizes the use of a rigorous yet straightforward methodology when researching and analyzing a company’s business model for current wealth and its share price for present value.
Checklist-driven investment research has contributed to our family portfolio’s market-beating performance. For example, as of this chapter’s writing, the QVI Real-Time Stock Picks have achieved alpha on an average per holding, equal-weighted basis, since inception in 2008, compared to the S&P 500 Index benchmark.
Please don’t take just my word for the positive impact of using an investor checklist. The investing universe’s most recognizable names employ a checklist approach for researching and analyzing stocks that are likely to outperform their targeted market benchmarks.
Superinvestors Bill Ackman, Warren Buffett, Benjamin Graham, Tony Kynaston, Charlie Munger, Mohnish Pabrai, and Guy Spier are among the household names often cited for adopting a checklist approach to achieving portfolio alpha.
This chapter summarizes my market-beating investment checklist, which I expand upon in subsequent chapters. Readers can use this template to develop or enhance their unique investment research checklists.
Checklist-Driven Investing Defined
An investment checklist for researching and analyzing stocks, exchange-traded funds, or any other financial product can help ensure that we conduct the necessary due diligence for sound decision-making regarding the long-term success of our portfolio.
Airline pilots must perform a mandatory checklist of items before takeoff from the departing airport, before final descent to the arriving airport, and again before landing.
Although airplanes crash more tragically than markets or portfolios ever could—thankfully, the occurrences are rare in each case—it is fair to presume that we should choose investments to build portfolios by navigating a prescribed checklist of urgent items, as we have come to expect from the pilots who fly us to our travel destinations.
Sample Investment Research Checklist
I share my proprietary list of essential metrics for educational purposes, which I have developed over the past several years. These metrics have led to an alpha-achieving basket of stock picks chosen for their high-quality business models and value stock prices at the time of portfolio inclusion.
Quality Stock Selection Objective
Buy and hold the common shares of U.S. exchange-traded, predominantly dividend-paying, well-managed, financially sound businesses that produce easy-to-understand products or services, have enduring competitive advantages from economic moats, enjoy steady free cash flow, and are trading at a discount to the perceived intrinsic value at the time of purchase. Then, of utmost importance—and perhaps the most significant challenge—practice patience in waiting for the investment thesis to play out as projected over a long-term horizon.
Remember that many online brokerages and financial sites provide accessible metric calculations for the equity investment research checklist illustrated below. Therefore, we need not worry about mastering the formulas.
Company Current Wealth Checklist
Limit due diligence to a company’s current financial health instead of relying on unreliable predictive analysis or excessive business modeling. The following items aim to answer the crucial question: “Is this a company whose current wealth implies a quality, enduring enterprise?”
Value Proposition
The value proposition outlines the competitive benefits that a company’s products or services offer to customers compared to those of its rivals in the industry or sector.
A company profile provides a concise description of the enterprise and its offerings, including products and services. Do we understand the business model? Is it within our circle of competence?
The stock profile favors large, mid, and small-cap stocks traded on major exchanges. Avoid microcaps and over-the-counter (OTC) shares, which are considered speculative.
An economic moat refers to a company’s products or services that provide a competitive advantage over other businesses in the same industry. Morningstar is the leading authority on economic moat research and credits Warren Buffett, the founder and chairman of Berkshire Hathaway (BRK.A, BRK.B), with coining the term. Alpha-rich investors target companies with clear competitive advantages. An investor can streamline the value proposition of an enterprise designated as having a wide, narrow, or nonexistent moat.
The value proposition elevator pitch describes why we believe the targeted company is a high-quality, enduring enterprise in one or two sentences. Quality-driven investors eliminate companies whose value propositions are difficult to define.
Due diligence resources provide a more in-depth analysis of the all-important value proposition. For example, visit the company’s investor relations webpage and its most recent Form 10-K annual report submitted to the US Securities and Exchange Commission (SEC) or the required report from the domiciled country’s financial securities oversight agency.
Chapter Two explores the value proposition in depth.
Returns on Management
The company’s returns on management or fundamentals checklist measure the performance strength of the business’s senior executives.
