A Value Investor's Checklist Before Buying Stocks

by: Alligator Investor

Yesterday I came across an excellent blog, ModernGraham.com - A Resource for Intelligent Investors. This particular post is an analysis of Union Pacific Corporation (UPC) as an investment. Other railroads have been analyzed in ModernGraham’s recent posts. I am not particularly interested in railroads, but ModernGraham’s classical value investment strategy and their methodology are attractive.

The analysis boils down to asking a series of questions and studying the answers. There are three categories of questions: Business and Management Review, Financial and Value Review - Defensive (stringent criteria for cautious investors), and Financial and Value Review - Enterprising (for investors who are willing to assume more risk).

You may not agree with all of the questions (personally, I use a lower threshold for market capitalization, and I have an expectation of dividend growth), but if you don’t know the answers, you definitely need to do more research before investing. You won’t find many companies that meet all the criteria in this elevated market, but if you do, you have probably found a good investment. And if do you choose to invest in a company that doesn’t meet the criteria, at least you will know what you are getting into up front.

I have separated out and clarified the questions for further study:

Business and Management Review

1) Is the business simple and understandable?
2) Does the business have a consistent operating history?
3) Does the business have favorable long term prospects?
4) Is management rational?
5) Is management candid with its shareholders?
6) Does management act in the best interest of shareholders?

Financial and Value Review:

Defensive Investors:

1) Is the size of firm over 2 billion market capitalization?
2) Strong financial condition - is the current ratio (current assets/current liabilities) greater than 2.0?
3) Earnings stability - has there been positive net income for the prior ten years?
4) Dividend record - have there been consistent dividend payments over the past ten years?
5) Price to earnings analysis - is the current P/E ratio below 20?
6) Price to assets analysis - is the P/B ratio below 2.5?

Enterprising Investors:

1) Strong financial condition - is the current ratio (current assets/current liabilities) above 1.5?
2) Earnings stability - has there been positive net income for the past five years?
3) Dividend record - does the company currently pay a dividend?
4) Earnings growth - are earnings for the company greater than five years ago?