Investing Tool: A Checklist For Identifying Bad Businesses
If you want to succeed as an investor, you need to avoid bad businesses.
Owning a stock means owning a piece of a business. This is one of the most important ideas that every investor must know and apply.
Warren Buffett’s professor and mentor, Benjamin Graham, popularized this idea in his book The Intelligent Investor, and Buffett almost always reminds audiences of the importance of looking at stocks in this way.
🔑 To be a successful investor, you need to avoid bad businesses.
Buying bad businesses is almost a sure-fire way to lose money, and as Warren Buffett says, the first rule of investing is don’t lose money.
Spending more time than is needed researching a bad business is also a losing activity.
For example, if you can quickly spot a bad business, you have an advantage over investors who spend the hours required to read that business’s 10-K reports and other research materials.
This gives you more time to research good buying opportunities.
🔍 We need a simple way to identify bad businesses
At the 1990 Berkshire Hathaway annual shareholder meeting, Charlie Munger noted that business schools would produce better managers if they taught what makes a good business good and a bad business bad.
The same is true for investors. Even if you know what makes a good business good and a bad business bad, checklists help us avoid the psychological causes of misjudgments.
🧠 The thinking-process I used to build this tool
How do we build a checklist that we can use to screen investment opportunities? More specifically, how do we build a checklist that helps us avoid buying bad businesses. It would need to have the characteristics of bad businesses.
I wanted to uncover everything Warren Buffett and Charlie Munger have said about good businesses and bad businesses dating back to the early 1990s.
Warren and Charlie are proud of the collection of businesses they own. Because of this, there are more quotes where the duo discuss the characteristics of good businesses. To build a larger list of characteristics shared by bad businesses, we can use one of Charlie’s favorite thinking tools: inversion.
Step #1: Review Berkshire Hathaway shareholder meeting transcripts for words and phrases that are used when discussing the characteristics of businesses.
Step #2: Build a list and categorize by good and bad.
Step #3: For the good characteristics, write the opposite characteristic. For example, if a good business has a strong brand, then write ‘weak brand’.
Step #4: Make a list with the resulting bad characteristics and share it with the CMQ Investing community:
✅ The final result: the bad business checklist
The characteristics are ordered alphabetically, not by importance. Please note that this is not an exhaustive list.
bad business model
distribution is expensive
easy to replace or low switching-costs
hard to understand
high churn rate
high production costs
little-to-no cash flow
low returns on capital
maturing business
no barrier to entry
poor reputation
poor past track-record
relatively unknown product
requires constant innovation
requires lots of capital to grow
unethical management
vulnerable to inflation
weak brand
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Related Quotes
“A stock is not just a ticker symbol or an electronic blip; it is an ownership interest in an actual business, with an underlying value that does not depend on its share price.” —Benjamin Graham
“I’m a great believer in solving hard problems by using a checklist.”
—Charlie Munger