Revenue growth refers to the compounded annual growth rate (CAGR) of revenues or net sales over a specified period. When analyzing a business, remain biased toward established growth rather than executive guidance and speculative sell-side analyst projections.
Gross profit margin is the company’s total profit after deducting its cost of goods sold from total sales or revenue, expressed as a percentage.
Net profit margin refers to the portion of revenue remaining after covering operating costs, interest, and taxes, expressed as a percentage of sales over the preceding 12 months. Also referred to as NOPAT (Net Operating Profit After Taxes), it is crucial to focus on profitable companies to avoid unnecessary speculation. Investors who prioritize quality favor companies with net margins in the double digits.
Return on equity is the income available to common shareholders for at least twelve consecutive months, divided by the average ownership equity from recent fiscal periods, expressed as a percentage. It shows the profit a company generates from shareholder investments. A return on equity of 15 percent or higher indicates shareholder-friendly management.
Return on invested capital is calculated by dividing net income after taxes by the average total equity, long-term debt, other liabilities, deferred income tax, and minority interest, and then expressing the result as a percentage. This metric evaluates how effectively a company utilizes capital to generate additional returns. Ideally, the goal is to find companies that achieve a return on invested capital exceeding 12 percent.
The weighted average cost of capital represents the corporation’s capital costs, with each category weighted in proportion to its contribution to the overall capital structure. The calculation encompasses all sources of capital, including common stock, preferred stock, bonds, and any other long-term debt. To demonstrate management’s capital allocation abilities, the return on invested capital must exceed the weighted average by a comfortable margin.
Owners’ earnings are a further test of management effectiveness. Calculate by adding earnings per share growth to dividend rate growth. For adequate shareholder returns, seek at least five years of an annualized positive double-digit return.
Chapter Three explores management returns in depth.
Enterprise Downside Risks
The enterprise’s downside risks checklist identifies and rates the safety margins of the targeted company’s business model.
Long-term debt coverage measures current assets divided by long-term debt. Investor, author, and Warren Buffett mentor Benjamin Graham valued it as a measure of a company's balance sheet liquidity and its ability to repay debt in a crisis. Ideally, the ratio should be at least 1.5 times the current assets to long-term debt.
Debt-to-equity is a ratio that assesses a company’s financial leverage. It is calculated by dividing total liabilities by total assets minus total liabilities, also known as shareholder equity. The ideal ceiling is 80 percent. Investors should be concerned if debt approaches or exceeds the amount of shareholder equity.
Short-term debt coverage, also known as the current ratio, is calculated by dividing total current assets by total current liabilities for the same period. It measures a company’s near-term liquidity. Target a current ratio above 1.00.
Chapter Six explores enterprise downside risks in depth.
Stock Price Present Value Checklist
Alongside the company’s existing wealth, due diligence should be limited to the current stock price value rather than relying on speculative and often unreliable calculations, such as discounted future free cash flow analysis.
The following items seek to answer the crucial question, “Does the targeted stock’s present value convey a temporarily discounted or reasonable share price?”
Shareholder Yields
Conventional market wisdom suggests that equities are riskier than Treasury bonds, so securities should offer higher yields than government benchmarks to justify stock ownership over bonds.
My shareholder yields checklist reveals the equity bond rate of the company’s common shares and compares it to the US 10-Year Treasury yield.
Earnings yield, the inverse of the price-to-earnings ratio, shows annual earnings per common share relative to the stock price. Earnings per share indicate the profits allocated to each outstanding share of stock. Aim for an earnings yield of over 6 percent, the inverse equivalent of a price-to-earnings multiple below 17.
Free cash flow yield indicates the amount of free cash flow generated per share relative to the stock price. It is calculated by dividing the cash available after operating expenses and capital expenditures by the number of outstanding shares at the end of the fiscal period. Aim for a yield of 7 percent or higher, or less than 15 times the inverted price-to-free cash flow multiple.
Dividend yield reveals how much a company expects to pay in average dividends over the next 12 months relative to the current share price. Whether or not we are income-motivated investors, we should remember that dividend-paying stocks generate shareholder compensation in the short term as we wait for capital gains to compound over time.
