Using This Allowed Me to Sleep Better At Night During Falling Markets

Ever wondered why we have nose hairs? Nose hairs act as a filter that prevents dust, pollen, and allergens from entering our lungs. They act as defence mechanisms meant to protect us.

Similarly, why do companies have standard operating procedures (SOP)? An effective SOP lays out what needs to be done for successful operation of the business. As investors, our SOP comes in the form of a checklist. A checklist helps us to filter out companies that are attractive to own. This serves as a defensive mechanism that protects us from wealth destruction.

What a Good Checklist Covers

A good checklist is selective. It covers common mistakes and leaves out those that are rarely made or that don’t matter. Checklists involve a large element of routine, where the consequences of a single error can be devastating. Which is why they are widely used in occupations like surgeons and pilots.

A checklist should be detailed, but not too lengthy. It’s ideal to keep it short and simple for practicality. The list will constantly evolve with the ever-changing market environment. Ideally, we should all have our own checklist of questions that we continually review over time.

I have gathered what I’ve learnt from my years of investing and compiled my own checklist. You can use this as a starting point and tweak it to your own liking.

Key Checklist Items

1. What if I am wrong?

Before I allocate capital to any investment idea, this is the number ONE question I ask myself. Most people only focus on “How much can I make?”, that they neglect the question “How much can I lose?”

As the saying goes:

Take care of the downside and the upside will take care of itself.

If I am wrong about this company, what is the likely reason for it?  This is especially true if you’re investing in growth companies. High returns attract competition, like bees to honey. It’s important to understand where your company stands in its industry, and who its key competitors are.

2. What’s my target return?

Before investing any of our hard-earned cash, we should have a target return we want to generate.

If your goal is to grow your portfolio by 15% per year, choose companies that are growing at a minimum of 15% per year. On average, the share price of companies increase (or decrease) in line with the company’s growth (or decline).

3. Does the company have good management?

Some characteristics of good management:

• Look for founder-led companies. Some examples include Tesla’s Elon Musk, and Coinbase’s Brian Armstrong.

• Listen to what they do, not what they say.

• Does the management have strong record on execution?

4. Is the company trading at a discount?

Valuation still matters. Value investing is not dead, meme investing is.

There used to be a time when people said value investing was dead, a time when growth stocks were mooning. I must admit that I (almost) fell for this narrative. This is no longer the case. It’s good to have a valuation method which you can fall back on, whether it’s DCF or others.

5. Wear the lens of a business owner

Investing is like buying a business. View it from the lens of a business owner. If you are buying the business, would you trust the current management team to run it? Look at the business from an entrepreneurial point of view, not as an outsider.

Conclusion

Focus on building up a good defence, before going on the offense. Attacking plays like growth stocks might seem sexy at first. But when they drop 70%, 80%, or even 90%, the people who call themselves “growth investors” will be the ones holding the bag. A checklist gives us a framework to separate the wheat from the chaff.