The dividend yield on a cost basis is calculated by dividing the annual dividend payout by the cost basis of common shares in a portfolio. Limit high-dividend investing to yields calculated on a stock’s cost basis. Yield on cost highlights that buy-and-hold, quality-driven value investing is superior to pursuing high yields at the expense of increased downside risk. For example, seven long-held quality stocks in the QVI Real-Time Stock Picks yielded between 6 and 18 percent on a cost basis.
The payout ratio is the dollar amount of dividends divided by after-tax earnings. Target payout ratios below 60 percent to ensure the company’s board of directors has the earnings and free cash flow to cover and raise the dividend instead of the dreaded cut or elimination.
The 10-Year Treasury Note is a debt obligation from the US government. Its yield is the fixed interest paid to the bondholder divided by the note’s closing price.
Average Shareholders Yields compares the stock’s average yields on earnings, cash flow, and dividends to the Treasury’s prevailing yield to determine the equity bond rate.
Chapter Four explores shareholder yields in depth.
Valuation Multiples
I have found that as few as four valuation multiples can estimate the intrinsic value or margin of safety of a targeted quality enterprise’s stock price. What is the present value of the shares?
The price-to-sales ratio is calculated by dividing the stock price by the sales per share over the last year. It gauges the stock price against revenue. Compare the price-to-sales multiple to the industry or market medians and target a multiple of less than 2.0.
The price-to-trailing earnings ratio is calculated by dividing the closing stock price by the GAAP diluted earnings per share for the past twelve months. This ratio is the inverse of the earnings yield. GAAP stands for generally accepted accounting principles. While it can be unreliable, aim for a price-to-trailing earnings ratio of 17 times or less, or below the industry, sector, or market averages.
The price-to-operating cash flow ratio is calculated by dividing the closing stock price by the most recent fiscal year’s cash flow from operations per share, excluding capital expenditures. For optimal value, aim for a single-digit multiple.
Enterprise value to operating earnings (EV/EBIT) is calculated by adding a company’s market capitalization to its debt, minority interest, and preferred shares, then subtracting total cash and cash equivalents. It serves as a sentiment indicator, showing whether the market has overbought the stock, a neutral or bearish signal, or oversold it, a bullish signal. Aim for an EV/EBIT ratio of under 15 times.
Chapter Five explores valuation multiples in depth.
Share Price Downside Risks
When assessing the downside risks to a company’s share price, focus on three key metrics that serve as indicators of the security’s asymmetrical risk-reward profile.
Beta gauges a stock’s volatility or systemic risk compared to the market as a whole. As a long-term investor, use a five-year beta trend line and screen for stocks with a beta lower than 1.25 or no more than 125% of market volatility. For example, the S&P 500 Index’s beta remains constant at 1.00.
Short interest as a percentage of the float indicates the percentage of outstanding shares borrowed for short selling that remain uncovered. This metric, relative to the float, signals market sentiment regarding potential price declines. Focus on stocks with short interest below 5 percent.
Performance versus sector and market charts a selected stock’s historical return against its peers. Investing in individual stocks should aim to outperform benchmark indices over the long term. Otherwise, it is more sensible to match the benchmark by investing in index funds rather than underperform the market.
Catalysts include expected outcomes (confirmations) and unexpected events (contradictions) that can affect the investment thesis. They represent a “bulls say, bears say” analysis, helping to reduce bias by considering different investors’ views. Online brokerages and fintech sites provide catalyst information.
Chapter Six explores the downside risks of share prices in depth.
Reach Your Investing Destination Safely
As airline pilots rely on checklists for safe departures and arrivals, quality-driven value investors use research and analysis checklists to enhance their chances of creating and managing a safe and secure portfolio of profitable stocks in quality companies.
Later chapters will build on this checklist of metrics for selecting the winning stocks of enduring enterprises by emphasizing investment research on a company’s current wealth and a share price’s present value.
The manuscript is copyright 2025 by David J. Waldron. All rights reserved worldwide.
Next in Quality Value Investing | Chapter Two: Begin With the Enterprise's Value Proposition
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